Monday 25 May 2015

Total Wealth and the Obvious Effect on Yields

Savers often complain that, with interest rates at close to zero, they are not rewarded enough for saving. I argue here that, on the contrary, they are actually rewarded too much for what is, at present, a socially and economically damaging activity.

Ben Bernanke recently wondered aloud about the disappearance of term premiums. I believe that it is all linked to the structural excess savings which cause stagnation, inequality and threatens our economic stability.

There is a very simple explanation for low yields. I present you the following graph of total gross financial assets in the UK divided by GDP from ONS data (to 2006 using the statistical annex of this report, and after using other ONS data):

Note that there are questions of double counting here, which would reduce this, but also the foreign sector and property have not been included here. It is merely to give an idea.

We have had an extended period of chronic excess savings, where demand has been too low. The monetary response has been to increase demand by lowering interest rates, stimulating more private sector debt. This has thus increased total assets and total wealth. Interest and dividend payments on this have increased the structural saving further. The economy is now struggling to cope with the loss of demand from the transfers from workers to savers. 

The reason is that the savers (eg pension funds and richer people) have a lower propensity to spend than the workers. This means that the increase in transfers from workers to savers lead to a reduction in demand. And the increase in debt has meant more and more transfers from workers to savers.

As I describe previously, wealth can be looked at as a claim on people's work in the future. We can therefore make a simple model of where future yields should be now, based on total wealth and total GDP. (Actually, to be more correct, it should be based on future GDP including growth estimates  - these are going down - and also how much rent can be extracted from the economy  - this is going up. I assume that these cancel out in the given time period and ignore them in my simple demonstration.)

Let me make the following assumptions:
  1. Interest and dividends remain a fixed share of GDP - for my back of the napkin calculation I will set this at 50%. The rest is shared between wages and investment. 
  2. The average real yield will be 3% above the real government debt yield. This is because people need to be rewarded for productive risk-taking in the economy. No-one would take risk if government bonds paid the same amount.
From these two assumptions, I can make a predicted yield based on total wealth.The total money from the economic activity of the country is apportioned out and 50% is given to the savers. This amount is then divided between the total outstanding wealth. 3% is then taken off to account for the difference between average bond yield and government bond yield.

I now plot my estimate against real yield from 1984 when the Bank of England data starts. The fit is pretty close I think. Possibly in the early 1980s wages and investment were a higher proportion of GDP than they are now - real government yields would not have been 10%. 

Put simply, the more wealth there is, the lower the yield on that wealth must be. Those that talk about an 'equilibrium interest rate' of maybe 3.5% are not taking this into account. 

Any increase in yields will have to come from the broader economy. This implies that either a) wages or investment would have to be reduced to compensate, b) asset values collapse, or c) economic growth increases substantially. 

With the structural excess savings we have, GDP can not go up without private sector debt increasing and thus wealth increasing. Therefore interest rates can not go significantly higher without a collapse in the claims of wealth or even more rent seeking.

All of the wealth amassed, and continually being amassed, is a huge drag on growth. The share of wages is constantly getting lower and thus so is the demand in the economy. As I argue in every other post, we need mild to moderate inflation (maybe 3%) to inflate away some of the wealth, as well as large government deficits (and preferably central bank money given free of charge to the government) in order to get demand sustainably high enough. The current situation is unsustainable and will only lead to economic misery.


  1. The central bank is government. It is part of government in the same way as the social security departments are. It would struggle to be classified as a Quango.

    It is explicitly part of government in the UK to the point where it is consolidated into the Whole of Government Accounts.

    Saying the government should give the government money free of charge is a bit daft. It always gives the government money free of charge when required even under the silly rules we currently have. Look at the latest UK Public sector finance statistics and you can see the government paid out £5.0bn in Interest and immediately received £3.9bn of it back from the QE holding of Gilts.

    So the majority is already 'interest free'.

    It doesn't really matter if it is interest free or not. If the interest is mostly saved, then that is just voluntary taxation. Let people count their coins if that excites them. Government should just concern itself with ensuring all real capacity is engaged in production.

