Does it matter what form savings come in?

by on June 9, 2005 at 6:16 am in Economics | Permalink

Americans save a relatively small percentage of their disposable incomes.  Yet many commentators argue that capital gains on homes and equities, as well as expenditures on education, should count toward the national savings rate.  But are those savings "as good" — from a macroeconomic point of view — as plain old abstinence?  If they were, that would make our lives so much easier; we could worry less about a national shortfall in savings.

To make it interesting assume that the capital gains are not the result of a bubble.  Bubbly asset prices would be an illusory form of savings in the longer run.

Now capital gains in the form of real assets or human capital are less liquid. You might make better widgets, but can lug the machine down to the store to buy groceries?  Will it finance your retirement?  Well, why not?  The advance of capitalism liquifies real assets to an increasing degree; borrow against the assets when you wish.  The still underrated Benjamin Anderson stressed this point in his 1920 The Value of Money

So what is the problem?  Does liquifying real assets somehow bring excess leverage to the economy?  I don’t see why.  Or does borrowing against real assets lead to a later switch toward consumption, thereby necessitating transformation costs?  Each individual thinks he has a more liquid savings position than is the case; borrowing is cheap but society as a whole must incur reallocation costs to convert the real capital into consumption.  But how big a factor can this be?

All seems fine.  Yet in my neo-Austrian gut I cannot bring myself to think as capital gains as analytically equivalent to abstinence out of income.

I file this one under the category of "macroeconomic problems I’ve been thinking about for twenty years but haven’t made much progress on."  I’m not even sure I understand what others believe, much less what is true.  I’ve turned on the comments, in case you have a good argument why one form of savings is worth less than another.

1 Patrick June 9, 2005 at 7:32 am

Well, I don’t know nearly enough to help you out!

But I can point out (if it hasn’t already occured to you) that in extreme situations, there are very clear advantages to one or the other. If there is very high economic risk, a house is worth much more than cash, because you can live in it. But if there is very high political risk, it is the inverse, because you can’t flee with the house.

What you are describing is not, of course, confined to the US. But is confined to a small selection of very developed countries. Do people think that political risk has been reduced to near-sero, and accordingly reveal ancient prejudices about money that we thought extinct everywhere outside of Ayn Rand’s novels?

Feel free to laugh!

2 ZF June 9, 2005 at 8:02 am

Aren’t you assuming away the answer? It’s a lot easier (especially right now) to get comfortable with the value of cash than it is to establish that the capital gains are not bubble-derived (and thus illusory beyond the short term).

One thing about cash is that specific asset price gyrations can’t take it away from you overnight. Perhaps we are missing a new financial transaction here, one which would allow you to, for a fee, realize part of your house equity via a non-recourse loan or a partial sale. This would enable homeowners to turn the unrealized and still vulnerable capital gain into an income stream measurable ‘on all fours’ with saving derived from income. Market prices for the transaction might also say something about the existence of a bubble.

3 pb June 9, 2005 at 9:14 am

I agree with Don… It just takes longer to turn the house into cash, but even cash can sit somewhere unused (IRA), so the end result is pretty similar. If I own my house it should certinaly be considered an asset, and likewise if I own 50% of my house, it should be considered 50% of an asset.

4 Brent Buckner June 9, 2005 at 9:20 am

Be aware: less-than-half-baked thoughts follow.

It seems to me that there are distinctions to be made between capital gains and abstinence out of income.

If the discount rate fell (and were to be sustained at the new, lower level), then capital gains would immediately be evident. However, there would be no immediate change in the real stock of productive capital or savings.

If all future oil exploration failed to turn up any new deposits then the understood scarcity of oil would increase and existing holdings would experience capital gains althougth the world would be understood to be less well-off then previously believed.

Where capital gains and abstinence out of income would seem more analytically similar would be situations where the capital gain is the result of an increase in productive capacity (e.g. availability of improved irrigation techniques rendering infertile land suitable for farming and hence more valuable, even though it is not yet farmed).

5 Huggy June 9, 2005 at 10:00 am

The problem is that mapping between capital and real assets can’t capture important attributes.

Capital can “spoil”. Capital can “ripen”. Capital can “gather dust”. Capital can be “targeted”. Capital can be “protected”.

