On Virtual Money and the “Virtue” of Saving

As I mentioned, my New Year reading includes Niall Ferguson’s latest opus, The Ascent of Money.  William Rees-Mogg got through it twice by Boxing Day, so I must be a slow reader.   But maybe a careful one, because like Cable, Cameron, Brown and Darling, I now believe I’m an expert on the topic!

Here’s what I’ve learnt from Ferguson’s Chapter 1 (they’re big chapters, all right?): there are many differences between the virtual money we have now and traditional currencies like gold or cowrie shells.  For example, it is a lot easier to achieve leveraging with virtual money than with gold.  Another salient characteristic of virtual money is that for every saver you must have a borrower.  Virtual money has to be used.  It can’t simply be stored like gold can.

Now, David Cameron seems to believe that saving is more virtuous than borrowing.  If we imagine for a moment that the UK economy were completely isolated, then banks would lend every pound that was deposited.  They would lend available cash to the highest bidder and compete with other banks to attract deposits at a lower rate than they could lend it.  Bubbles in the price of assets, such as houses, will therefore be more likely, the more inequality there is, a point made very well in a comment by Brian Barrington on a Willem Buiter Maverecon blog entry (an entry that incidentally was itself reported in the Telegraph – maybe I’ll comment on it later myself).

The UK economy is not isolated, of course.  What Cameron presumably wants to do is replace overseas savings (which reach the UK mainly via the money markets) with UK savings.  But the pool of overseas sterling funds looking for a home depends on our cumulated trade deficit with the rest of the world.  Whether or not we have a trade deficit with a particular country depends largely on the exchange rate.  If a country, such as China, keeps it’s currency artificially cheap, then they are bound to have a trade surplus, and at least some other countries will be in deficit to it.

All else being equal, and, in particular, unless the trade deficit is addressed, a higher rate of savings in the UK will make asset bubbles even more likely.  Perhaps saving is not so virtuous after all.

Money is for spending or investing.  Many commentators treat the term saving as equivalent to investment, and generally compound the problem by confusing speculation such as on housing with true investment.

Investment is the process of acquiring assets that provide an income stream.  Since the income stream has value, successful investment is a way of preserving or increasing one’s money.

Speculation is the process of aquiring assets in the hope that other people will value such assets more in the future than today.  Buying art is speculation, but so is buying property if you pay more than the value of the income stream from renting the property.  Sound familiar?

Saving is the process of retaining money in the hope that it will value in the future.  This was a reasonable expectation with gold.  Unless it was stolen, or – as Ferguson explains in The Ascent of Money – someone discovers a huge supply of it, you could be reasonably certain it would retain its value.  This is not the case with the currencies of the modern world.

It is in fact very difficult to preserve the value of virtual money.  Inflation is a bit of a headache, and as we saw in 2008, banks can go down as well as stay afloat.  Society already provides a very generous service to savers in allowing them to not only preserve the value of their money, but actually increase it (through earning interest), at (virtually) no risk.  Even if they deposit their money with an institution, such as an Icelandic bank, which is taking such risks with the money that it can pay a higher interest rate to savers than other banks, we (the taxpayer) still compensate them in full. And they’re not even grateful!  [You need to scroll to the Ron Kipps correspondence on the last two links].

Even if it’s remarkably unpopular, surely taxing savings interest as income is the least we – society – should expect in return for the service of protecting the value of savers’ money – in other words, insuring savers’ risks?

Sometimes I want to shake that David Cameron!