Macro Roundup

Joseph Politano unpacks the ~ $2.5 trillion in American excess savings, given the distribution he is skeptical that excess saving are keeping low skilled workers out of the labor market. "... Since the start of the pandemic, Americans have spent approximately $1 trillion less than the pre-COVID trend and have earned approximately $1.4 trillion more than the pre-COVID trend. Total excess savings are approximately $2.5 trillion. Incidentally, excess savings have been shrinking over the last few months as total consumer spending runs above the pre-pandemic trend....Additionally, households are not the only members of the private sector. Business and non-profits have also increased their savings since the start of the pandemic. Undistributed corporate profits (analogous to “corporate saving”) are up significantly in 2021. Note that this is not “total corporate profits” but rather “corporate profits not distributed to shareholders”. One reason why capital income growth has been below trend since the start of the pandemic is that businesses are currently distributing a smaller share of their profits in order to shore up their balance sheets given pandemic uncertainty....All but the bottom 20% of households have accumulated significant additional liquid financial assets,but the top 1% have seen their liquid financial assets increase by a staggering 150%. That number is even more astonishing when you remember that the top 1% already held an extremely large amount of liquid financial assets before the pandemic. As a result, the top 1% has accumulated an additional $1 trillion in bank deposits, currency, and money market fund shares since the end of 2019. The next 19% have accumulated another $1 trillion with all other income levels adding less than $1 trillion combined.Eagle-eyed readers will note that the total change in liquid financial assets is higher than the total $2.5 trillion in excess savings we previously identified. Keep in mind that this is measuring total change in financial assets while the $2.5 trillion is excess (that is, above-trend) savings. Also keep in mind that excess savings could have been socked into paying down debt or new investments, not simply accumulating extra cash. Finally, remember that an increase in liquid financial assets can come about without additional savings by converting other financial assets to cash (like through the Federal Reserve’s Quantitative Easing bond-buying program). These are complimentary, not analogous, data points....JPMorgan Chase Institute’s Household Balance Pulse Report. They see higher percent increases in checking account balances of low-income households but higher nominal increases in checking account balances of high-income households. In other words, the majority of aggregate excess savings are held by the top earners even though low-income households have seen a higher percentage increase in savings. This data also excludes liquid financial assets held outside of checking accounts, likely missing some cash held by high-income households in savings accounts or money market funds....What do excess savings mean for America’s short term economic outlook? For one, I am extremely skeptical of claims that excess savings are hampering employment growth or keeping workers out of the labor market. Mark Zandi, the Chief Economist at Moody’s Analytics, claims that as excess savings deplete “the financial pressure to return to work is thus quickly intensifying”. I flatly do not see it this way. The median checking account balance of households in the bottom 25% is up a meagre $363 from its level in 2019—hardly enough to sustain a long period of time without labor income. Even before the pandemic, the vast majority of Americans did not have sufficient savings to cover even 3 months of expenses (personal finance experts usually recommend an emergency fund large enough to cover 3-6 months of expenses). Fundamentally, the majority of excess savings are held by high income households who retained their jobs throughout the pandemic while the majority of government benefits went to low income households who may have lost their jobs during the pandemic...."

Joseph Politano, "Understanding Americans' Excess Savings,"Apricitas, January 15, 2022, https://apricitas.substack.com/p/understanding-americans-excess-savings

Understanding Americans' Excess Savings

Since the start of the pandemic, Americans have socked away an extra $2.5 trillion in so-called “excess savings”. A drop in consumer spending coupled with increased income from stimulus checks and enhanced unemployment benefits resulted in a large pile of household savings. In April 2020 the personal saving rate hit a record 33.8%, absolutely dwarfing the previous record of 17.3% set in May 1975. What Americans do with their savings will define the economy in the coming years.

That’s why it is critical to dig deeper into the causes, composition, and distribution of America’s excess savings. Though government benefits have played a crucial role in buoying the savings rate, they are by no means the only factor. Households aren’t simply keeping more cash on hand either—a lot of excess savings have been used to pay down debt or replace borrowing. Nor are households the only ones saving money—corporations have been shoring up their balance sheets with excess savings since late 2020. And while low-income Americans benefitted the most from the expansion of government transfers, it is high-income Americans that have accumulated the largest stockpiles of cash. These facts are critical to understanding how, or if, Americans will spend their excess savings.