My take on capital? “Footprints” and “smells” that allow for some prediction of where the economy is and where it may go.

6 conchis June 9, 2005 at 11:26 am

Continuing in the theme of half-formed, and possibly misguided thoughts…

A swimming pool, like housing, is different from IBM stock because it’s a durable consumption good rather than, or as well as, an investment. As Richard so insightfully pointed out, price increases in durable consumption goods increase both consumption and assets (for owner-occupiers their own consumption increases, for landlords, their tenants’ consumption increases, but the net effect on savings is the same) – so it’s not clear how more saving is actually occurring.

However, it might still be possible that falls in measured savings rate could either:

(a) understate savings – if it counts one side of this ledger (increased consumption of housing services) and not the other (house price increases); or

(b) misrepresent the extent of the problem, because if all of the increase in PV wealth is being consumed, the savings rate will fall (rise) if there is net positive (negative) savings to begin with, despite the fact that absolute savings hasn’t changed.

My other question would be what impact Richard’s point has on the wisdom of owner-occupiers consuming out of House price increases, if they’re not planning on cashing out and moving somewhere cheaper in the future?

7 Michael Cain June 9, 2005 at 12:05 pm

From a policy perspective — ie, I think low national savings is bad and wish to propose policy to change that — what would seem to matter is households’ perception of whether capital gains is savings. I would argue that they will perceive such gains to be savings. At the end of the year, they see that the balance in their retirement account has increased significantly; they see that they own a larger fraction of their home than their principal payments can account for; it seems inevitable that they will perceive that they have saved. Policy to increase actual savings (ie, decrease current consumption as a fraction of income) must overcome that perception. I think perhaps a more fundamental question that must be answered before taking on “Are capital gains savings?” would be “Are capital gains income?”

8 Peter Fitton June 9, 2005 at 1:07 pm

The question of housing assets being so difficult, I would rather concentrate on the other piece of the savings puzzle that Tyler mentioned – does expenditure on education count as savings? Education, especially at the post-secondary level, appears to be a combination of consumption (some classes are enjoyable but do not increase employability and future earnings) and investment (students obtain credentials and knowledge that increase their employability, and lead to higher lifetime incomes). It seems then that a substantial proportion of education should count as savings, to the extent that it leads to higher future levels of consumption (mostly of services) by the individual and society as a whole than would be possible without it. Thus, if Americans spend four percentage points of GDP more on post-secondary education than Europeans do, I would have to guess that at least two percentage points of that represent additional savings that are not missed in the official savings rate.

9 Jeremy June 9, 2005 at 1:56 pm

Another half-awake thought, playing off the excellent points of Michael, Michael and Brent:

Side-stepping the argument of liquidity, consider that a house used as a house offers utility both in present and in future, and can increase offerings of utility without amending the asset itself (a Beckerian way of saying “the kids like the house too, and the more there are of them, the more utility is additive”).

However, a house purchased with intent to re-sell for gain in the future is really an asset intended for intertemporal arbitrage; futures purchased at the Chicago Merc Exchange are an example of intertemporal arbitrage between markets with distinct perceptions driving a difference in expected value. Likewise, cigarettes purchased in Missouri and re-sold in Illinois (to take advantage of the $15/carton price difference) do not contribute to savings since the increase in value is only due to price and is illusory.

Consider it this way: say the tabulators of national accounting consider homeowner equity as savings, but housing prices decline. Then all house owners technically incur negative savings, which would also be illusory since a negative savings implies an increase to consumption. If housing prices drop, there is no correlated increased consumption; the illusion stems from the now top-heavy houses (since the value of the mortgage debt would remain constant but the value of collateral would decrease, and that liability on the right side would have to be offset by an asset on the left side, in this instance depreciation).

Thus, housing does not behave consistently with the concept of savings, both because it does not reliably store value (as when a housing market crumbles) nor does it increase value (except through arbitrage).

10 David June 9, 2005 at 2:54 pm

As to point 1, Why is a house not savings if you plan to buy another house? That makes no sense. If you didn’t have the first house, you’d have to get the money for the second house from somewhere else. It doesn’t matter that the first house has or has not appreciated relative to other houses.

