Apr

22

Savings, from Rudolf Hauser

April 22, 2011 |

The term savings can be a bit confusing because it applies to both a stock and a flow concept. On the individual level, savings on a balance sheet concept is the amount of income one has set aside for possible future consumption. It's level will change with price changes of assets held. Stock savings can either be thought of as changes in the balance sheet value of savings (marked to market) or as the portion of earnings from production and profits not consumed but set aside for future consumption. This includes investments made directly in addition to financial assets. The term stock used in this context is not to be confused with equities. It refers to the balance sheet value of assets, that is the value of outstanding amounts.

From a flow standpoint, savings refers to valued added (amounts earned) not consumed. For business this value added is wages, interest payments and earnings based on economic depreciation not an accounting definition of depreciation. Economic depreciation refers to the amount of an invested asset that in effect is consumed in the production process and as such is a cost factor. Earnings the person as an individual it includes the amounts earned on capital by business paid out in interest and dividends. For corporations the amounts not paid out to providers of capital is called retained earnings. These savings have to be invested. Investment can be made by individuals by purchases of homes and durable goods, the value of which is consumed over the life of the items in question. Consumption includes the economic depreciation on those items. The amounts invested in financial assets represent purchasing power passed on to other entities. They can be used for consumption as is the case with consumer credit. For the economy as a whole this reduces savings as some people are dissaving. Part allows other consumers to make investments in residential housing and durable goods. Part goes to finance government, which uses proceeds for consumption, transfers that mainly result in consumption and some actual investment in such things as military weapons and highways. We treat spending on human capital (education and training) as consumption, although one can argue that this is really investment in large part. It is in the investment in plant and equipment, R&D, education that we increase the future productive power of our work effort. That is what we need to grow on a per capita basis and also on a total basis and new workers have to be supported by capital investment if overall productivity is not to be dragged down. Changes in asset values are not savings in a macro-stock sense. They add nothing to real savings, which are physical assets not financial values.

Changes in the value of equities represent changes in the discount rate of expected future cash flows to stockholders and changes in expected future cash flows. Changes in expected cash flows in part represent differences in actual retained earnings from anticipated amounts, unanticipated issuance and retirement of capital and the required rate of return (cost of capital) not paid out in dividends or stock repurchase, where we are taking in aggregate not per share terms. (Transaction prices in stock issuance or repurchase that differ from economic book value will influence per share figures.) Changes in fixed income securities represent changes in interest rates. Both interest rates and equity discount rates reflect the real non-risk rate of interest, risk premiums, inflation premiums and time preference premiums. All of these can change over time. Since these are determined on the margin, changes in the marginal investor can cause such changes.

Productive investment is made to facilitate the production of other capital assets and goods for final consumption. As capital assets are ultimately designed to produce consumer goods, one could envision a case in which present and future consumption is less than productive capacity and additional capital investment is not economical. Under such circumstances, cost of capital would be driven down to negligible levels, but it cannot go below zero in nominal terms. What often happens is that all sorts of crazy speculative investments may occur that will go down in failure. A key question is what risk premiums will remain and to the extent they deter productive investment. If investment demand is less than the savings not all labor resources will be able to be utilized until lower national income levels again equate savings and investment. Fortunately, consumer demands in most societies are such that such a problem does not represent itself except over more limited time periods. Labor may be idle for other reasons such when the productive value of the worker is below that of some prevailing minimum wage limit. The latter can be set by law or in the absence of legal restrictions by the amounts below which the workers would become ill or starve. That was never much of a problem in more primitive economics but is a greater possibility in current modern society.


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