"... I'd fax my Congressman and support a $2T on-budget buyout of bank creditors as part of that bill, as long as it had teeth. ..."

Wrong. No cash for trash, period.

the banks have been lending to the banks.

this is not sweden -- a comparitively highly homogenous society.

if you haven't noticed, this is not really a "constituional" "democracy" anymore, either -- but a corporatist oligarchy. fancy words to describe the logical outcome of a century of increasing moral hazard. we NEED liquidity now in mulitples of output.

the dismantling of banking functions you speak of means the dismantling of a social class, the subordiinate classes that serve them, and a big hit to the population at large, which is implicated in it all via excessive debt.

this doesn't happen because someone made a good argument about "receivership": it happens because there are mobs in the street that want it to happen.

ws — speaking of banks and soft information, did you see this rortybomb post, and the very nice study behind it?

turns out that bankers can make use of specific knowledge in evaluating credit. FICOs ain't everything. who knew?

ws — i have very mixed feelings about economic notions like "efficiency" and "optimality" in general, but i will make a small point.

credit allocation affects more than who wins and loses, but also affects what gets done. so, in housing markets, very EZ credit did result in a transfer from buyers to sellers. but it also resulted in a lot of people purchasing homes who otherwise would not have purchased homes (and some lesser number of people not purchasing homes who otherwise would have, for a variety of reasons). as i know you know, "efficient" in the way that economists use the term is not so much about who wins and loses, but about aggregate welfare however defined.

(of course no reasonable definition of aggregate welfare can be indifferent to who wins and loses, given radically different "marginal utilities" in the lingo, but like most convention economics, we'll put that aside for the monent.)

so, a case can be made for efficient credit allocation on the grounds that it results in changes of behavior that increase aggregate welfare. the case is much stronger with respect to business lending than consumer lending. (the case for consumer lending beyond non-rolling transactional credit and the financing of necessity long term durables is weak in general.) consider two businesses looking for loans. if funded, one business will create immense value, while the other will produce little, although both entrepreneurs are sincere. neither business will get off the ground without the loan. ideally, bankers would price the loans accurately, giving an objective view of the project prospects to the budding capitalists. by offering the poor business plan loans at only a high rate of interest, bankers at the margin discourage the squandering of real capital on bad projects, while by offering favorable loans to the good prospect, at the margin, they encourage good use of real capital. there is a range of loan prices that both the banker and the good business would accept, and where in the range of prices the loan is eventually made doesn't matter from an efficiency perspective. that's just a split of the proceeds. what matters, what makes lending efficient or not, is that the pricing of the loans is consistent with encouraging good projects to happen and bad projects to get nixed.

you can extend this kind of analysis to houses and mortgages, but the informational task facing the banker is much, much trickier. the market price of housing has nothing to do with whether a mortage is "productive" in an economic sense, although bankers may be tempted to believe that it offers them security in their collateral. but market prices only offer security when markets are rational and circumstances are stable. a rational banker would have to evaluate the home/homeowner pair as a single utility producing entity. she would have to ask 1) to what degree is the homeowner capable of meeting the terms of the loan despite the fact that the good produced by the investment (housing consumption) is nonsalable; and 2) to what degree is the utility gained by purchasing the home certainly greater than the utility that could be produced by some alternative use of the borrower's funds. just as a business lender will price loans differently based on the probability of business success, even among secured loans that in all probability be repaid, a mortgage lender should price home loans based on these criteria, assuring that homes are easily purchased when they'll be worthwhile to the consumer, not in terms of comparable market price, but in terms of consumption foregone in purchasing the home. but of course bankers have no way of independently evaluating the utilities of alternative consumption baskets, so they defer to the potential borrower, offering a very limited informational contribution to the question of "should this person buy this home at this price". capitalists are supposed to be gatekeepers, crosschecking the enthusiasm of entrepreneurs and thereby contributing to efficient real behavior. but with respect to homes, other than (sometimes) evaluating capacity to pay, they defer to enthusiastic homebuyers who don't reliably check the burden of market prices against alternative consumption baskets. so they enable inefficient use of capital.

i think lenders should be very skeptical of financing consumption goods, for this reason. they cannot evaluate the projects, and may be enabling myopia and foolishness. myopic borrower sometimes service their loans like reliable slaves once they realize their error, but people paying for a mistake are much less likely to pay than people getting continual value for their interest payments. for both the borrower and lender's sake, questionable consumption benefots should be self-financed. of course if this became the law of the land, mortgage finance would in general be restricted to say $200K max (the cost of a utilitarian home for a fam of four), and anything over would be paid with cash. i think that would be a better world, frankly, but the real-estate community would disagree.

oh, the 200K thing wasn't intended as an absolute limit, just as an example of where a philosophy of not financing consumption would lead (with basic housing being evaluable in clear terms as investment, relative to a lack thereof). and there wasn't a policy proposal there, just some thinking out loud about how the world might be different under an ethic of "efficient lending" in the sense of using credit allocation to increase overall economic efficiency.

i have mixed feelings about the german model as you describe it, but i am sure it would be much closer to "efficient" because borrowers are so much more on the hook that they'd evaluate the opportunity cost of consumption more skeptically, and because high down payments permit one to evaluate the opportunity cost of consumption in the near rather than far future, which is easier. but what is a "savings contract (bau-spar)", as opposed to a down payment or mortgage loan?

making shareholders look like bondholders either means a lot of fragility (if dividends or redeptions become like interest or principal payments, enforceable by bankruptcy), or interpreting in the other direction, making bondholders look like shareholders so no one gets to force bankruptcy, takes us towards all equity financing, which would be much less fragile, and more in a direction i'd like to go... (more on this soon, i hope.)

but i feel like i'm missing the point, missing the essence of what you had in mind. i remember our conversation about eliminating limited liability, and the idea that excess leverage might be a trigger for doing so, but can you flesh out where you're going? is it your proposal to make firms effectively all equity by flattening the capital structure, thereby making limited liability moot? all claimants get an equal share of the corpse if stuff happens, and that's that?

The problem with the regulated model is always what to regulate. As you've mentioned, the availability of credit is power. Those with credit use it to successfully bid on scarce resources, shaping what our society produces.

How does the regulator know what should be produced? Here in America for instance it was decided that housing was something we wanted produced, so it was subsidized heavily (interest deduction, Fannie/Freddie, etc.) That seems idiotic now, but it was all the rage a few years ago. If your going to have regulators giving banks direction on how to allocate capital exactly what guidelines are you going to use. How are regulators suppose to know what a responsible investment is and isn't?