A Penny Saved…

Now, this rise in personal incomes and the personal saving rate is a mechanical result of deficit-financed stimulus spending. Public sector deficits are private sector surpluses, meaning that a net increase in deficit spending will also represent a net increase in private sector financial balances. Or to put it simply, for the government to owe additional money—an increase in the deficit—the private sector must be owed additional money—an increase in private sector surpluses.

In normal times this does not really matter due to the Federal Reserve’s monetary offset. In theory, whenever the federal government enacts expansionary fiscal policy the Federal Reserve simply tightens monetary policy to keep aggregate income growth stable and prevent inflation. In other words, the Federal Reserve offsets increased public sector borrowing by raising interest rates to curb private sector borrowing. COVID is not normal times, however. The Federal Reserve chose to limit their monetary stimulus so as to not drop short term interest rates below zero while committing to accommodative monetary policy for the near future. Essentially, they announced that they would not be offsetting fiscal stimulus for the duration of COVID. Stimulus money therefore directly increased total household income and personal savings.

Since the start of the pandemic, Americans have spent approximately $1 trillion less than the pre-COVID trend and have earned approximately $1.4 trillion more than the pre-COVID trend. Total excess savings are approximately $2.5 trillion. Incidentally, excess savings have been shrinking over the last few months as total consumer spending runs above the pre-pandemic trend.

First, it is obvious that increased government transfers—stimulus checks, enhanced unemployment benefits, and child tax credit payments—are single-handedly pushing savings up the most. Since the pandemic stimulus programs represented extreme upward deviations from the trend growth rate of government transfers, they show up as having a large cumulative affect on excess savings. The cumulative reduction in personal consumption expenditures (household spending on goods and services) also explains a large chunk of increased savings. Either one of these items is more than enough to offset the reduced labor income and capital/proprietor’s income that households have received since the start of the pandemic. Decreased interest payments have pushed excess savings slightly higher while increased taxes pull savings marginally lower.

At this point, it is worth examining what personal saving actually means in the National Income and Product Accounts. Personal saving is simply total income minus total outlays, which leaves a lot of ways for saving to manifest. That includes increased bank account balances, additional retirement contributions, cryptocurrency purchases, paying down the principal of mortgages or other household debt, and even home remodeling (technically categorized as “residential investment”). In other words, it is not like there is precisely an additional $2.5 trillion sitting in household bank accounts because the personal saving rate has increased by $2.5 trillion.

Finally, it is worth remembering that aggregate saving rate to increase in one sector it must generally decrease in another. The last six months have seen a dramatic reduction in household saving and increase in corporate saving as consumers spend more of their money and corporations distribute a smaller share of their profits. We have also seen a large decrease in the federal budget deficit, mechanically reducing private sector surpluses. However, without the government running a surplus private sector cash savings cannot decrease (though it is worth remembering that not all personal savings are financial and that governments will likely need to run large deficits in the future in order to counteract a declining real interest rate).

…Is A Trillion Earned

So far, we have only examined excess savings in the aggregate. But to truly understand how excess savings are affecting the economy, it is critical to examine how those savings are distributed throughout the economy. For this, the Federal Reserve’s Distributional Financial Accounts are an indispensable tool.

Eagle-eyed readers will note that the total change in liquid financial assets is higher than the total $2.5 trillion in excess savings we previously identified. Keep in mind that this is measuring total change in financial assets while the $2.5 trillion is excess (that is, above-trend) savings. Also keep in mind that excess savings could have been socked into paying down debt or new investments, not simply accumulating extra cash. Finally, remember that an increase in liquid financial assets can come about without additional savings by converting other financial assets to cash (like through the Federal Reserve’s Quantitative Easing bond-buying program). These are complimentary, not analogous, data points.

Conclusions

What do excess savings mean for America’s short term economic outlook? For one, I am extremely skeptical of claims that excess savings are hampering employment growth or keeping workers out of the labor market. Mark Zandi, the Chief Economist at Moody’s Analytics, claims that as excess savings deplete “the financial pressure to return to work is thus quickly intensifying”. I flatly do not see it this way. The median checking account balance of households in the bottom 25% is up a meagre $363 from its level in 2019—hardly enough to sustain a long period of time without labor income. Even before the pandemic, the vast majority of Americans did not have sufficient savings to cover even 3 months of expenses (personal finance experts usually recommend an emergency fund large enough to cover 3-6 months of expenses). Fundamentally, the majority of excess savings are held by high income households who retained their jobs throughout the pandemic while the majority of government benefits went to low income households who may have lost their jobs during the pandemic.

