

So it is clear that we need more aggregate demand right now in the world especially in Europe.



However rarely do we see discussion about what kind of demand we need. I keep reading that people and governments should just spend more regardless of their means. There is some truth to this because almost any kind of increase in aggregate spending increases wealth and welfare in a demand anemic world, however this is setting the bar extremely low. Spending can increase welfare much more if it is aligned with people’s needs and the timing of their needs.



You can classify spending in two big categories: investment and consumption of final goods and services. Investing is saving. I would even say that it is ultimately the only real form of saving for the economy as a whole. This means that increasing spending can mean increasing saving. The only type of saving that doesn’t count for the aggregate economy is saving in money, and it only doesn’t count when you keep it out of banks or banks are not lending enough.



There is evidence that what we need more of right now is not consumption but investment demand.



The first piece of evidence for this is that people want to save, we see this in what Ben Bernanke has called the “global savings glut”. It’s one of the explanation for interest rates having been falling for so long (even before the financial crisis).



The other big piece of evidence is the obvious ramifications of the demographic wave in wealthy countries. It is no secret that baby boomers are nearing retirement and it is natural to do a lot of saving when preparing for retirement. A lot of people want to work now to be able to consume later. Since there is going to be predictably more consumption needs in the future relative to available labor, we need to invest in thing that can fill these needs and reduce future needs for labor.



Plus, as I have explained in my previous post, people and banks investing in idle fiat money is an illusory form of saving that is not tied to production and will only force devaluation of savings later. If people knew that part of their savings were fictitious, they would want even more savings and investments to replace what they are missing.



Unfortunately, there seems to not be a sufficient supply of investment opportunities with safe real returns above -2%, the rate that makes them seem better than cash in most places.



This means that to make enough investments available to the markets, inflation may have to be higher than 2%.



A lot of people seem to see negative returns as unnatural aberrations. Once they’ve earned their money they think they should be able to keep all the value without taking any risk. This might be due to of the fact that the 20th century was one of unprecedented technological and demographic growth which made low risk positive returns easy to find.



The law of thermodynamics tells us that most things decay over time unless you input work and energy into them. Widely available low risk positive real return investments could be a thing of the past. Lower return investments could be more common now and we should not allow overvalued fiat to price out a range of investments that may be emerging as a crucial part of the savings market.



There are really three big ways to restore higher levels of investment.



1. Sufficient inflation as I have mentioned.



2. Fiscal stimulus, which means letting the government allocating the spending instead of private markets. This might work with the caveat that without a market for investments with lower than -2% real returns, we can only hope that they will invest in the right mix of things and the right maturity structure matching the timing of future consumption needs.



3. Make wages be widely lower and reduce inefficiencies. This makes all investments have a higher return. I put this one here because it seems it is what the ECB is somehow waiting to happen even though it would have to happen in very wide and coordinated manner. Who wants to be the first to negotiate their salary down? That’s what I thought.



A positive supply shock like we are seeing with oil prices could also help the situation but we have little control with this and we can’t count on it to continue or be sufficient.



All three options would result in some currently employed individuals’ real buying power going down a bit now but would increase the number of employed and thus bring more buyers and more wealth in total. Plus in exchange for suffering a slight decrease in buying power now, the increase in total investment means there would be more supply in the future and less forced future devaluation of people’s savings.



If people and banks are allowed to continue to invest in fiat money instead, current workers get to keep a bit more value now at a cost of having their savings decimated when it comes the time to spend them because either increasing velocity of idle money will create inflation or a corrective restrictive monetary stance will devalue their other investments and push taxes up. Also in this situation, the unemployed will continue living in poverty until enough people retire. Overall this will create lower production and lower wealth. The only consolation I can offer to the current unemployed or underemployed is that they will have leverage when the current savers retire and there isn’t enough people or production facilities out there, one generation against the other I guess.

The first two options are complementary and boost each others effect. I favor, an emphasis on option one since I think it is the more efficient and the one that is most likely, if not implemented to prevent the other options from being effective, but some reasonable people favor option two. We likely need at least some of both.



There are variants on the first option such as plt and ngdp targeting which show promise but it’s difficult to know how good they are and we shouldn’t wait till we have answers before acting.

Real saving and real investment is about building the tools and infrastructure to support future consumption. The fact that incentives are such that people and banks prefer putting their savings in fiat instead of supporting jobs to build the future, means that savings are a claim on a piece of a much impoverished future.