Going back to a little Hayek, isn't the information needed to know which projects are best distributed out there in the market, beyond the reach of a central regulator.

To me the entire finance debacle is a principle agent problem. Ownership of capital has become so diluted that owners aren't excersizing oversight of their capital. They are trusting it to agents, who have their own interest, not the principles interest, in mind. Will adding another layer of government agents to monitor the first set of agents change the fact that owners are not managing their capital?

The more layers of agents you add just distorts the fundamental problem: that people are not investing in real economic activity, but whatever they feel they can sell to the next guy for more. Simply put, its more profitable for owners to speculate on which accounts will be blessed with a government guarantee then figure out what companies have promising products. Telling principals that they don't need to worry about that stuff because a government agent is looking out for them isn't a long run solution, assuming of course those government agents are flesh and blood human beings with all the same limitations as private agents.

that's cool, dave, i always like a little rentier thought with my afternoon gruel.

What do you mean by FMR. Google was no help:
http://acronyms.thefreedictionary.com/FMR

dave — i'm with you. that's why i very much prefer structural to supervisory approaches to regulation. ensure financial intermediaries are structured in such a way that funders have incentives to monitor. government supervision can never be adequate, skews credit allocation, and creates implicit warranties and guarantees.

ws — mostly agreed, though it's worth pointing out that patterns of who buys houses for how much are real economy facts with real economy consequences that might be more or less "optimal". also, bank credit allocation led to much more obvious real economic costs, in that scarce physical capital was pretty clearly squandered in building new homes and subdivisions and other residential investment (improvements). it didn't, and doesn't just lead to transfers of the existing stock between buyers and sellers.

mittlewerk — i think ws is talking about a zero-percent (real) risk-free rate on gob't obligations. borrowers would still pay interest as compensation for risk in the form of a credit spread. that its quite the opposite of "communism with a twist". on the contrary, governments offering positive real returns on risk-free short-term lending is socialism for savers, because it implies a transfer of real goods and services to savers who bear no risk on behalf of any productive enterprise and make no other contribution, to the producers of those goods and services. you might argue that lending to the government is a contribution to the broad economy, as after all the government does invest in crucial public goods. but as ws will point out, the government doesn't need to borrow to fund anything, it has the power to conjure funds out of thin air, and it can "sterilize" the inflationary effect, if it chooses to, by straightforward taxation. government borrowing is a kind of subterfuge, a means of obscuring the inflation and/or taxation implications of its spending. politicians may find it convenient to pay lenders a real return for their contribution to that subterfuge, but there's little reason that the rest of us should be enthusiastic.

dave — two quick comments. i don't think we disagree very much, although i am more skeptical than you are about the legitimacy of governments using borrowing as an alternative to taxation and inflation. i think that it's important to point out that from a cash flow perspective, everything you could do with (domestic) borrowing, you can almsot simulate via taxation. a government could tax lump sums from the very same people who would otherwise purchase a bond, and reduce their future tax levels relative to the preexisting baseline to repay the loan. there are obvious problems with this thought experiment — govt doesn't have perfect information on individual preferences to tax exactly the same people who would have purchased its bonds, plus the perception that arrangement are voluntary rather than coerced may have important effects despite identical cash flows. but to a rough approximation, anything governments do with borrowing they could do more transparently without borrowing.

the second point i'd add is that government only needs to offer positive real yields to investors when it borrows in very large quantity or when there is uncertainty surounding govts ability to maintain price stability (ie expected volatility in the price level/inflation). government securities are the financial asset best capable of providing long-term insurance of wealth preservation, if the govt and economy are such that price stability is doable. zero-real-interest Treasuries are the best available option for people who are genuinely savers — that is people who are not maximizing returns, but are trying to transfer the wealth they have today into the future with a high degree of certainty. Transiting wealth into the future, without seeking any appreciation is hard. The next safest tack — storage of some commodity, is costly (storage and insurance), risky (think theft and decay), and speculative (who knows what commodities will be valuable when you retire?). A fiscally cautious state can offer effectively costless storage, as long as its economy does not collapse. For zero-cost, cautious investors can eliminate all idiosyncratic risk (including market risk) and gain assurance that their wealth will be carried forward unless the state weakens or collapses (which risk savers in the aggregate have absolutely no means of avoiding).

unfortunately, the abuse of government debt as a financing scheme reduces its suitability as low-return insurance. A financial crisis, in a sense, comes about when no entity can credibly offer a risk-free asset. In good times, large bank obligations as well as USG obligations were considered that, not now some kind of volatility in the price level is nearly certain, and bank obligations are toast. my view is that the availability of the insurance provided by credibly risk-free assets to small savers (who shouldn't be expected to take risk-investment decisions) is far more beneficial than whatever fiscal smoothing and consequence-hiding is offered by unrestricted borrowing of assets. rather than hawking its obligations far and wide and in quantity, i would rather that government ration the obligations it sells, quite analogously to how it rations FDIC insurance. A person should be able to hold no more than $250K in government assets. government debt should be low, so that members of the public can be confident that the purchasing power of these limited-size nest eggs is secure (for exactly the same reason you want your insurance company to have a conservative balance sheet). to the degree we treat govt assets as a license to avoid market discipline, we are likely to provoke market discipline and lose the govts ability to insure the wealth of the middle class. govt should really think of every Treasury security it offers as an insurance contract, not a loan.

P.S. Trying to use a financial fix for housing available is just dumb. It ignores the price of land - that any subsidy just pushes up eventually the price of land. You need to invest in infrastructure to increase the supply of good neighbourhoods (and research to know how best to do that). Neighbourhoods are mostly about externalities and so a clear case of a public good. Subsidising housing just subsidises developers and corrupts local government.

DAVE: Steve is right, by FMR I meant the Federal Funds Rate (that it targets and tries to achieve by open market operations). I should have been clearer.

SRW: I hear what you're saying, but I've become less concerned with the real asset misallocation of the past. Not because I think it was a good thing, or I underestimate the long term opportunity cost of misallocation, but because when one takes a walk outside in the US it becomes clear that this is a nominal crises, not a real crises. The real misallocation is a sunk cost, there's no sense in trying to reverse it or cry about it now. The stupidest proposal I've heard for ending this crises is to destroy houses (and that's in the face of some stiff competition).

Take a walk outside in Pakistan, and the problems there are very real, but here they are nominal, it's a matter of inconvenient numbers in a spreadsheet. The Govt could simply add $1M to every American's bank account, or they could simply buy every house for twice the zillow value (Moldbug's favorite remedy). Housing crises solved, although we may have problems with inflation.

