Please note that an “articles by category” section has been added to the sidebar so that you can quickly access the blog entries you wish to read. The Ivory Tower category features academic debate on issues related to trading, investing, capital markets, and economics.

Let’s kick it off with Gene Epstein’s May 28, 2007 article in Barron’s called The Great American Savings Myth:

People often associate “savings” with the quaint picture of a hard-working employee dutifully depositing part of a paycheck in a passbook bank account. Such venues are hardly extinct. Of the $55.6 trillion in household net worth by year-end 2006, $6.7 trillion was in checking accounts, time deposits and money-market funds. But in a modern economy, most saving is money put at risk, often with the hope of large returns and the chance of substantial losses.
So even if the dramatic rise in net worth is based on asset bubbles waiting to burst — though the historical evidence belies this dour view — it would not alter the fact that saving occurred. It would mean only that the saving was misallocated.
What’s most important to understand is that saving increasingly happens through a type of automatic withholding — without the saver’s conscious participation. Baby boomers may never have acquired the virtue of thrift that came naturally to their parents’ generation. More likely, their relative success at saving results from the greater prevalence of institutional aids serving them in their capacity both as shareholders and — as we’ll see — homeowners.
Let’s look at some of the numbers to see how record household riches can occur despite an anemic — at best — official savings rate. Household net worth — assets minus liabilities — stood at a record $55.6 trillion by the end of 2006, according to “Flow of Funds” data from the Federal Reserve Board. Owing to methodological limitations, the net-worth figures also include assets and debt held by nonprofit organizations that are hard to separate from the totals.
But Fed statisticians still find the household totals accurate enough to run them against the standard measure of disposable personal income, which is after-tax income. Household net worth was 584.1% of DPI by year-end 2006, the second highest multiple on record. To arrive at real-net-worth per household, annual data from 1956 through 2006 were first inflation-adjusted in terms of 2006 dollars, then calculated per household by dividing each figure by the growing number of households. For example, since prices rose by 22% from 1996 to 2006, net worth had to rise by 22% just to remain the same in real terms. Since the number of households rose by 15% over that period, real net worth had to rise by 15% to stay the same per household.
The result of these two adjustments puts real net worth per household at a record high of $486,000 by year-end 2006, or 31.7% higher than at 1996’s conclusion, one of the fastest 10-year increases ever.
But can’t this figure plummet if asset values fall as they have in the past? What about the precarious state of many housing markets? Yes, they can fall, but the effect can be offset by other household assets.
Assume the value of homeowners’ equity falls by as much as a third — an unprecedented setback given that the biggest-decline ever in homeowners’ equity ran a little over 12% back in 1974. That kind of drop would punish disproportionately those households whose major assets were their homes.
But since equity in a home made up just one-fifth of total household net worth as of year-end 2006, the overall impact would be muted: The total household decline would be less than 7%. Even after such a big hit, household net worth would still be 22.9% higher than in 1996.
If you look at the 50-year trend in real net worth per household against the conventional measure of personal saving, the results seem strange. Saving often looks strong just when gains in net worth are weak — and weak just when gains in net worth are strong.
Whatever the virtues of hoarding for its own sake, saving is more properly viewed as a necessary sacrifice for the accumulation of assets; try adding a “y” to “miser.” So if those two conflicting trend lines were a given, it would be only proper to celebrate the amazing rise of the Free-Lunch Economy, as we rejoice in the spectacle of Americans building wealth by saving nothing. Or we could question whether something is missing in the official data on personal saving.
A lot is missing in the official data. Calculated by the Bureau of Economic Analysis, or BEA, the Commerce Department agency in charge of the national income accounts, “personal saving” is defined in a way that sounds plausible. It is essentially whatever is left over after spending on consumption is subtracted from disposable personal income.

Epstein has been Barron’s Economics Editor since 1993, writes a column called Economic Beat, and is the author of ECONOSPINNING: How to Read Between the Lines When the Media Manipulate the Numbers. He holds an M.A. in Economics from the New School and a B.A. from Brandeis University.

The Rebuttal

The rebuttal comes from Paul L. Kasriel, Senior Vice President & Director of Economic Research, The Northern Trust Company and the recipient of the 2006 Lawrence R. Klein Award for Blue Chip Forecasting Accuracy:

I offer a counterargument that increases in household net worth do not necessarily represent saving in an economic sense. I also present evidence showing that investment in human capital — higher education and research/development — has not shown any extraordinary growth since the official measures of household saving have been plummeting in recent years. If households are so wealthy, why have they recently been on a borrowing spree? If the return on business capital is so great, why have businesses been buying back record amounts of their equities rather than using their profits to spend more on physical and intellectual capital?

The full article is available for download from Northern Trust.

Food for Thought

There is an interesting background article that might be helpful. Edward C. Prescott wrote a commentary called Five Macroeconomic Myths that appeared in WSJ.com on December 11, 2006:

The sky is not falling. No need to panic and start playing around with all sorts of policy responses. Despite the impression created by some economic pundits, the U.S. economy is not a delicate little machine that needs to be fine-tuned with exact precision by benevolent policymakers to keep from breaking down. Rather, it is large and complex, with millions of people making billions of decisions every day to improve their lives, the lives of their families and the health of their businesses.
On the one hand, it’s difficult to screw up all these well-intentioned people by crafting bad policy, but, on the other hand, it is of course entirely possible to do so. And once things are broken, they are much harder to fix. For example, all those doomsayers predicting a recession will get their wish if taxes are suddenly raised, new productivity-strangling regulations are enacted, the U.S. turns against free trade, or some combination thereof. Otherwise, we should expect 3% real growth, based on 2% increases in productivity and 1% population growth. This economy is fundamentally sound.
So we have to be careful that we don’t believe everything we read in the papers. Things are never as bad as the last data that was released, nor are they as good. Likewise, policy should not be revised at every turn, nor rules changed by political whim. Meaning, we should be careful about accepting conventional wisdom as, well, being wise. One of the great disciplines of economics is that it challenges us to question status quo thinking. So let’s take a look at five pillars of contemporary conventional wisdom that have current standing, and see how well they hold up. …
Myth No. 3: Americans don’t save. This is a persistent misconception owing to a misunderstanding of what it means to save. To get a complete picture of savings we need to investigate economic wealth relative to income. Our traditional measures of savings and investment, the national accounts, do not include savings associated with tangible investments made by businesses and funded by retained earning, government investments (like roads and schools) and business intangible investments.
If we want to know how much people are saving, we need to look at how much wealth they have. People invest themselves in many and varied ways beyond their traditional savings accounts. Viewing the full picture — economic wealth — Americans save as much as they always have; otherwise, their wealth relative to income would fall. We’re saving the right amount.
Myth No. 4: The U.S. government debt is big. The key measure here is privately held interest-bearing federal government debt, which includes debt held by foreign central banks, and does not include debt held by the Fed or government debt held by the government. So let’s turn to the historical data once again.
Privately held interest-bearing debt relative to income peaked during World War II, fell through the early 1970s, rose again through the early 1990s, and then fell again until 2003. Even though that number has been rising in recent years (except for the most recent one), it is still at levels similar to the early 1960s, and lower than levels in most of the 1980s and 1990s. This debt level was not alarming then, and it is not alarming now. From a historical perspective, the current U.S. government debt is not large.

Mr. Prescott is senior monetary adviser at the Federal Reserve Bank of Minneapolis and professor of economics at the W.P. Carey School of Business at Arizona State University. He is a co-recipient of the 2004 Nobel Prize in economics.