As to point 2, Savings that lose value due to inflation still count as savings.

Richard Squire’s explanation is interesting but by that standard, cash in the mattress or piggybank, gold, art, and other collectibles are not savings either.

11 Rich Berger June 9, 2005 at 4:34 pm

I’ll leave comments on housing values to others, but it seems obvious to me that abstinence from spending all or part of your capital gains on equity investments does constitute savings (above and beyond mere price level changes). My income certainly consists of income earned from employment and earnings from past investments. Dividend yields are relatively low and I do expect the majority of my return to come from share appraciation.

I hope soon to provide most of my income from investments. Looking back, I could have reached that goal in a variety of ways: saving much at an early age, and letting compound interest carry me forward, saving continuously over my working career, or starting late and drastically cutting back my expenditures. At least in the first case, if you ignore savings from capital gains, I would appear to be saving very little now.

12 David June 9, 2005 at 10:52 pm

If saving is just avoiding or postponing consumption of present income, and savings is the accumlated sum of all acts of saving, then. . .

The negative of the sum of all historical house-related cash flows (in today’s dollars)–including mortgage payments, down payment, closing costs, maintenance, taxes and tax credits, etc.–PLUS the sum of historical rent & renter’s insurance for an equivalent property over the same period (in today’s dollars), EQUALS the amount you have “saved.” If this number is zero or less, you were not saving for some or all of the time you lived in the house.

The price you sell the house for is the value of those savings. This value may be less than or more than what you saved.

You could do a similar exercise with education, but it’s much more difficult to get a good estimate of your opportunity cost.

13 conchis June 10, 2005 at 10:06 am

Brandon writes: “The reason we worry about low savings is not that we’re afraid that people won’t be able to afford luxurious retirements; it’s because we worry that there won’t be enough capital to fuel future growth. So it’s economic savings, not personal savings, that we want to increase.”

Really? I’m worried about both. Presumably we care about growth because we’re worried about our future well-being (retirement or otherwise), rather than as an end in itself. So aren’t these kind of the same issue?

14 Brandon Berg June 10, 2005 at 12:54 pm

Personal savings are a personal matter. When I hoard wealth, whether as cash, bullion, or as a house, it helps to ensure that I’ll be well off in my old age, but it doesn’t do anything for you. Likewise, I don’t particularly care whether you spend your old age in luxury or poverty. But when I save in a way that adds to the pool of capital, it helps everyone (except maybe other capitalists) by improving labor productivity and funding research for technological advances.

15 eddie June 10, 2005 at 3:22 pm

As an aside, Brent’s oil exploration scenario is missing an important piece. If all the current exploration efforts turned up dry, then it’s true that the world’s capital stock would fall while the asset price of proven reserves went up. The missing piece is that the asset price of the properties being explored would go down.

Before exploration, their market price reflects the best estimate of their future value modified by the uncertainty of that value. This risk adjusted value represents real capital. As exploration happens and comes up empty-handed, the uncertainty is removed and the present value adjusted, downwards, perhaps to nothing. This loss in value is a real loss in capital stock, and the net after the rise in value of the remaining proven reserves represents the total loss to the world’s capital stock, in amounts exact to the dollar.

16 Brent Buckner June 10, 2005 at 3:34 pm

eddie – thanks for pointing out my flawed thinking on the oil exploration scenario!

17 battlepanda June 11, 2005 at 12:10 am

A tangential point: thanks to eBay, all sorts of second-hand consumer goods are becoming more fungible. Or is that a misuse of economic lingo? But it seems to me that there are implications on wider consumption patterns if this trend continues and the depreciation on everything we own is reduced to simple wear-and-tear instead of the steep discount its value immediately suffers as soon as it is taken out of the store.

Now, I’m not saying that the component of the price I can get back for my iPod if I need the money and sell it on eBay should be considered as savings. But in a pinch, that value performs the same function.

18 David Foster June 12, 2005 at 6:11 pm

Equities and homes seem to me to be very different cases. To the extent that stock price appreciation represents retained earnings, it actually represents savings on a national level. But if a house appreciates in value, it merely transfers wealth from potential purchaser to current owner, for no net increase.

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