Instead, the Obama administration gave some americans a check for $400, and is funding private savings through unemployment. Unemployment is a *real* cost to the economy, both in terms of opportunity, and the degradation of real skills. There is a number between $400 and $1000000 that would solve this crises *without* enriching the already grossly overpaid Goldman Sachs.

I don't have the same attitude towards savers that you do, Steve, which is fine, but I will point out that positive interest rates on Govt debt are probably the mildest form of redistribution the Govt engages in! Taxes and spending move a far greater amount of money around than the current 0.25% a t-note gets you (down from a recent high of -- gasp -- 3% or whatever). If you want to talk about transfer, interest rates are the pimple on the elephant.

I also don't think that we think of Govt borrowing the same way. I don't think the Govt needs to borrow at all -- it can issue no notes or bills and simply run an overdraft at the Fed. JKH will jump all over me for this, and he may be right, but it remains a fact that the US Govt does not need to borrow dollars from anyone. It should just stop pretending. Yes, lots of other things would change, but I think how US Govt spending is *actually* "financed" would become clearer, and then maybe we could deal with nominal crises by changing numbers in a spreadsheet instead of putting 30M out of work.

As for your call for low Govt debt, you really *do* have it in for savers don't you! ; )

am i missing something here?

US external debt (currently about $14 trillion) does a lot more than pay the bills; it's probably our dominant foreign-policy instrument. and also the best way to "tax" every trading country for use of the dollar and implied use of the US military.

ws — from the above, i hope it's clear that the reason i object to positive expected real-return on government securities is because it creates incentives for the government to overinsure and the private-sector to underprovide capital-allocation and risk-bearing. (when the private sector fails to bear the risk of economic projects, project quality deteriorates. the overinsured are disproportionately paid off, then, during bad outcomes largely of their creation, while those who invested privately get swallowed by systemic crisis without recourse to insurance. unlimited access to government debt creates a game where the nash equilibrium is everyone-is-insured, aggregate real economy tanks.)

the fiscal costs and distributional ramifications of real-return-to-government-debt are concerns, but less important than the effect of "moral hazard" on the quality of private real investment.

blissex — i wonder how well norquist's logic holds after the "investor class" loses its shirts in a crash clear incubated during a Republican administration...

(btw, i say that by no means as any kind of capital-d Democrat. for the moment the dems seem lots less bad than the repubs, except on the financial issues that most exercise me, on which the two parties are mostly indistinguishable. my politics don't jibe well with either party. jus' sayin', norquist's logic included a hidden assumption -- "and we manage the economy at least well enough that the investor class thinks we're better than the other guys" -- which the repubs extravagantly forgot to sustain.)

ws — I think we are basically on the same page re the nominal crisis and how it could be fixed (and how it cannot really be fixed). And I'm glad, and not surprised, that you are worried about longer term bad incentives.

A couple of things: When thinking of savings and investments, I don't think very much about banks or money. Suppose I want to invest in Winterspeak, Inc. I have claims on a mutual fund. I exchange them for clams on Winterspeak, Inc. The fact that, for the moment, I must instantaneously go into and out of "cash" is an implementation detail of the transaction. Winterspeak, Inc. takes the cash and buys a roboWinterspeak, so your brilliance is not lost to the world even while you sleep. The seller of the robot purchases a share the mutual fund. On net, I gave the robot-maker a claim on a mutual fund in exchange for a robot, which I then traded with you for a claim on Winterspeak, Inc. What I hope to realize from my claim on Winterspeak, Inc. is not a dollar return, but a real return, even if, as an implementation detail, my payoff will be instantaneously in dollars, before I save it in some other worthy investment.

The quantity of dollars, or bank deposits, in these scenarios can be constant, as long as it is larger than any individual transaction requires. The quantity of government obligations held by the public need not grow, if its purpose is only to serve as a medium of ephemeral exchange. There might be transactional frictions that imply some convenience in letting the quantity of one grow with the scale of transactions, some rigidities in "velocity", but these are entirely second order. There is no investment need for anyone to ever hold claims on the government in significant quantities, no reason why the private sector should hold cash or Treasuries, or insured deposits, except for transactional convenience. The reasons why the public does hold claims on government beyond transactional convenience are precisely as insurance, to avoid investment risk, or because the government/banking-system is offering real returns that make hoarding government claims an idiosyncratic-risk-free substitute for real investing.

Paying down debt is not "Winterspeakian savings", in the sense of hoarding government obligations. If, oddly but still very commonly, debt is denominated in dollars, then Winterspeak, Inc. paying its debt involves instantaneously converting goods and services to dollars, delivering them to me with an appropriate return as compensation for my robot advanced, following which I purchase a claim on some nongovernment investment vehicle. Individually, you have paid down a dollar debt, which feels to you analogous to putting dollar savings in a bank, because you are not so deluded as to think there is very much special about the number zero. But in fact, the position of the aggregate private sector with respect to the public sector has not changed at all when you paid me your debt, unless I hoarded the money as cash instead of investing it.

Again, there need be no connection between savings, investment, and the aggregate indebtedness of the public sector to the private sector. The public's desire to hold government obligations is a portfolio choice that the public sector can accommodate or not, at whatever price it chooses, so long as sufficient "money" is made available to mediate ephemeral transactions. If the government imposed a steep tax on holding money or government claims, transactions could still be mediated by dollars, but portfolio balances would shrink to near zero. (Imagine a tax of 0.5% per day -- far less than the credit card fees that are worth convenience of transaction to the private sector.)

I think the line I am drawing is very real. I think that money, as an asset rather than as a unit of account, hardly needs to exist at all, and technological change renders it ever less important. Except that the public loves assets with no downside risk and a positive real return, and so demands bank/Treasury obligations. That's demand we should not much accommodate.

Re moral hazard, I agree we've given up on small depositors disciplining banks with deposit insurance, and recently we've given up on large depositors disciplining banks with TBTF.

But that's not the moral hazard I'm talking about. It is individuals and firms in the nonfinancial sector who require discipline, who suffer from moral hazard. They (we?) are failing to tend to their real investment responsibilities, because the government offers investment insurance cheaper than free. The government/banking-system agglomeration is the soon-to-be insolvent insurance company, selling this insurance in a manner that changes the behavior of its customers in a manner that harms the insurance company's investment portfolio, so that when its customers' claims for real good and services come due, the government may not be able to deliver.

