Economists love jokes about accountants, on the notion that such jokes make economists look better by comparison. This is a false notion. Economists are the butt of jokes because they deserve to be the butt of jokes. No amount of benchmarking against accountants changes this reality. In fact, economists rely far more than they will admit on the intellectual underpinnings of the accounting profession: double entry book-keeping! Debits must equal credits. Assets and liabilities must foot. Revenue recognition and expense recognition must be linked, with any difference accruing to either receivables or payables. Accounting is a very tidy business, and therein is the beauty of the profession.

Economists retort, of course, that life ain’t tidy, and that while accountants may make that which should foot indeed foot, the profession is a static one, blind to the dynamic economic processes that make all that footing come about. Conceptually, this is true. But it is also true that the accounting profession’s job is to document what happened, not necessarily the economic rationale for why it happened. To be sure, accountants do have some latitude in inferring metaphysical economic meaning to the sums they sum. For example, determining the useful life of a depreciating asset is a judgment call, and timing the migration of receivables and payables from the balance sheet to the income statement is both a science and an art. But if art comes to dominate the exercise, then the accountant can be rightfully accused of cooking the books. Accounting is supposed to be a matter of score keeping, not divining the motives of the players in the game.

Economics is, in contrast, supposed to be about forecasting the game. And macroeconomic policy making is supposed to be about improving the quality of the game. That requires developing a view as to why the players are doing what they are doing, and whether they will continue doing it. And to me, the motives of the players always boil down to two things: The strength of the wallet and the strength of the will. For example, a sailor on shore leave has both wallet and will, and it is quite easy to forecast the outcome. In contrast, a stock speculator on margin following a crash has neither wallet nor will, and it is also quite easy to forecast the consequence. The much tougher forecast to make is when there is a dis-parity between wallet and will. Which, naturally, brings us to the matter of the outlook for the global economy, and more specifically, the outlook for the United States economy. 

Figure 1
Source: Bureau of Economic Analysis

It Depends Upon What Your Meaning of "Imbalances" Is
While poking fun at accountants, the macroeconomic profession is presently mesmerized by two putative “imbalances” in the American finances: a large current account deficit, and a large private sector savings deficit. Now, as an accounting matter, these are not imbalances at all, because there are balancing entries carrying the opposite sign in the form of a large capital account surplus, and a large government surplus. How so? Start with the following accounting identities:

  • Net Domestic Savings = Net Private Savings + Net Government Savings
  • Net Private Savings = Gross Private Savings – Gross Private Investment
  • Net Private Savings = Net Household Savings + Net Business Savings
  • Net Government Savings = Tax Receipts – Expenditures
  • Current Account Deficit = Capital Account Surplus = Net Foreign Savings

Doing a bit of rearranging and substituting, we get the cause celeb tautology that is currently wrapping the macroeconomic profession ‘round the accounting axle:

  • Gross Private Investment - Gross Private Savings = Net Foreign Savings + Net Government Savings

All four moving parts (plus a fifth, net private savings) display visual elements of bubbles in recent years, as shown the graph on the cover. The United States enjoyed a boom in gross investment despite a bust in gross private savings (and, therefore, net private savings), as the govern-ment moved into a massive surplus and foreign savings inflows boomed. Those are the facts. Why they came about, and whether they are sustainable, is, however, a matter for debate. And what a debate it is!

Where Economists Stand Depends Upon Where They Sit

Some will argue that America went on a orgy of over-investment, notably in information technology, funded by the kindness of foreigners. In this Calvinist interpretation, the proverbial day of reckoning has come, with investment busting on the back of falling profits and share prices, both of which will cause foreigners to become less kind. To wit, both gross private investment and net foreign savings will fall, with net investment perhaps falling even more, which would provide room for a “much-needed” increase in net private savings, or at least a reduction in the net private savings deficit. Many of these economists seem to live in London, the capital of a country still mourning the loss of global reserve currency status. And the loss of global naval supremacy, perhaps, too.

Others will argue that America experienced a “much-needed” capital deepening process, which is fostering a structural productivity miracle, and that the private sector went into savings deficit only because taxes were too high. In this don’t-worry-be-happy interpretation, there need be no day of reckoning, if the government will reduce its savings by cutting taxes on the private sector, which would provide “room” for both sturdy gross investment and increased net private savings. Many of these economists reside in the Republican party. And where they don’t, they seem to be in the 39% income tax bracket.

