Michael Pettis Responds; Fantasyland Thesis vs. Reality; Counter-Challenge!
In response to my article Pettis Proposes Savings Glut and Income Inequality are Source of Global Imbalances; Mish vs. Pettis: I Respectfully Disagree, I received an interesting reply from Michael Pettis.
Before posting his response and my reply to his response, I reiterate my gratitude to Pettis. He has taught me much of what I know about trade. I recommended his book "Great Rebalancing"," and still do. I also deeply appreciate even having this discussion and for Pettis to personally respond.
That said, Pettis failed to convince me. Here is his reply. Does he persuade you, or do my arguments make sense?
Michael Pettis Responds
Thanks for the discussion, Mish, but I don't really think you've addressed the essay, which provides a logical argument, not a moral or political one. My argument has been praised as brilliant by one group of people and as evil by another, but too many people on either side have failed to understand and instead have resorted to political prejudices.
The problem is that you cannot agree with just the part you like. Either the entire argument is true or it is false. In fact all of these conditions can be true but are likely to be more or less important under different conditions. One of the great follies of contemporary debate, it seems to me, is that certain policies are considered to be intrinsically and always wealth-enhancing, or intrinsically and always wealth-destroying, depending on your political beliefs, whereas I would argue that these policies, and in fact many others (free trade, unionization, free banking, etc.) can be wealth-enhancing under certain conditions and wealth-destroying under others. Rather than close the door to debate we should try to figure out the conditions under which they are one or the other, and guide policy according to the relevant conditions.
But let me explain why I do not think you, or most others, have addressed the argument. To summarize, I start with three propositions, from which everything else follows:
1. The rich in any economy save a greater share of their income than do the poor. This is an assumption that can be proven or disproven empirically. The fact that some countries are rich and others poor may complicate things, but this only means that income inequality inside a country matters, whereas income inequality between countries might or might not matter.
2. In every closed economy savings is equal to investment. This is true by definition because the demand side of an economy consists of consumption and investment, while the supply side (how we allocate total production of goods and services) consists of consumption and savings. Because demand and supply always balance, savings is always equal to investment. I know you understand this.
3. No one has infinite debt capacity. I don't know if this is an assumption or true by definition, but at any rate I know you agree.
Here is the argument which, if you accept the three propositions above, can only be logically true or logically false:
1. From Proposition 1, if income inequality rises, the savings rate must rise.
2. From Proposition 2, if savings in one part of the economy rises, we must see one or both of the following:
a) investment must rise, or
b) savings in another part of the economy must decline.
3. If investment rises, one or both of the following must be true:
a) productive investment rises
b) non-productive investment rises
4. If savings in another part of the economy declines, one or both of the following must be true:
a) the "non-rich" increase their consumption
b) unemployment rises.
So far I think you would agree that the argument is true and in fact obvious. You might question whether there are indeed only two ways for savings in another part of the economy to decline, but these are the only two ways I can think of. If you find a third way, it would interesting to see how it would affect the argument.
This leaves us with the following. If income inequality rises, we must see one or more of four possible outcomes, which I list as 3a, 3b, 4a, and 4b. Unless you discover any other possible outcome, these are the only ways to balance an increase in income inequality, right?
Let us focus on 3a and 3b:
5. If productive investment rises, we all get wealthier, both rich and poor (this is what the supply-siders mean by "trickle down"). The process is clearly sustainable.
6. If non-productive investment rises, wealth declines. Once wealth declines to some limit (it could be zero but it could also be, and is likely to be, much higher than zero) the process can be maintained only by rising debt, but from Proposition 3 there is a limit to rising debt, so this process is not sustainable.
Now let us focus on 4a and 4b:
7. If some of the non-rich increase their consumption, they eventually draw their savings down to their minimum level (which might be zero, but doesn't have to be), at which point they have to borrow to consume. But again, from Proposition 3 there is a limit to rising debt, so this process is not sustainable.
8. If unemployment rises, total savings decline, although because it might also cause investment to decline, unemployment might have to rise a great deal, which is what happened in countries like Spain once debt-fueled consumption and debt-fueled non-productive investment came to an end in 2008. This is, unfortunately, sustainable.
End of the argument.
The conclusion, which follows inevitably from the three initial propositions, is that a rise in income inequality can lead temporarily to an increase in non-productive investment or to an increase in debt-fueled consumption, but in both cases they are unsustainable. A rise in income inequality can also lead to a rise in productive investment or a rise in unemployment, neither of which is unsustainable (unemployment in the long run might be unsustainable, but of course this does not invalidate the argument).
This means that rising income inequality must eventually lead to more productive investment or to more unemployment. There is no other conclusion.
Can this argument be attacked? Of course it can. If you disagree with any one of the three initial propositions, then even if the argument is completely logical, the conclusion may be wrong. Alternatively, if you disagree with any of the logical steps, then even if the three initial propositions are correct, the conclusion can be wrong. These, of course, are the only ways in which the conclusion can be wrong.