Again, investors in government securities are the insured, and citizens (and China, etc.) are the customers who are led to misbehave by overgenerous insurance. The risk that is insured is loss of individual purchasing power, but by not tending to private investment, the insured are increasing the likelihood that the loss occurs in a manner that exceeds the government's capacity to pay claims. That is the moral hazard about which we should be concerned. (I think we should be concerned about the moral hazard of banks too, but the government/banking-system's discouragement of discriminating risk investment is the mother-of-all moral hazards.)

I'm not really arguing for permanent ZIRP, because that implies low borrowing rates as well as low lending rates. I'm arguing for rationing of the right to lend to the government, rationing that in quantities sufficiently small that the government needn't pay a real return on the funds it borrows. (I'm also arguing that the government not pretend it requires private lending to "finance" its expenditures. I think we're on the same page about that too.)

reason — to be clear, i don't think that government investment offers no or negative returns. i think the returns to government spending can be very high, actually.

but conditional on government keeping its promise of price stability, lenders to the government don't bear any downside risk on their "investments". they are not, in fact, supplying risk capital, it is like they are buying an option that will certainly be in the money. usually the writer of an option is paid for the service, even when its eventual moneyness is in doubt. not so for "investors" in government debt that offer a real positive return. the risk bearing investors in government projects are the equityholders — taxpayers, as JKH has pointed out — not the lenders. to the degree there are financial returns on risky government investment, those should be use to defray tax costs, not to pay zero-risk lenders.

all that said, it's worth noting that historically, short-term US treasury debt has not offered much of a real return, so in a sense the price part of this argument is moot. as you point out, as long as alternative investments offer sufficiently high return at moderate risk, there needn't be much enthuasiasm for lending to government. [the question of longer-term government debt is trickier, in that lenders do bear interest rate risk but not credit risk, which from their perspective requires compensation. the question is why a government would pay this compensation, when it can tax instead of borrowing and return the taxed funds (in lower future taxes or in public goods and services) as it sees fit.]

there is no mystery to me why US aggregate investment returns have been abysmal. 1) quantitatively, we have had an investment boom during this decade, as foreign capital poured into the United States. even under the best of circumstances, diminishing returns would have kicked in; 2) qualitatively, the investment was skewed towards noninformation "safe" investment, which does not creatively discriminate to find hidden high return, productivity-maximizing projects, but instead flows into Treasuries and whatever Wall Street can mass-produce as AAA or low-risk, primarily housing and financial sector leverage. so we had an investment glut targeted at crappy projects (and destabilizing projects, because financial sector leverage tempts gamblers). the results should be a surprise to no one.

dave — great comment. i don't know how hard it would be to develop a productive capital base sufficient to support the lifestyle to which we have grown accustomed, if foreign financing / dollar support disappeared. it may become an empirical question.

we have plenty of "capital" from the recent period: it's not that we quantitatively didn't invest enough, but that we qualitatively invested poorly, e.g. by overproducing houses. what we'll miss before we miss imported capital is imported consumption capacity that masqueraded as capital. GDP will mechanically fall from the depression in residential construction, but those of us outside the construction/real-estate industries will feel is that it'll get harder to make or borrow a buck, or at least harder to make or borrow a buck that buys very much.

as you emphasize, we need to restore a capital base that, despite being flush quantitatively, is qualitatively all wrong. a high savings rate isn't enough, if for example we use TALF to persuade savers to keep investing in houses. we may (or may not, that's up to others) require a high domestic savings rate, but what we really need is a means of using investment capital wisely, of channeling savings to productive uses.

i'm with you wholeheartedly on the last paragraph. one underappreciated aspect of the recent boom is that americans' low savings rate was rational. ex-ante, returns on savings and the cost of borrowing were very low. ex post, actual returns on invested capital were negative. it was smarter to buy a plasma in 2006 than to buy an index fund.

until americans perceive we have a financial system that can offer sustainable returns by funding productive problems, substantially all of our savings will be defensive hoarding of government obligations, which will eventually crack under the load. americans considering saving by investing in risk capital now have no idea who to trust, since as you point out, the intermediaries vying for their business are the same intermediaries who only just squandered unimaginable wealth, and who have not been punished, reformed, or reorganized for doing so. you'd be a chump to trust your funds to "high-reputation" wealth managers now, you've got to either be very selective, or select your own risks by purchasing claims on specific firms or projects.

ws — re imports, i think it depends. imports are good in terms of present consumption, but if they deter capital development in the importing country and are not indefinitely sustainable, than they can be bad, ultimately both for the importer (who is left with a depleted capital base) and for the exporter (who forewent current consumption that is ultimately not paid for in equivalent goods and services). debt-financed imports certainly provide short-term benefits to the importing country, and in theory, a well-managed importer could foresee future capital needs and avoid long-term costs. that would be a clear win. but in practice, countries with the luxury of debt-financed imports are often behave myopically, with bad consequences. although there are exceptions (debt-financed imports of tradables-producing capital goods, or asset-financed imports by an aging nation), as a rule of thumb, imports are much better in practice when trade in current goods and services is balanced.

i think we talk past one another a bit, but i stand by my claim that deleveraging needn't imply "winterspeakian savings". private-sector balance sheets can be arbitrarily leveraged to one another without involving the government at all. if i owe you $1000 and you owe me $1000, and i have $1000 cash too, i can pay you, and then you pay me, and we have both deleveraged, while the public sector deficit has not increased. winterspeakian savings (ie hoarding govt obligations) must occur only when the aggregate private sector deleverages with respect to (or simply lends to) the public sector. but not otherwise.

the private sector cannot increase "savings" only if savings are defined as holdings of government obligations. if building a factory counts as savings, the private sector can certainly increase savings without any government accommodation at all. balance sheets, even dollar denominated balance sheets, needn't collapse to zero. i can use dollars as simply a unit of account, even if none of the actual asset exist in the world. if there were literally no dollars, transactions would be difficult. but as long as there are enough dollars to cover any given transaction, the quantity of dollars places no constraint on any particular private sector entity's balance sheet. you are right that the private sector as a whole cannot net deleverage without govt accommodation, but that's because the world is divided into two sectors, and there'd be no one else for the private sector to transact with. but the quantity of overall debt in the economy does not depend upon the government. in the recent past, the private sector levered up much much more than it borrowed from government. the public sector is being forced to lever up to counter the effect of intra-private-sector deleveraging on nominal GDP.

fiat currency almost never has non-negative real return if placed in a mattress, but government guaranteed assets have had reliably positive medium-term returns. if the gov't can maintain a price-stability commitment of 2% inflation and offers securities paying at least 2%, we have an asset with no downside risk and positive real returns.

you are right that, in fact, there is no such thing as a guaranteed investment, and government price stability commitments are always contingent. i think we will see a US fiat money breakdown, and it will take the form of violating the public's "risk free" expectation with inflation higher than bond returns. but ex ante, that is not what the public expects, nor what an investor extrapolating from past experience would expect.

