Tuesday, August 11, 2015

High Inequality and Deflation 2015: The Problem of Too Much Savings

Today, China devalued its currency, effectively cutting the price on everything it produces. It was the largest devaluation out of China in 21 years. It is just the latest sign of spreading deflationary pressures. It will probably get much worse from here.

A potentially historic deflationary vortex threatens to engulf the world. In fact, a recent survey of financial experts found that an overwhelming majority think that deflation is a much larger worry than inflation. Worse, the Fed seems determined to raise interest rates notwithstanding the deepening slowdown behind falling prices. The Fed seems oblivious to the fact that despite massive monetary stimulus, a deflationary spiral simply cannot be discounted.

This blog has long covered the deflationary forces gripping the global economy on a step by step basis. That vortex is manifestly forming today as evidenced by the oil and commodities crash, the apparent crash in China, the increasing deflationary pressure emanating from the Eurozone and Japan, negative interest rates worldwide, collapsing emerging market exchange rates, and a world awash in debt and debt defaults. Today, it is fair to say that world economy hangs by a thread above a vortext of deflationary forces. What are the roots of this deflationary threat?

Perhaps the most deflationary force in the world today is very high economic inequality in the US. I will support and defend this proposition in a series of blog posts, starting with this one.

The first problem with high economic inequality is that the marginal propensity to consume is much higher for the middle class and lower classes than for the very wealthy. High inequality therefore leads to too much savings.

The very wealthy save much more of their income. This means that as the very wealthy control more of the nation's GDP, and today they control a historically high amount of GDP (as demonstrated in the chart at right), the more national income than diverted from growth stimulating consumption and toward savings. Too much savings leads to savings gluts and bubbles because massive income is diverted from consumption to savings but too many consumers are deprived of the ability to pursue growth-enhancing innovation. That leads to too much savings and not enough productive investment opportunities.

At the same time, more global GDP has been diverted from consumption to savings by the continuing growth of globalization and China as the world's manufacturer. The savings rate in China is about 50 percent, compared to 18 percent for the US. India saves nearly twice as much as the US. So every time jobs move from the US in search of cheaper labor it leads to higher corporate profits for the top income earners here who enjoy dividends and incentive bonus compensation as well as more savings in developing economies such as China or India. The net result is a massive transfer of global demand to less stimulative savings. This point is more fully documented in Chapter 4 of my book Lawless Capitalism, entitled "Rigged Globalization."

In a forthcoming post, I will discuss the highly dysfunctional global financial system that is supposed to channel savings to productive investment but does not. The point here is simply that massive money is drained from the economy to fund a highly sub-optimal global economic system and distribution of income, and that is highly deflationary.

ADDENDUM (AUG. 12, 2015):

“As investors realise yet another recession beckons, without any normalisation of either interest rates or fiscal imbalances in this cycle, expect a financial market rout every bit as large as 2008.” China's currency devaluation could spark "tidal wave of deflation," Guardian (quoting Société Générale economist Albert Edwards).

1 comment:

  1. Seriously? Another financial crisis? How do we not learn?