From my reading of your piece, you agree that all three propositions are correct. This means that you must believe that the logic is wrong, but I cannot find where you disprove the logic. In fact I do not think the logic is wrong anywhere, and economists ranging from Keynes to Friedman, including both liberal democrats and the supply-siders, all invoke the same argument because it is based either on propositions that are true by definition or on propositions that we all believe empirically to be true. They all agree with the propositions and the logic. Where they disagree is wholly on the issue of whether or not higher savings will lead to higher productive investment.
This I would suggest, is where you must concentrate your own arguments, unless perhaps you disagree with Proposition 1. I cannot think of any other way to attack this argument except by calling it politically incorrect, which of course is not a refutation at all. That does not mean that there are no moral, social, or political arguments in favor or against rising income inequality, but these have nothing to do with the economic impact of rising income inequality.
In one sense I think we are talking past each other. In other respects, I disagree with some of your assumptions.
For example, we both can agree that savings = investment.
However, from my point of view, you ignore malinvestment and monetary printing, whereas I propose savings = production - consumption.
Please consider global debt ...
Global Debt Up $30 Trillion in 7 Years
Bloomberg notes that Global Debt Exceeds $100 Trillion and it's up 40% since the start of the crisis.
If rising debt is a synonym for rising investment (and savings = investment), then in your model, it seems we have "saved" $30 trillion in the past seven years, a rather remarkable (preposterous) achievement.
Consider the US credit market in isolation.
US Credit Market vs. Base Money
What would happen if people attempted to cash in those savings? Is there sufficient savings to allow that to happen or would the system implode?
I suggest a whopping $54 trillion in imagined savings would vanish overnight.
Let's try a simpler case. What if people went to withdraw just the amounts held in their checking and savings accounts?
M2 vs. Monetary Base
Supposedly there is $10 trillion of "savings" in banks. But what would happen if everyone were to try to get their savings all at once?
Once again people would discover their alleged savings are not there.
If it Isn't There, Does it Exist?
How can something that isn't there and does not exist be considered saving? Murray Rothbard calls this fraud, and I agree.
The fraudulent nature of this system confuses people about what constitutes "savings".
Of course, were there to be a run on the banks, the Fed would print as much money as required to make the system whole. Is that "savings"?
Income Inequality Thought Game
Let's play a thought game. To even out income inequality, while making up for all alleged prior transgressions, let's give $1 trillion to everyone. To do this, we will actually have the Fed issue enough currency so the money is really there.
Would that constitute saving? For sure, the new-fledged trillionaires would rush to spend their money. But what would it buy? Anything?
Someone responded to me last week that printing money constitutes "production" because it buys something. I laughed.
In reality, printing money cheapens every dollar before it, but in decidedly uneven ways, to the benefit of those with first access to newly printed dollars (banks, government, and the already wealthy).
At the same time ...
Income Inequality Is Necessary
Fundamentally, people are not equal, and their ability to serve consumers and accumulate wealth isn't equal either. Innate inequality is actually necessary to achieve economic progress.
To achieve progress, someone needs to come up with new ideas and new ways of thinking, and be rewarded for them.
Trying to achieve 'economic equality' by forced socialism never has, and never will work.
Problems caused by fiat monetary systems are similar, except those problems are better hidden from the public's sight given that damage accumulates slowly and is spread over a very large number of people.
Pettis sees extreme income inequality and excess saving as the problems. I propose extreme income inequality is a result, not of excess savings, but rather a direct result of the fraudulent nature of the system that benefits those with first access to money.
Whether or not forcing the .1% to spend their alleged savings would increase employment is actually moot, because that is not the source of the problem.
Attacking symptoms of problems can never solve anything.
Do the Wealthy Save More?
Given the fraudulent nature of the existing system and how it has totally perverted the nature and meaning of "savings", I am not even sure it is safe to say (in aggregate) "The rich in any economy save a greater share of their income than do the poor."
Perhaps most do, but then where did $30 trillion dollars of global debt come from in the past seven years?
If that wasn't a result of free-market production (and it wasn't), then it wasn't savings, in my book. So where did the savings = investment equation break down?
Right here: savings + malinvestment + monetary printing = investment.
Savings = investment - malivestment - monetary printing.
Malinvestment and monetary printing are capital- and saving-destructive activities. That some people get wealthy from them does not make it saving.
Acting Man Chimes In
I asked my friend Pater Tenebrarum at the Acting Man blog to chime in on this discussion. He replied ...
Additional fiat money only serves to misdirect already existing capital, it does not create new capital. In order to create actual, additional investment (and not just malinvest existing resources), only genuine savings can be used. As you [Mish] have rightly remarked, savings is the excess of production over consumption.
Let's also not forget that a large part of genuine savings is needed to merely maintain the economy's capital structure. Only after maintenance can something be added to it.
The problem is precisely that 'inverse wealth redistribution' is an effect of fiat money inflation (it matters not whether commercial banks create additional deposits ex nihilo or whether the central bank does it). The effect is a result of the 'Cantillon Effect' - money enters the economy at discrete points and spreads out from there. The first receivers can engage in exchanges of 'nothing' (new fiat money) for 'something' (real resources). Once the money reaches later receivers, prices have been bid up by all the activities of the earlier receivers. Later receivers thus become 'forced' savers.