(in the 1970s, there were 6 years when short-term gov't debt failed to outperform inflation. also 1980. also in the mid 30s and WWII related in the 40s. but otherwise the 50s, 60s, 80s, and 90s all offered consistently positive real returns to T-bills, and long-term real returns to T-bills have been positive. real returns on longer-term gov't debt — bonds — are year-to-year volatile due to interest rate fluctuations, but holders of LT gov't debt over time have earned substantial real returns. holders of FDIC-insured bank CDs would have also earned positive real returns, although holders of insured checkable deposits would not have.)

the public believes that govt securities (and bank CDs) preserve purchasing power at zero risk. (at least the public believes that of TIPS and govt securities whose nominal return is >= ~2%) that's a bad promise for government to make, but it is an expectation that govt has intentionally cultivated.

i'll agree with you that the phrase "government obligations" is an oxymoron. ("private-sector tax anti-obligations" might be more accurate.)

SRW: My question about imports was to see how you separate real vs nominal. Based on your answer, we don't see this distinction in the same way. If you look at real goods and services, physical stuff and work, then imports are always a real benefits, and exports are always a real cost. You can make sophisticated arguments (as you do) about long term capital erosion etc., but fundamentally, if you ignore money, stuff coming in is good.

I'm not sure why "not being sustainable long term" makes imports any less good? Maybe this is an extension to your capital erosion argument (which I am sympathetic to, btw.) In real terms, imports are good for as long as you can get them. Long term sustainability, ie. exporters won't remain stupid forever, doesn't change that dynamic.

Not sure I know what you mean by debt financed imports. Is it households going into debt to consume goods that happen to be imported? Or a nation running a budget deficit AND trade deficit at the same time? My question was very much focused on the real economy remember, financing does not come into it.

The private sector as a whole cannot delever, although private sector balance sheets can shrink as a whole can absolutely shrink to zero. Your example actually makes it clear why this must be so.

In your initial state, the combined balance sheets add up to $3000, $2000 of which is credit, and there is $1000 of equity (the initial cash).

In the final state, the credit gets paid and cancels out, so the combined balance sheet for the sector if just $1000, all of which is equity.

My point is that that $1000 of initial equity *has* to come from somewhere, and the place it comes from is another sector, the non-private sector, AKA government. In a fiat world, Government currency primes the pump. Now, if the private sector has $1000 in equity, the Govt balance sheet must have negative $1000 in equity, and this is why I resist JKH's characterization of the Govt having positive equity in its combined balance sheet.

If that equity was not there, the private sector balance sheets would simply collapse to zero. Private sector balance sheets *must* net to zero.

Also, note how the private sector *cannot*, as a whole, increase the amount of equity it has. It began with $1000, and it ended with $1000. For it to get that number about $1000, it needs another sector to lend to it.

Building a factory does not count as savings. That's investment. Buying a car does not count as savings either, it's consumption, or maybe investment too depending on the car. Buying gold does not count as savings, it's investment as well, but might be consumption if it's jewelry. Paying taxes does not count as savings no matter how you spin it. You save money when you don't spend it. This is not some crazy definition I came up with, it's how it's defined in then national accounts, and how it's understood by everyone. Try running a poll:

1. If you get some money and spend it on building a factory are you:
[ ] saving the money?
[ ] investing in a factory?

2. If you get some money and don't spend it, keeping it in the bank instead are you:
[ ] saving the money?
[ ] ?????

I don't mean to be snippy, and I'm also happy changing "savings" to "hoarding" in the above example, but I think it would be really helpful to define savings as what it is -- not spending.

I'm using a narrow definition here, and certainly not claiming that hoarding defers consumption, or does any of the positive things people associate with savings. But money that comes in, and does not go out, is money hoarded.

Private sector balance sheets can lever to any degree, and provide investment for any number of factories, and credit for any quantity of consumption. But, at a sectoral level, they must always sum to zero. The private sector is totally self funding in this sense. But it can also collapse to zero. For the private sector to have any equity at all, that needs to come from another sector, which could be the Government, or it could be some fixed third party, like Gold. Under a gold standard, with credit, a credit collapse would limit the amount of money in the world to the amount of gold in the world.

ws — we live in such different frames of reference! you chide me for being overly "nominal" wrt imports, but i think you are being overly nominal wrt balance sheets.

the private sector requires no government scrip to have equity, even if we measure balance sheets in dollars. equity and cash/govt-securities are two completely distinct concepts. if my firm owns two cars, one outright, one financed with a nonrecourse loan (so its debt can be said to be one car), the firm has a equity of one car. i can redenominate the balance sheet in dollars, claim each car is worth 20K, and i have 20K in equity.

this isn't at all unusual. i prepare a balance sheet for my dormant consulting firm each year as part of a tax return. i'm too lazy to look, but it has maybe 40K in equity, and maybe 300K in cash or govt securities. that the balance sheet is written in dollars is a just a choice of units. (it is a "choice" required by the IRS for US tax purposes, but if my firm had significant operations elsewhere, i might be required to duplicate the same economic balance sheet in pesos for some other tax authority.)

the private sector's net equity is the value of the real economy privately owned. it is not zero. the balance sheets of firms tautologically net to zero, but the "balance sheets" of households do not, in any meaningful way. household equity is not an obligation to anyone, and can't be netted away.

neither balance sheets nor income statements nor transactions depend upon any form of government scrip. the private sector can increase its absolute equity. in Arnold Kling's fave metaphor, begin with a seed, plant a fruit tree, harvest the fruit, then plant two more. the private sector has self-capitalized, in a way that is visible if balance sheets are measured in dollars or any other tradable asset.

you are right that most people view savings as saving money, and view claims on government scrip as money. but that view is not what economists mean by savings, and this is one of the few places where i think it'd be better if the general public learned its lesson from economists. actually they have, kind of. most people do view their 401Ks as savings, but if their "money" is invested in an equity fund, their "savings" consists not of dollars (although they might think of it that way), but of claims on factories and fleets and the dance of business organization. in economic theory, savings and investment are an identity, savings is investment. in real terms, we've created financial investments that support consumption, or that might provoke no real economic consequence at all, like credit-card receivables and government debt. but those are and ought to be aberrations, you have canonized as "savings" the aberrant practice of putting money in a government-affiliated bank. but the bulk of people's savings, at least until very recently, was not held as claims on government or claims on banks. it was held as claims on capital or future labor.