Most attempts at analyzing the effects of pandemic stimulus spending seem to miss the mark either by over-aggregating fiscal transfers or by treating stimulus money as equivalent to windfall earnings. Take this Goldman Sachs research note that ascribes half of the drop in labor force participation to increased fiscal transfers due to the correlation between fiscal transfers and the drop in labor force participation. Unsurprisingly, countries that experienced a large drop in labor force participation tended to increase fiscal transfers because more unemployed workers means more spending on unemployment benefits, not because unemployment benefits created unemployed workers. Or take this Richmond Fed economic brief that uses data on the employment outcomes for lottery winners to estimate the effects of fiscal benefits on aggregate employment levels. I shouldn’t need to tell you that getting unemployment insurance is not like winning the lottery.

While most of the excess savings is held by high-income Americans, who do not have a particularly high marginal propensity to consume, I do think that high income earners will consume more of their excess savings than they would under a traditional increase in wealth. For one, high-income households have been stockpiling extremely liquid financial assets, an indication that they may only be waiting for a good opportunity to spend their money. For two, historical episodes of excess savings (like the post-WWII era) have seen a slow but steady drawdown of excess savings over the following 5-10 years. For three, polling from earlier this year showed that consumers intended to spend down some of their excess savings, and personal consumption expenditures have already exceeded their pre-COVID trend.

Where high-income households spend their savings will also prove just as important as when they spend their savings, especially given high inflation and the disproportionate spending on goods throughout the economy—but I will leave that for a future blog post.

“…Someone has to take a loss somewhere if fossil fuels are going to be left in the ground rather than extracted and sold. ESG investors’ hope is that the losses will fall on other people. The problem is that less environmentally-minded investors buying those shares, oil wells or power plants are absolutely not going to shut them down unless they stop being profitable. It might make sense for an investor or company to sell out of fossil fuels early if they think the retreat from coal and oil is inevitable—indeed, that was the pitch by the activist who took on Exxon—but that is simply to invest according to a political prediction, not a way to fight climate change….My big concern about ESG investing is that it distracts everyone from the work that really needs to be done. Rather than vainly try to direct the flow of money to the right causes, it is simpler and far more effective to tax or regulate the things we as a society agree are bad and subsidize the things we think are good. The wonder of capitalism is that the money will then flow by itself….”

Also note“…In practice, there has been avery weak link between the cost of capital and overall corporate investment for at least a couple of decades. Small changes in the cost of capital pale in comparison to the risk and return projections of a new project…”

James Mackintosh, "Why the Sustainable Investment Craze Is Flawed,"Wall Street Journal, January 23, 2022, https://www.wsj.com/articles/why-the-sustainable-investment-craze-is-flawed-11642865789

Why the Sustainable Investment Craze Is Flawed

The financial industry has spotted an opportunity to make money by helping people feel good about themselves. Despite claims to the contrary, these investments don’t do much to make the world a better place.

ESG funds, as they are known, promise to invest in companies with better environmental, social and governance attributes, to save the planet, improve worker conditions or, in the case of the U.S. Vegan Climate ETF, prevent animals from being eaten.

Money has poured into ESG funds as noisy lobby groups push pension funds, university endowments and some central banks to shift their investments. The United Nations-supported Principles for Responsible Investment says signatories have $121 trillion of assets under management; even assuming lots of double-counting, that is most of the world’s managed money.

Over the next few weeks, Streetwise will explore the explosion of ESG investing and why I think it is mostly—but not completely—a waste of time. I will also offer up some solutions and discuss how to use your money to make a difference, while understanding the inevitable trade-offs.

ESG supporters can point to what look like successes: Their pressure has encouraged many companies to sell off dirty power plants, mines and, in the case of Anglo-Australian miner BHP, its oil business. It has even forced board changes at Exxon Mobil.