Still others would argue that there is nothing the United States either can or should do about these “imbalances,” because they are the consequences of a dearth of investment opportunities abroad, which leads foreigners to send their savings to the States. In this pragmatic interpretation, the global economy would be a better place if foreign economies were to boost incentives for domestic investment, keeping more of their savings at home. But if they don’t, it would be foolish for the United States to purposely do anything to make our economy a less hospitable place for those savings. One economist adhering to this view lives in Newport Coast, California. More generally, this camp carries thick passports, including many stamps from emerging countries.

And finally, there are those who argue that the private sector in the United States was willing to run down the domestic savings rate and borrow ever more foreign savings only because an irrational rise in equity prices gave comfort to diminished thrift out of current income. In this Calvinist-lite interpretation, plunging equity wealth will generate an autonomous increase in desired private sector savings. In this interpretation, the road-to-Damascus conversion to thrift will so weaken consumption as to induce a reduc-tion in all three of the other moving parts: gross investment falls, net government savings fall, and net foreign savings fall (as the current account deficit falls). Economists peddling this angle tend to hang their hats anywhere but Denver, Colorado.

So, you see, economists, working the same set of macroeconomic accounting facts can offer four different interpretations of both the past and the future. How dare economists have the temerity to make jokes about accountants?!? The reality of the matter is that in macroeconomics, there are no right answers, but only a range of possible answers. This particularly applies when forecasting. And especially when forecasting the future.

Where do I come out on these matters? I reject Calvinism a as macroeconomic construct. I do not view spending as a vice, or thrift as a virtue. They just are. Too much of either can be a macroeconomic problem, and too much of both at the same time is the global economy’s current malady: Too much spending in the United States and too little spending outside the United States. The configuration has been in place for many years, and gave birth to a bubble economy in the United States. Now, the United States is suffering from Post Bubble Disorder (PBD), which is putting downward pressure on domestic demand growth. As a consequence, the global economy suffers from both insufficient and mal-distributed aggregate demand growth. This is a much more serious condition than 1998, when American spending provided global aggregate demand salvation.

But as a man who congenitally believes that most macroeconomic woes are but flesh wounds in search of a good policy sawbones, I do not believe that PBD needs to be fatal to secular prospects for continued prosperity. What is needed is merely a proper global diagnosis of the macroeconomic malady that affects us, and an aggressive application of both fiscal and monetary stimulus to global aggregate demand.

What Are The US Symptoms of PBD?

Manufacturing is in recession, and industrial capacity utilization is falling. This is a traditional, Old Economy malady, of course. But it is also a symptom of PBD, in that capacity utilization is falling precipitously in information technology, even as inventories of the stuff are still rising. The good news here is that the Old Economy inventory correction, notably in motor vehicles, is well advanced. And since motor vehicles have a lot of technological goodies these days, a reacceleration of motor vehicle production, which is slated for the second quarter, should help relieve some of the inventory overhang in technology. So manufacturing probably looks about as bad right now as it’s going to look.

But given that there is patently a surplus of capital capacity relative to labor capacity, as shown in Figure 2, the long secular run of a rising profit share of GDP relative to wages, as shown in Figure 3, is over. Yes, I believe there has been a positive structural productivity shock, borne of capital deepening. But I also believe that capital — and government, of which more later — got a disparate share of the fruits of the productivity shock as it was unfolding. Now, its labor’s turn to catch up. There need not be some mythical backlash of labor to produce this outcome. Rather, it will be simply the outcome of capitalism: shares of GDP shift toward the factor of production that is in relative scarcity, and labor has become scarce relative to capital, the opposite of a decade ago. Policy makers should neither deny nor try to “fix” the implied deflationary pressure on corporate profit margins.