it is simply a bad idea to define "savings" as the odd subset of the category that takes the form of unallocated claims on government. it has a certain intuitive appeal, because naive savers think they hold "dollars". you are right to plumb deeply the consequences of the world in which we live, where people demand "dollars" and government can supply it. that fact does have real effects, and creates real economic opportunities and traps with respect to how the government issues its freely conjurable scrip. but you need to be clear about why it would be useful to call holdings of that stuff "savings", and segregate it from "investment". i'll not let you get away with it in our conversations, i'll make you qualify holding scrip as "winterspeakian savings".

i will grant you a distinction that i sometimes use: it is one we've much discussed. "savers" are primarily motivated by hedging, by minimizing the risk of losing consumption power as they move into the future. "investors" are primarily motivated by seeking positive real returns. but even here, the distinction is slippery, a matter of degree rather than kind. savers do seek positive real return, if they can get it at sufficiently low risk, and investors do avoid risk as much as possible while seeking good returns. for both groups, the question of whether to hold govt scrip of any sort is only a portfolio allocation decision. cash, T-bills, bank CDs, etc. are just ownable assets. to those who have faith in a govt price-stability commitment, govt scrip is just a very low risk, modest return asset, so "savers" tend to have portfolios disproportionately in those assets, while "investors" gravitate elsewhere. but there's a continuous terrain between, and fundamentally the distinction is arbitrary.

re imports, i suspect in actual conversation, we'd agree more than we'd disagree. i'm happy to concede that real imports are better than no real imports, ceteris paribus. however, bundling real imports with a short position on promises (whether denominated in dollars or any other thing) break the ceteris paribus, and such an arrangement is not necessarily a good thing.

unsustainable real imports might be a bad thing too, even with no promises asked, if they break ceteris paribus by altering our behavior in maintaining the capacity to produce. but if we can maintain (however dormantly) our full production capacity, then sure, we might as well enjoy costless temporary consumption (or investment), and be no worse off when the good times end and we have to get by on our own. unfortunately, we tend not to maintain our capacity to produce while others temporarily supply, we are not collectively good long-term optimizers in the way that simple theory holds we should be. if our long-term optimization capability is sufficiently good, then we clearly gain from temporary real imports with no strings attached. however, if we are too myopic, temporary free imports can paradoxically provoke long-term harms. it's hard to say no to a subsidy, but poor decision-makers can be better off when they are constrained than when they are free, and that yukky paternalistic argument might apply more strongly to national economies than it does to individuals.

Steve, I also wanted to apologize if I come across as being curt. If anything, it's because I have too much to do and cannot spend the time I'd like to thinking about your ideas.

If you're in the bay area ever, let me know.

Steve,
I dispute your claim and that of the Austrians that there has been a massive overinvestment in housing (never quantified). Look at this chart:
housing starts

It is the price of LAND shooting up that is the bubble not the very weak (despite massive fiscal stimulus) real economy. It asset prices that tell the story. But why is all the money going to speculation rather than real investment?

My reading is that the peak (never so high) has already been offset by the subsequent crash. And given the relatively low level of industrial investment, why shouldn't resources be allocated in that direction? The problem is not that people didn't want to consume more housing, but that they bought it at too high a price. I stick by my view that speculation in asset prices is the main story here.

Hi, interesting post. I have been wondering about this issue,so thanks for sharing. I will definitely be coming back to your blog.

SRW: The connection of savings to investment is *exactly* the nexus that I'm trying to explore.

In the typical model, and I used to think this as well, savings would be capital allocated towards investment, so S->I. Now, "I" could be inventory, so you get high savings and cars piling up on Long Beach, but the causality driver was clear. First you get savings, and those savings fund investment.

Your point, I think, is that many forms of savings (ie. bank deposits) don't drive investment at all, or do so in ways where the saver is abdicating all of the due diligence an investor is supposed to do (to justify their compensation). Why does a "saver", who just puts their money in an FDIC checking account, deserve anything other than a 0% return? We want more minds thinking hard about the future and making asset allocation decisions, not fewer.

My contention is that the causality is reversed, S does not drive "I", instead, I->S. If you have "I", "I" that works out, then that creates S.

The S in S=I is the same as the Keynesian S. S=I comes from National Income Accounting, which defines GDP = C + I + G + (X - M). Winterspeakian savings is GDP - C - I - T = G - T (X-M). GDP (income) - C - I - T is exactly the same as income minus expenditure, and distinguishes between investment and consumption (which is someone's income) and hoarding (which is no one's income).

Am I missing something?

reason — FRED is back, so do check out this graph of real residential investment. The investment boom was not subtle. I agree with you that it was in part due to a lack of good investment opportunities in other sectors, that it was partly a "tallest pygmy" story in a time when the US was awash with financial capital seeking returns. And, per my comment to Winterspeak, much of why it was the tallest pygmy was because financial intermediaries knew how to fund residential investment "safely". But all this did lead to a very large redirection of real resources to building and upgrading residences.

You are certainly right that price inflation played a substantial role. But per Winterspeak, on the upside price-inflation just results in transfers between individuals. It is anti-price-inflation that becomes a systemic concern and produces harms. But overinvestment in residences destroyed real resources during the boom, even if many people didn't know it. Dilapidating tracts in the exurbs, especially out West, now tell the tale.

I won't argue that things were "right" before the R.I. boom, although to get before the R.I. boom you really have to be in the middle of the dot-com bubble. Things haven't been quite right for a long while now. (Maybe "right" is too much to ask for.)

dave is certainly right to point out that poor investment was made in lots of sectors during the credit bubble. The R.I. boom is a salient and important example, but it is hardly unique. Private equity, commercial real-estate, etc were similarly overinvested. (Although with PE, it was more a matter of price inflation, the excess financial investment resulted in a lot of transfers, sometimes slimy transfers, but PE investors tended to withdraw financial capital rather than employ it, so real costs are side-effects of the fall, e.g. overlevered productive businesses fail unnecessarily, leading to less production than under alternative scenarios.)

Pls ignore cribbed S=I derivation at the bottom of the post.

Steve
(and this relates to your discussion with WS as well) I think the housing boom only got serious in about 2005. It looks to me like a short and narrow spike (which means that the total amount of investment is not that great). I still read the charts as saying that any "excess" investment judging by the area above and below a trend line, has already been wiped out. If we want to see that something is seriously wrong, we have to look at debt - particularly household sector debt.