Sadly, selling off assets or shares by itself does nothing to save the planet, because someone else bought them. Just as much oil and coal is dug up and burned as before, under different ownership. And there are plenty of people out there to buy the assets, because never before in history has there been so much private capital operating without the public reporting requirements brought by stock markets.

Rich people who want to make the world greener could make a difference, by buying and closing dirty businesses even when they are profitable. So far, though, this hasn’t happened in any significant way. The pitch from Wall Street fund managers is the exact opposite—that by going green investors can change the world and make more money, not less.

“A lot of only really get enthusiastic if they get comfortable that they are not sacrificing return,” says Valentijn van Nieuwenhuijzen, chief investment officer at fund manager NN IP, which is being bought by Goldman Sachs.

Someone has to take a loss somewhere if fossil fuels are going to be left in the ground rather than extracted and sold. ESG investors’ hope is that the losses will fall on other people. The problem is that less environmentally-minded investors buying those shares, oil wells or power plants are absolutely not going to shut them down unless they stop being profitable.

It might make sense for an investor or company to sell out of fossil fuels early if they think the retreat from coal and oil is inevitable—indeed, that was the pitch by the activist who took on Exxon—but that is simply to invest according to a political prediction, not a way to fight climate change.

There are three big pro-ESG arguments, which sound reasonable, but have major flaws.

First, if companies treat the environment, workers, suppliers and customers better, it will be better for business. This could work where companies have missed something to boost profits, such as add solar panels on a sunny roof or create a better employee retention program. Early ESG activists plucked the low-hanging fruit here, but management has become painfully aware of changing customer and employee expectations, so there is less opportunity ahead.

Adding costs to reduce a company’s carbon footprint, or paying staff more, should only help the stock price if it also raises revenue or reduces other costs, by say generating more loyalty from carbon-conscious consumers, lowering staff turnover or improving relations with regulators.

Otherwise profits can only be maintained by passing the higher costs through into higher prices, and—unless the firm has monopoly power—eventually customers who don’t care will go elsewhere. The alternative is to reduce profits, but ESG investors are almost universally against this.

The second ESG point is that by shunning stocks or bonds of dirty companies, and embracing those of clean companies, it will direct capital away from bad things and toward good ones. After all, a lower stock price or higher borrowing cost in the bond market should make it less attractive for dirty companies to expand, and vice versa for clean companies.

In practice, there has been a very weak link between the cost of capital and overall corporate investment for at least a couple of decades. Small changes in the cost of capital pale in comparison to the risk and return projections of a new project.

That is not to say there is no link. Tesla, with extremely expensive shares, has repeatedly taken advantage of its ability to issue new stock to invest in factories and research. The high prices early last year for clean-energy stocks might have encouraged similar corporate investment. The flip side of course is that buying wildly overpriced shares isn’t a good way to make money, as losses of a third or more from this year’s peaks for clean-energy stocks shows. Shifting the cost of capital just might help save the planet, but after the short-term shift in valuations is over, it should lead to underperformance.

The third claim from some ESG investors is that they are just trying to make money, and that involves shunning firms that are taking unpriced risks with the environment, workers or customers. Since they call themselves “sustainable” or use “ESG integration,” funds doing this look very like the rest of the ESG industry. The selection principle of the most popular ESG indexes, for instance, those from MSCI, involves identifying only risks that are financially material.

I would say, sure. If you think the government is going to, say, raise fuel taxes, don’t buy manufacturers of gas-guzzlers. If you think the government will impose more restrictions on coal plants, then coal generation will be an even less attractive investment.

Equally, if you think customers will be willing to pay more for brands that cut their carbon use, by all means bet on their shares. Just don’t fool yourself that you are making much difference to the world with your investment decision. Red-blooded capitalists chase these profits just as much as any green-minded investor. There is no need to try to persuade capitalists to have a conscience; they will do what you want if you make it profitable via customer demands or government intervention (or, if we are lucky, new technology).

There is one way that ESG investing does, sort of, work. Shareholders can push companies to stop lobbying governments in favor of fossil fuels. Conceivably this might help push customers and governments to do the things that would really make a difference.

My big concern about ESG investing is that it distracts everyone from the work that really needs to be done. Rather than vainly try to direct the flow of money to the right causes, it is simpler and far more effective to tax or regulate the things we as a society agree are bad and subsidize the things we think are good. The wonder of capitalism is that the money will then flow by itself.