Clem Sunter

Punish the saver, bless the borrower

2013-03-28 15:07

Clem Sunter

There is a classic macroeconomic equation I learnt in my economics course at university: savings equals investment.  If individuals and companies don’t save out of their income, if governments don’t generate surpluses in their annual budgets and if foreigners don’t put some of their savings into your country’s economy, then you don’t have money to invest in new infrastructure, plants, machinery and new business ventures. Think about yourself: if your current expenditure equals your current income and you are putting no money to one side, investing in property, stocks and bonds is something you can do in your imagination, but not in reality.

Hence, I have always thought of saving as not only a virtuous activity (something my father lectured me on as well) but also a necessary condition for a healthy economy. Paul Samuelson, the great American economist, would I am sure be nodding his head in approval as it was his textbook that was the foundation of all economic learning at the time I was a student. So I am totally baffled by the economic policies pursued in the advanced economies over the last twenty years which have progressively discouraged people from saving and sometimes penalised them as well (such as negative interest rates in Japan occasionally making you pay to have money on deposit at the bank). 

The tightening noose on savers

It all started with capital gains, interest and dividends becoming taxable in many countries, even though the capital invested had already been taxed at source. Up to a point I suppose you can justify that, especially when you hear Warren Buffett has one of the lowest rates of personal tax among his company’s workforce. The reason is that most of his income is investment income. Then Alan Greenspan came along in the early part of this century and, as chairman of the US Fed, drove interest rates down to record lows in order to stimulate the economy after the dot-com bubble burst. It enabled all those sub-prime borrowers to take out mortgages that they subsequently defaulted on. There followed the 2008 crash and, guess what, his successor Ben Bernanke has zeroed prime interest rates indefinitely, or at least until the unemployment rate in America has fallen to 6.5%. The mechanism he uses is to purchase over one trillion dollars of US treasury bonds annually, essentially meaning that the US government does not have to borrow too much from other people (like the Chinese) to cover its deficit and roll over its loans. It can make ends meet with newly printed money as a substitute for savings.

Europe, the UK and Japan have followed suit in implementing the policy of printing money under the euphemism of “quantitative easing”. The flipside of the coin is that many savers who used to rely on a safe income from money held on deposit at the bank or invested in the money markets have had to “reach for yield” – another quaint expression which disguises the fact that such action increases the risk of losing the capital in the event of a market downturn. Indeed, the argument is now put forward that if you don’t reach for yield, you will definitely lose out in real terms as your after-tax return from bank interest is nowhere near the rate of inflation. The switch to higher yielding (but also higher risk assets) is promoted as a no-brainer.

Of course, the whole bailout episode in Cyprus has added a new dimension to the punishment of savers. Essentially, those with deposits in excess of €100 000 are going to have to cough up between 20 and 30% of their savings in exchange for bank shares which are pretty much worthless. Literally, big savers are overnight being penalised like criminals with no distinction between honest Cypriot entrepreneurs who have made a lifetime success of their businesses and members of the Russian mafia. Cash under the mattress or a secret hoard of gold must now seem a much better option to many of them. These measures can certainly lead to a run on the small banks.

Debt, debt, glorious debt

The net effect of these strange policies is that the world is now drowning in debt. The only governments that have brought down their national debt-to-GDP ratios are probably Ireland and the UK. The US, Europe and Japan are soldiering on with their budget deficits in the hope that it prevents the “Great Recession” becoming the “Great Depression” and somehow recovery will come sooner rather than later.  Small businesses and individuals are being urged to borrow again when unserviceable debt was the cause of the last crash. Total debt in the world is now estimated at around $180 trillion versus total equity capital valued at $65 trillion. Put another way, bond markets are nearly three times the size of stock markets. Any significant rise in interest rates triggered by an increase in inflation could thus have a spectacular impact on all markets.

The old and the new thinking

All in all, I would be intrigued to know what my guru Paul Samuelson would have thought of this if he had been alive today. Would he have disagreed with his Nobel-prize winning successor, Paul Krugman, who believes that the creation of new jobs in the US is paramount and nothing in the short term should be done to trim aggregate demand even when it is entirely financed by credit? The new thinking is to kick the can down the road and let renewed economic growth sort the problem out in the longer term. Who am I to argue with Krugman, but justice is not being served when savers are demoted below borrowers.

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