Outside the Box

Boosting the economy one account at a time

Pass the Baton

Spend or save? It pays to be prudent if you want financial security. But governments and central bankers do everything they can to encourage people to buy more stuff. So what happens if you try to sit on the sidelines of the consumer economy? If you spend little, but save and invest a lot, are you contributing to or damaging the economy?

An anonymous reader sent me this:

“I personally have a high-saving, zero-debt lifestyle. Everything I need – house, cars, etc. – is paid for, so my essential expenses are quite low (except for health care, on which my spending has increased as I’ve aged). While this allows me to accumulate capital and grow my personal wealth, it also means I’m not contributing very much to aggregate consumer spending (other than keeping doctors, nurses, and a dentist busy). Does my high saving/low spending lifestyle help or retard the economy?”

A good question, and not one that gets much focus. If you spend little and save and invest a lot are you a valuable contributor to the economy? Or is it only the spendthrifts that keep the economic juices flowing?

Let’s start with savings, as opposed to investments. Most of these are bank deposits of one type or another. To understand them we need to take a quick look at the basics of how banks operate, and what they do with your money.

Why your bank needs you

A bank “deposit” is a misleading name, perhaps deliberately so. In reality it’s a loan that you make to the bank. There’s no box with your name on it that’s stuffed full of cash. It’s just a liability entry in the bank’s computerised accounting ledgers. Money that they owe to you. In return they pay you a tiny bit of interest and provide some payment services.

Deposits are cheap funding for banks. Customer money goes out every day, but more money comes in. Overall a bank’s customer deposit accounts make up a huge, constantly churning, revolving credit facility with a low interest cost.

Why do banks need your deposits? Because they have to fund their assets with something (balance sheets have to balance). In the case of a commercial bank their main assets are loans made to customers. Money owed to them in other words.

Where do loans come from? It’s simple: a commercial bank creates money from nothing, adding a new entry into the asset ledgers of its balance sheet. At the same time a matching customer deposit – bank liability – of equal size is created. That deposit may of may not stay on the books of the lending bank. (Very few people understand – or agree – on how the money system works. For more see here.)

At the end of each day each individual bank has to make sure it has enough funding to cover all its lending, old and new. This means that as lending banks grow their customer loan assets they also need to attract customer deposit liabilities. (In the short term – on a daily basis – any shortfalls are covered by borrowing money overnight from other banks that have excess deposits in relation to their funding needs.)

What’s all this got to do with whether your savings are helping the economy or not? It means that if you have money deposited at a bank you are helping to fund its lending to customers.

That may or may not be productive lending, but much of it will be. It’s mortgage finance, car loans, credit cards for consumption, loans for business expansion, overdrafts. In this way, by doing nothing more than saving money and keeping it at the bank you’re doing your part for the economy.

So much for savings. What about investments? Let’s now turn to bond and stock holdings.

Not all bonds are created equal

Bonds are nothing but tradable loans. Organisations borrow money in the bond market. The bond investor receives interest payments and eventual repayment of the loan. The main borrowers – bond issuers – are governments (national or sub-national) and corporations.

You may or may not think it’s a good idea to help fund the government, on top of the taxes that you already pay. But if you buy government bonds then that’s what you’re doing.

Subject to personal taste on the specifics, most people accept that much government spending is necessary, or even desirable. But inevitably a huge amount of money is wasted by the bureaucrats.

In my career I’ve seen massive waste inside large private companies. I shudder to think how much of it there must be inside the vast public sector. For this reason, investing your wealth in government bonds is probably one of the least effective ways to contribute to the economy.

That’s not the same as saying government bonds are always a bad investment in terms of their value to you. Sometimes it makes sense to own them. It’s just that a lot of your wealth effectively becomes dead money this way, in terms of its wider economic benefit.

The other main type of bonds are corporate bonds. If you buy these then some of the lent money will be used productively, for example as capital for successful business expansion. But some will be wasted in unsuccessful activities or on overpriced stock buybacks. Which bonds you own, issued by which companies, will determine whether your money is being put to productive use.

Stock check

Next let’s get on to stocks. There are a lot of people who think that investing in the stock market is a “casino”. Or that buying stocks from someone else in the secondary market (“used” stocks, if you like) has no economic value since it doesn’t inject extra cash capital into a business.

But even if you’re buying and selling in the secondary market, you’re part of the market system which allows the primary market to function. The primary market is where companies sell new shares for cash.

This includes “IPOs” – initial public offerings – where companies list their shares on the stock market for the first time. It also includes “secondary offerings”, which are when already listed companies sell more shares into the markets for cash.

That capital is used to fund business expansion, or acquisitions of other companies, or sometimes to bail out companies in trouble. Just by owning the stock of any companies you are participating in the market that sets the prices that are used for new capital raising.

In other words, owning stocks and shares always means your money contributes to the economy. And, if it’s done right and over enough time, you’ll make a healthy profit in the process. Certainly far more than is on offer from bank deposits and bonds, especially these days.

Overall it’s clear that if you spend little but save and invest a lot then you’re still doing your bit for the economy. Savers’ and investors’ wealth is transformed into someone else’s active capital via the magic of the financial system. That system isn’t perfect, far from it. But it is essential in its role of linking those with excess money to those with a need for it.

So let’s raise a glass and toast the savers and investors for all that they do. Whether they know it or not.

Of course they still have to find the best places to park that wealth, in terms of generating a decent profit for an acceptable risk. In a world where inflation continues its long march – sometimes faster, sometimes slower – low return cash deposits and low yield bonds are the true definition of “high risk”, at least in the long run.

So are overpriced stocks, whose current headquarters is located in the US. But there’s always opportunity to scout out bargains in some corner of the stock markets, whether it’s at home or abroad. Here at OfWealth we continue the hunt…

Stay tuned OfWealthers,

Rob Marstrand


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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.