An economist breaks ranks

For some time now, many economists have been saying that the negative U.S. personal savings rate - personal disposable income minus personal consumption expenditure - is not nearly the problem that some make it out to be because it doesn't factor in the recent, dramatic rise in asset prices, notably real estate.

That is, instead of simply looking at month-to-month income and spending, where spending has been greatly enhanced in recent years by an enormous amount of home equity withdrawal, it is important to factor in personal "wealth" since assets are a form of "savings".

Talk to just about any middle-aged homeowner and they'll probably tell you the same story, "Thank God home prices have skyrocketed - otherwise I'd never be able to retire".

This has come to be almost "mainstream" economic thought and, month after month, when the personal savings rate posts another negative number, economists yawn en masse.

Former Federal Reserve Bank of Dallas President Robert McTeer has broken ranks with many of his peers by coming out and stating what seems patently obvious to many who only dabble in the dismal science - real estate wealth is not "savings".

In this editorial($) appearing in the Wall Street Journal earlier in the week he makes clear that confusing wealth and savings is a dangerous practice. For those without WSJ subs, a summary of the article can also be found here.

Don't Dismiss Our Dismal Savings Rate
By BOB MCTEER

The main fallacy in monetary theory and policy is the confusion of money and wealth. Money is wealth from the individual perspective since individuals can usually exchange it for goods and services. Money -- and financial assets easily converted to money -- may not be wealth for society as a whole if the production of goods and services has not kept pace with claims on it. Early spenders may have some success, but inflation will dilute the buying power of others. The bottom line is that real wealth has to be produced; it can't be printed.
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A parallel is the farmer who hopes for a good crop year. But, if all or most farmers have a good crop year, the decline in prices may more than offset higher yields. What our farmer really needs is a good crop in a bad crop year. Then he could look for a popular restaurant that isn't crowded.

I realize this is not very sophisticated stuff, but it's on my mind because of the many talking heads I hear dismissing the adverse consequences of our low personal saving rate by saying it ignores capital gains as a source of spending. "Properly measured," they say, saving is not a problem.

Again, that may be true for the few, but not for the many. A penny saved may be a penny earned, but it matters whether it was earned by producing more or by a rise in the price of existing financial assets. A stock or housing market boom creates apparent wealth in the form of capital gains, but trying to convert it to real wealth en masse can make it disappear.
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The problem goes beyond government entitlement programs. Consider the baby boomers whose IRAs, 401(k)s and personal investments helped drive the stock market to record highs. What happens when cash-in time comes? There will be a mountain of paper claims on output, but will there be an equally tall mountain of output?

The great French economist, Frederic Bastiat, said that "The state is the great fictitious entity by which everyone seeks to live at the expense of everyone else." It's time to get real about producing real wealth, not just financial claims on wealth.

As some of you may realize by now, this view seems like a departure from what Mr. McTeer was most famous for during his tenure at the Fed.

Early in the last recession, after the stock market crash but before the 9/11 attacks, Mr. McTeer famously said, "If we all join hands together and buy a new SUV, everything will be OK." To be fair, this comment precedes most of the recent housing boom and he probably never meant that thousands and thousands of homeowners should tap their home equity to buy a Hummer.