The housing bubble (post-2005), financed fraudalently, was a last desperate attempt to keep the good times rolling, I see it is something endogenous in response to underlying problems, not the source of the problems.

Now I agree with WS that the US is lucky - they own the reserve currency and can just print it to pay off their obligations. And they should print it, and spread the money widely rather than narrowly. Some will still go under, some will prosper and some will hang on - hopefully the least prudent will suffer the most. This however, still leaves the problem of the disastrous foreign balance (which is the source of the problem in my view). If the US is lucky enough and prints enough money then maybe it can be rid of the reserve currency status. It works like an oil or gas industry (the dutch disease) to distort the real economy.

P.P.S.
And I'm with Winterspeak in that we need to see the financial economy and the real economy as related but parallel worlds, large parts of which function independently from one another.

One thing I think is valuable to understand is that investment must meet future demand i.e. demand from savers. Borrowers will not be able to borrow more and more forever so at some point they will have to pay back their borrowing to savers who gave it to them.

This is important because businesses generally respond to past demand trends. They see what people are consuming today, what rate it is increasing at, and extrapolate. Investors do the same thing. This has some problems. Ideally, we would like investors to be expressing their own future consumption preferences so that the capital to produce them will be available. For example if an investor if going to need more healthcare as they age it would be nice if they invested in stock of healthcare providers so they could expand capacity to meet those demands.

Instead, borrowers are generally driving capital allocation. Savers/investors, rather then expressing their future consumption preferences, are largely providing the capital to produce the things borrowers want. Herein lies the misallocation. After years and years of ever rising debt levels (the cause of which lies at the heart of our banking system) our entire economy is organized around producing goods to be consumed by a pool of ever indebted borrowers. No thought is given as to how those borrowers pay it back. What are they going to produce that the savers want in return and how do they produce it?

Steve,
I'm not too sure that savers know what their needs will be in the future (particularly as the future will offer options they don't have now AND vice-versa). Savers just trust the system to deliver what they will need in sufficient quantities, they don't have a crystal ball. But yes, the system hasn't worked too well, but I'm more inclined than you to think it is the international system that has failed, that a big part of the problem is that their are NO profitable productive investments in the US because the US imports twice as much as it exports.

In practical terms we agree a lot more than in theoretical terms... we'd make very similar policy choices, but never stop jousting with our pens...

So, there's lots I disagree with here. In a closed economy without a government, one might define...

Y = C + I

We'll let it be a barter economy, since there is no government scrip. Maybe some commodity evolves as a convenient medium of exchange, maybe it's a high-tech world where frictionless markets and cross-exchange rates between goods and services render money unnecessary.

In that economy, would it be true that

Every investment would lead to some consumption until there was no investment left.

No, of course not. There would, as you say, be some "hoarding". In the accounts, my exchange of say gold for a television might count as "consumption", but in fact, purchase of a television is more like investment than consumption. Nothing goes "poof" when I buy the television. To prevent some consumption black hole, all that needs to happen is people have to hold goods without destroying them.

Let's suppose now that there is an indestructible monetary commodity. Let's call it "gold". Assuming property rights are exhaustive (someone owns everything), it would be impossible for everyone to have zero monetary balances. So, some people would hold gold. But is there any relationship between the stock of gold and the fraction of other goods that is held or used in production rather than being destroyed? Of course not. Some "investment" would take the form of gold held. Other investment would take the form of lumber purchased and transformed into looms. Consumption might take the form of burning wood for heat. (The distinction between "investment" and "consumption" is a judgment call about the future value of a present use. Even burning wood is investment, if the alternative is starving to death. Output can't be neatly decomposed into categories of what is "saved" and what is "consumed".)

But let's simplify. Let's consider a two good economy, where the goods are gumballs and gold. All exchanges are mediated by gold. There is a magic gumball machine that produces 100 gumballs each period, which are randomly distributed. I think this is fairly close to the economy you are imagining.

People may be fickle about which color gumballs they like, so there may be exchanges of old gumballs and gold. But we don't count that as Y. Of the output, the new gumballs, some gumballs get eaten within the period, some do not.

Y = C + I = C + S by definition

Does the quantity of gold have anything to do with how many end up "saved" and how many "consumed"? If it does, it certainly isn't obvious to me. Assuming an equilibrium, probably the gold is primarily in the hands of those with a low time preference of consumption, since holding gold substitutes for holding gumballs, but only gumballs can be consumed. Eventually those with low time preference hold all the gold, so very few transactions occur. We end up in a spenders, savers equilibrium where gold is irrelevant, and aggregate savings is determined by the ratio of spenders to savers. If gumballs held yield more than one future gumball, the proportion of output saved goes to one in this economy: "savers" hoards grow exponentially, output does as well, and the fraction of output falling to spenders and consumed goes to zero. In every period...

Y = C + I = C + S

...but despite the fixed money balance, Y and I (or S) go to infinity while C remains constant. (A Marxist crisis of accumulation in a nutshell...)

Now suppose that there is no gold, but there is government scrip. If the quantity of government scrip is fixed, it is identical to the gold case. However, if G collects taxes in scrip, and only issues scrip in exchange for gumballs, consumers will have to consume less, and savers will deliver some of their gumballs to the state for scrip, which script they will also deliver to pay taxes. If the government budget is balances, there is no net scrip issuance, since all the new scrip surrendered for gumballs is taxed. What effect does this have? The goverment can itself store the taxed gumballs, in which case we haven't fundamentally altered the economy. Government will be like a saver, and we'll have the same crisis of accumulation, but faster as some of what would have been consumed will be saved. If the government can destroy assets, and does so, the existence of a currency-issing taxing G will lead to less aggregate savings. If the government itself neither saves nor consumes, but simply distributes the gumballs it collects, the effect on savings and consumption will depend upon its pattern of distribution.

Now suppose the government issues more currency that in collects in taxes. It does so by purchasing gumballs with currency, but not taxing back all the scrip. Savers in the economy sell gumballs for the excess scrip, as long as they believe that the scrip will allow them to avoid selling a future gumball to meet a tax burden, the scrip is "as good as gold". From the savers' perspective, holding a gumball or holding excess scrip are perfect substitutes. In their own accounts, this transaction has not affected savings, although some of their investment portfolio takes the form of scrip.