Forced saving, as Hayek has pointed out, is really only the other side of the malinvestment coin. When genuine savings rise, and no-one interferes by lowering the interest rate below its natural level by throwing additional fiduciary media (circulation credit, or unbacked money from thin air) on the market, then investment allocations will be sensible in the aggregate.
The appearance of additional monetary units from thin air makes it seem as though there were enough real savings available to support a production structure of a certain type (of a certain length and width). But in reality, the saved real resources are insufficient to maintain it.
Such errors accumulate and it is possible to sustain such a distorted capital structure for quite some time if ever more money is printed. But ultimately it is the functional equivalent of heating one's home by burning the furniture.
No additional capital is created in this process - on the contrary, capital is consumed. Then, when the inevitable bust strikes, it is found out that the production structure is actually in disarray - certain projects cannot be completed at all, and many projects that were completed during the boom are in fact not profitable - economic calculation was falsified by the addition of new money, and all the profits turn out to have been accounting fictions.
The US and Spanish housing boom are great examples for this - first everybody thought they were getting rich, and then they lost all their gains. But the gains never really existed in the first place - they were an illusion.
The Real Problem
If the problem was income inequality, then surely giving everyone the same income would fix it. But clearly it wouldn't.
Yes, the poor would spend more money if they had it, but if we printed enough money and handed it out, it would be worthless.
Q. What is the real problem here?
A. The fraudulent nature of fractional reserve lending makes it appear that nonexistent savings can somehow be redistributed and spent without causing still other distortions somewhere.
Pettis proposes the problem is excess saving and income inequality (the savings glut thesis).
I propose that extreme income inequality is a result, not of excess savings, but as a direct result of the fraudulent nature of the system that benefits those with first access to money.
There is no savings glut. Rather, the fraudulent nature of fractional reserve lending can at times make it appear that way.
Reflections on Wealth-Enhancing Policies
I also need to comment on Pettis' statement "One of the great follies of contemporary debate, it seems to me, is that certain policies are considered to be intrinsically and always wealth-enhancing, or intrinsically and always wealth-destroying, depending on your political beliefs, whereas I would argue that these policies, and in fact many others (free trade, unionization, free banking, etc.) can be wealth-enhancing under certain conditions and wealth-destroying under others."
I disagree. Fractional reserve lending is inherently fraudulent. And the fraudulent nature of fractional reserve lending is the source of the problem, whether or not Keynes, Krugman, or anyone else thinks otherwise.
Under fractional reserve lending money (more precisely pseudo-money) is lent that does not really exist. Money is also lent for 30 years when rights to lend stop at 5. Both practices constitute fraud. Period.
Whether or not there are "some conditions" in which things "appear" to operate smoothly under fraudulent schemes is irrelevant. All Ponzi schemes "appear" smooth until they implode.
Fraud is fraud, and sooner or later fraud always causes problems. The increasing amplitude of economic bubbles over time and the destruction of the middle class in the process should be proof enough.
Getting the wealthy to spend more money, cannot and will not fix the root problem, whether or not it increases employment (something it cannot possibly do without causing other problems, an issue that Pettis fails to discuss).
If everything were so simple as building bridges to nowhere and cities that no one lives in, then redistributing the alleged "savings" from such schemes, we could all live happily forever after in Fantasyland.
Sound banking and sound money are always correct, in every situation. To propose otherwise is to promote fraud.
Why Fractional Reserve Lending is Fraud
For a short, easy to comprehend discussion as to why fractional reserve lending is fraud, please read.
I strongly encourage everyone, but especially Pettis to click on and read those links.
Who Benefits From Inflation
For further discussion of who benefits from central bank sponsored inflation, here is a free refresher course.
- Reader Asks Me to Prove "Inflation Benefits the Wealthy" (At the Expense of Everyone Else)
- Monetarism, Abenomics, QE, and Minimum Wage Proposals: One Bad Idea Leads to Another, and Another
- Can Inflation be Too Low?
Income Inequality Fact and Fiction
Finally, income inequality benefits far fewer people than you may think!
For a discussion, please see No Increase in Wealth Inequality for Top 1% Since 1960
The problem is not a "savings glut" or income inequality. The "primary" problem is the Fed (central banks in general) and fractional reserve lending.
That said, numerous (and important) secondary problems such as public unions, vote buying by political parties, warmongering, prevailing wage laws, etc., must be addressed as well. In every instance, fractional reserve lending greatly compounds the secondary problems.
Attacking symptoms of problems is a dead-end tactic. Unfortunately, that is the path most are on, simply because people prefer Fantasyland solutions that involve little pain, vs. real solutions that will require sacrifices.
Given that attacking symptoms cannot and will not work, and that it is counter-productive to figure out under what conditions fraud "appears to work", I counter-challenge Pettis to work with me and others to come up with the least disruptive ways to end fractional reserve lending as well as the secondary problems that are the true source of the economic mess the world is in.