Labor Is Scarce Relative To Capital
Figure 2
Source: Bureau of Labor Statistics

Rentiers Are What Rentiers Do
Figure 3
Source: Bureau of Economic Analysis

It is what it is, a capitalist signal that investment as a share of GDP has overshot its new “normalized” New Age equilibrium. Nothing really nefarious about this, as overshoots are the wont of the capitalist system. Unless, of course, policymakers try to repeal the laws of relative factor scarcity. Declining profits as a share of GDP are a “free hand” signal that investment has bubbled, and now needs to burp. PBD.

But, of course, if private investment demand is in for a dark season, if not winter, then some other sector must step to the pole position in the aggregate demand race. Conceptually, labor, with its relative pricing power versus capital, naturally fits the role, with rising wages providing the wallet to express basic hedonistic will. But alas, since capital employs labor, and capital has the power position, labor must labor under the threat of being fired, a wholly disagreeable frame of mind for hedonism.

Such is macroeconomic life when capital is controlled by the few, but labor is supplied by the many. Which brings us to the matter of the democratically-elected government, which ostensibly is controlled by the many, not the few. Both the current level of real interest rates and federal taxation is skewed to the benefit of those with capital and against those in need of capital. Put in more populist terms, the current level of real interest rates and federal taxation is skewed to the benefit of the rich over the poor – reverse Robin Hood economics.

Yes, I know saying such a thing is politically incorrect, but that doesn’t make it any less true. Rentiers are what rentiers do, as that famous economist Forrest Gump might say – the marginal propensity to consume declines with income. Thus, when the economy suffers from PBD, the rentier class is not part of the solution, but the essence of the problem. What is needed is for those long of will but short of wallet to be provided with spending money. Or as I mutter occasionally ‘round here, when there is a surplus of movie theaters, the solution to the problem is not in promoting the building of yet more movie theaters. Instead, tradesmen who built the viewing vestibules need to be provided with the wallet to take their families to the movies!

Aggressive monetary policy ease, explicitly targeting at reducing rentiers’ real return on money balances to zero is one means towards that end. The Fed should simply do it, with dispatch. An even better means to a desirable Robin Hood outcome would be an aggressive reduction in taxes targeted at the financially weakest amongst us, not the strongest. Put more bluntly, I neither need nor deserve a tax cut. Not that I wouldn’t take one, ‘cause I’m as cravenly covetous of more after-tax income as the next chap.

But if stronger aggregate demand growth is required, then I’m a poor candidate for a consumption-boosting tax cut. I traded up some years ago from Oscar Meyer bologna to Boars Head ham, so a tax cut would not have any noticeable impact on my day-to-day spending, but rather my wealth-building ambitions for the future. Nothing economically or morally wrong with building wealth, I hasten to add. But tax cuts for the relative well-off are a damp squib for goosing aggregate demand growth.

What is needed is a tax cut for those whose spending growth is constrained by the hand of Uncle Sam in their wallet, a condition that manifestly describes the “average” American, as shown in Figure 4. The federal government has itself become part of the rentier class, and it is time for the rents, otherwise know as taxes, to be cut. Income distribution should no longer be a philoso-phical third rail in discussing policy aimed at boosting aggregate demand. It’s not a matter of class warfare, it’s a matter of the macroeconomics of aggregate demand growth.

It Is Hard To Put Money In The Bank When
Uncle Sam Has His Hand In Your Wallet
Figure 4
Source: Bureau of Economic Analysis

Time for Principled Populism
The New Age Economy has come of age, marked by a PBD rite of passage. It is time for economists and policymakers to quit belly-aching about the sustainability of putative accounting imbalances, and to find ways and means to improve accountants’ ledgers. To identify a bubble after the fact is merely a bean counting exercise. To suggest the only remedy is to liquidate excesses, as Treasury Secretary Mellon advocated to President Hoover in 1931, is an act of both ignorance and cowardice.

What is needed is capitalist enlightenment, as so manifestly displayed by Henry Ford, when he declared that the men making cars should have sufficient income to buy the fruits of their labors. PBD is an affliction whose cure must arise from the self-interest of the afflicters. The cure, which need not be painful, is dramatically lower real short rates from the Fed and lower tax burdens from the Congress, aimed at bolstering both the will and wallet of the proletariat to consume.

Go ahead, call me a communist, if you must. But if you do, please also tell me where I’m wrong, I plea.

Paul A. McCulley
Managing Director
March 29, 2001


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