  2. I agree with you Neil. But the perception is still that the public debt is the major issue facing the UK; hence economically incompetent governance.

    Making the write offs explicit may help this.

  3. What is or are the definition's of saving that your using? When you say savings are you always using the same definition?

    Is the definition of savings that you use the same for people as for organizations. Are people's time counted as some sort of cost of goods sold and subtracted from revenues? You see, labor is taxed on revenue unlike organizations that get to deduct costs. The time invested in the activity is a non tax deductible and non recoverable cost for people.

  4. What do you mean by wealth?

  5. Is/are your definition/s of saving consistent? And, equally applied to different types of accounting entities?

    For your definition of savings are you always including real flows with the monetary assets flows? Do you count the liabilities too? Do, you count peoples time?

    Are you only talking about cash and deposits?

    Are you only talking about monetary assets and liabilities?

    Are you only talking about financial assets excluding real assets?

    This question is to see a little where your coming from. Do you understand double entry bookkeeping or accounting?

  6. I should have been clearer.

    Wealth is defined as total financial assets held by the household, the corporate and the financial sector, taken from this ons report:

    All of these assets require interest or dividends to be paid. So it does not include real assets.

    Savings in general I define as assets that have monetary value but which cannot be consumed or used. So they are savings with monetary value rather than savings of actual value.This includes money, bonds, shares, property for investment and anything that is held as a store of value. I discuss this a bit more in other posts.

    Basically, everything I discuss refers to monetary value. Does this help?

  7. " I present you the following graph of total assets in the UK divided by GDP:"

    The graph says total UK wealth to GDP ratio and you said, total assets in the UK divided by GDP.

    For wealth I would subtract debt from assets. equity=assets-debt as wealth.

    Also, the graph says extrapolated from 2006-present ONS figures from a 2008 report. It is currently 2015.

    The problem of the aggregate:

    Also, when every thing is aggregated together almost most meaning is lost. Less aggregated would be to have data for sectors. One sector could be doing poorly and an other doing great but the aggregate could look horrible, O.K., great, or other. This is known as the problem of aggregation.

    1. The whole point is that it is not net assets. It is gross assets. All of these assets require interest or dividends to be paid on them.

      The people who are short the assets (eg homeowners with a mortgage or corporations owing money) must pay interest or dividends.

      The total amount of money paid on interest and dividends is almost all paid to savers rather than workers. Therefore, assuming that workers get a certain proportion of gdp, then what is left needs to be divided up between more assets.

      I should have said gross wealth rather than just saying wealth. I do describe it by saying that increase in private sector debt causes wealth but should have been more clear.

  8. Here's how I would construct a helicopter drop in the U.S. to provide good bang-for-the-buck as well as to learn something about the effects of income/wealth inequality :

    Year 1 : Send checks to everyone in the bottom 90% of the income distribution , amounting to 5% of gdp ( $800-850 billion ) , distributed proportional to their last year's earnings ( or , alternatively , the average of the last 3 years ). Since the bottom 90% now gets ~ 50% of incomes , this would amount to a noticeable 10% increase.

    See how things go. Some of that money will be used to pay off debt ( a good thing ), but I suspect that demand will increase substantially nonetheless , and it will be considered a successful stimulus.

    Year 2 : Same as year 1 , except now you appropriate 5% of gdp from the wealth of the top 1% , using a progressive schedule so that the very rich are hit the hardest. Since the 1% hold about 40% of the 4.5x wealth/gdp total , this will only reduce their holdings from 1.8x gdp to 1.75x gdp. They'll scream , but they'll do just fine. Use that 5% to fund government spending and/or across the board tax cuts.

    Over the two year period , note the changes in consumption , gdp , private debt , net worth , etc. The results from this exercise will tell you a lot about how income and wealth inequality impacts the economy. My guess is that the evidence would be compelling enough that a re-balancing of the income distribution would be undertaken , with confidence that further helicopter drops would be unnecessary once in place.


    1. Ha ha! Yes, interesting experiment. I suspect that you are correct about the economic impacts.

      Good luck in getting it through Congress though. I assume you have a few billionaire backers to bankroll the politicians.


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