Tuesday, October 13, 2009

French Keynesians Or Why The US Fights The Secular Force

This is a topic I wanted to write already months ago. Last time I touched this issue was, I suppose, this one in August.

Now I have got the time and an excellent research note from the economists at Societe Generale they wrote back in mid-September. Here is the quote in full:

Higher savings needs higher income and flatter income distribution.

Another secular force that helps to explain long-term movements in savings is the income distribution. Recently, distribution statistics of 2007 income became available, revealing the most skewed income scales in the US since the 1920s, or in some cases even exceeding the 1920s. For example, the top 10% of earners (incomes above $109,630) took in 49.7% of total US income, the highest on record. The top 1% of earners (incomes above $398,909) took in 23.5% of total income, the highest ratio since 1929. These peaks tend to coincide with secular troughs in savings trends.

The peaks in income skewness – 1929 and what is likely to be 2007 – tell us that there is something fundamentally unsustainable about an excessively uneven income distribution. The key lies in the fact that consumption distribution tends to be far more stable. Maintaining steady consumption shares as income shares shift dramatically can only be achieved via expansion of credit from the rich to the poor. This can continue only up to a point, until middle-class incomes can't support any additional debt.

Click on charts to enlarge, courtesy of Societe Generale.

Cross-sectional data also supports a strong relationship between savings and income distribution. France, with one of the flattest income distributions in the western world happens to have one of the least-leveraged household sectors.

The other side of the story is that the top earners in periods of uneven income distribution have tended to invest their excess savings in very inefficient ways. For example, in recent years the savers have financed the excess expansion of housing stock via purchases of mortgage bonds and other indirect investments into the financial sector. Had those inefficient investments never been made (or had the savings been channeled into more productive investments), the savings transfer and a build-up of debt would not have gone on as long as it did.

The moral of the story is that at some point an uneven distribution of income becomes unsustainable because there is no-one left to consume. In the end, the market tends to force an adjustment as it did in 1929 and in 2008. Though these adjustment periods are painful for everyone, the wealthy suffer disproportionate income losses. These include not only lower pay, but also capital gains losses which can wipe out accumulated income earned in previous years. When 2008 figures become available, we are likely to see a significant reversal of fortunes.

If historic relationships continue to hold, the anticipated secular rise in the savings rate will likely be accompanied by a flattening income distribution. Whether these will be market-driven or policy driven trends remains to be seen. However, there is little doubt that deleveraging of household balance sheets requires not only higher incomes overall, but in particular for the middle-income households with highest debt burdens.

Correlation does not mean causality? Well, let's put all, including foreign, resources to fight the secular forces of "Mother Nature"?

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