But in aggregate, whether savings/investment increases or diminishes depends upon what the government does with the gumballs. If the government stores the gumballs, nothing changes. But if the government destroys the gumballs, or redistributes them to those who would consume rather than save them, savings decreases! This, "Winterspeakian savings" — a government deficit — can result in increased consumption and less aggregate savings/investment in real terms. This is an intuitive, and conventional, analysis. If governments borrow and spend their borrowings in a manner on goods and services that are consumed or destroyed in a way that does not improve future periods, or if they redistribute to those who do, aggregate savings diminished. Note that this can be a good thing: It is quite possible to save and invest too much (and if we allow for variations in investment quality, too poorly) so that more present consumption by parties who otherwise would be unable to consume is optimal. But "Winterspeakian savings", or government budget deficits, can lead to less aggregate savings than would otherwise occur in exactly the manner that people conventionally understand.

However, government can issue scrip to people who would otherwise consume. This seems odd: if scrip is convertible to gumballs, and I'd rather consume a gumball than hold one, why would I hold scrip? But governments can set the price in gumballs of scrip arbitrarily, and can make the penalties for not coughing up arbitrarily large, so that even those who ordinarily would prefer to consume prefer to hold scrip against future taxation, for fear that if they do not have scrip they will be badly penalized. If governments persuade those who otherwise would have consumed gumballs to sell them for scrip (as well as those who would have saved anyway), and if government stores rather than destroying, then net issuance of government scrip can increase aggregate savings.

The lesson, I'll say again, is there is no necessary relationship between the quantity of a medium of exchange and the fraction of output that is consumed or invested, and there is no necessarily relationship between government currency or debt issuance and the fraction of output consumed. It depends. But in practice, government deficits more often increase the fraction of output consumed rather than "marking" in some sense private savings.

The economy you want is one where investors only hold government paper (that is, they do not directly store capital goods), and where the government holds but does not destroy the goods surrendered in exchange for that paper. In such an economy, yes, government paper would serve as a marker of private savings. Only government would hold real investments, and S = I = G - T would hold. In such an economy, storing money under a mattress implies government savings or investment, sure. But that is far, far from reality.

If individuals can hold capital goods directly, or if they can hold paper claims directly on one another's properties, then there is no necessary relationship between (G - T) and government savings and private investment. If government does not save or invest the goods and services it purchases with taxes (that is, if it destroys or distributes to people who increase their consumption), then (G - T) is in no sense a stand-in for investment, and the relationship between (G - T) and aggregate real savings can be (and often is) negative.

I think you are hung up on accounting. If something is saved, it must show up in someone's accounts as savings, right? It certainly does. But here we come back to balance sheets, and the lack of relationship between units of denomination and assets held. If I am a saver of gumballs, I may write a personal balance sheet that includes an asset of 10 gumballs, valued at $10 ea, so an asset of $100. My equity is then $100 on the other side. This is not a net-zero balance sheet, since my equity is no one's claim. I have "savings" worth $100. But I don't actually hold $100 of government scrip, and the quantity of government scrip out there has no bearing on my ability to save. If there were no government and gold were the medium of exchange, I might write a balance sheet for my gumball holdings in terms of ounces of gold. I can save individually, and the economy can save in aggregate, and the expressed-in-gold-value of the economy's wealth can grow without bounds, even though no new gold is issued. (The in-gold-value of the aggregate balance sheet might do all kinds of crazy things, as nothing fixes the gumball/gold exchange rate. But the total quantity of gold never limits the total expressed-in-gold value of private balance sheets.

Back in the dungheap, if you believe the Fed Flow of Funds, US household net worth is roughly $51T, while USG liabilities (including the Fed) are roughly $13T. If we consolidate liabilities of the whole financial sector as USG obligations (screams of agony!), we add 17T, bringing us to $30T. Anyway you cut it, household net worth exceeds the stock of US guaranteed claims. The quantity of USG claims tells us something about the fraction of household assets (not net worth) that is state guaranteed, but nothing about the fraction of assets that will be held forward or used to produce in future periods. Running a greater deficit implies that households swap other assets for government claims, so it probably implies something about the volatility of household assets in USD terms (since govt claims are guaranteed). There is a strong relationship between govt claims and the liability side of household balance sheets, since as you often point out, household sector liabilities must be to the public sector, since liabilities to firms are indirectly liabilities to households. (FoF US household liabilities ar ~14T, which is close enough for govt work to the $13T formally guaranteed and just a bit of the financial sector guarantees taken "on balance sheet" (so not added back into the household sector somewhere).

I find Winterspeakian savings to be a very useful concept, because it gives us intuition about how guaranteed the private sector's assets are, demand for such savings tells us something about private sector risk aversion, and choices we make in meeting or failing to meet (or partially meeting via unemployment &benefits) that demand are important. I love your consolidated view of money, where government speand or lends it into existence and borrows or taxes it out of existence, and never requires "financing" of any sort in its own currency. But I really think it's misguided to imagine that there is any necessary relationship between G-T and real savings or investment (good or bad). I think the closest you can get is that if you define G-T as investment (maybe very bad investment, but on the theory that lending counts as investment whatever its purpose, like credit card receivables), then you can say S = I > G-T, with the quality of I due to G-T questionable. There may be second order effects — govt may borrow from "spenders" and then make transfers to "savers" savers so that govt deficits and even quality real investment covary. A lot of scenarios are possible, but there's not a deterministic relationship.

Anyway, we agree that, mediated by govt claims or not, savings/investment in an accounting sense tells us nothing of quality. I think we agree that the line between savings/investment and consumption is blurry at best. But however defined, I think we still have pretty significant disagreements about whether government deficits and real savings/investment (however defined) have a necessary, positive relationship. I don't think so, but I'll bet your unpersuaded. It's remarkable, that despite that, our actual policy intuitions are very close.

[Update: Struck an incoherent bit in the above. The liablity side of the aggregate household balance sheet can't be interpreted in the way I suggested, it makes no sense. The FoF household sector's liabilites are also household sector assets. The liability side just "grosses up" the balance sheet, without an effect on net worth or any plausible relationship to govt liabilities. Brainfart!]

Ack. I promised myself I would not do this, but I think I see the point you're making.

You're saying that the private sector can increase it's savings rate by simply altering the balance between cash in circulation and cash in the bank. No need for higher Government deficits. When I say "increase savings" I should say "increase savings while maintaining aggregate demand" because as velocity falls to zero (100% savings) AD falls to zero as well. In the real world, Fisher's debt deflation keeps prices from adjusting, as lower income is not met with lower prices but with dramatic decreases in money supply as credit is written down, and equity is consumed. I think that puts us in the same place wrt to goods, scrip, and prices. I still don't think you believe that I = S, to the penny, because S accounts for I.