Private Sector Saving is Not Saving Net of Investment

I’m highly sympathetic to Post-Keynesian economic perspectives. Post Keynesians generally prefer to work from an operational perspective so there is a strong influence on how the economy works at an operational level which includes a fairly thorough understanding of stock flow consistent accounting.  As I like to say, accounting is the language of economics so it’s pretty important to get the accounting right if you’re going to understand how the monetary system and the economy operate.

Anyhow, David Graeber had a popular video and op-ed in The Guardian the other day in which he appears to be using a line of thinking that is often commingled with Post-Keynesian Economics – Modern Monetary Theory (MMT).  Unfortunately, David made several errors in his video because he was using these MMT based misunderstandings (MMT responded to this, but made the same errors they always do).

MMTers have been harshly criticized (primarily by Post-Keynesians here, here and here for instance) for these errors and it continues to generate a good deal of confusion. The Graeber video generated a discussion on Twitter and here so let’s see if we can’t clarify some things.

In the video Graeber makes a series of bold statements about “accounting identities” and “simple math” when he refers to the government’s deficit.  He concludes saying:

“If the government balances its books it makes it almost impossible for you to balance your books”

This statement is wrong and misleading.  And David’s error stems from something we see in MMT on a consistent basis where they depict the economy through a 2 or 3 sector lens.  The cause of this error is the result of MMT’s alternative definition of “net saving”.  Now, in economics 101 net saving is consistent with the way the OECD defines it:

“Net saving is net disposable income less final consumption expenditure.”¹

MMT consistently uses the term in a different manner, however.  They take the 3 sector model of the economy (as seen in the Graeber video) and simplify it.  Not to get too wonky, but here’s how they get there:

GDP = C + I + G + (X – M)

Where C = consumption, I = investment, G = government spending, X = exports & M = imports

Or stated differently;

GDP = C + S + T
Where C = consumption, S = saving, T = taxes

From there we can conclude:

C + S + T = GDP = C+ I + G + (X – M)

If rearranged we can see that these sectors must net to zero:

(I – S) + (G – T) + (X – M) = 0

If we rearrange the above sectoral balances equation we can arrive at a very important identity:

(S – I) = (G – T) + (X – M)

If you assume a closed economy you could say:

(S – I) = (G – T)

This is precisely what Graeber does in his video.  And the conclusion is simple – private sector net saving (S-I) is a function of the size of the government’s deficit which leads one to think that the private sector cannot save unless the government is in deficit. Except that (S-I) is not “net saving” in any traditional economic perspective.  (S-I) is saving net of investment. It’s extremely misleading to define private sector “net saving” as (S-I) because Saving cannot identically equal (S-I) unless I is equal to zero. This is, to be kind, preposterous as investment is the most important part of the entire economy. Investment spending is quite literally the thing that makes the entire economy tick as it reflects the things we build, innovate and produce.

MMT redefines private sector net saving as saving net of investment in an effort to argue that the government “must be in deficit” or by saying comments like “absent…government deficit, the domestic private sector cannot net save“.  They even go so far as to say “If the government always runs a balanced budget, with its spending always equal to its tax revenue, the private sector’s net financial wealth will be zero.” Or saying things like “the national debt is the equity that supports the entire [economy].” This is all incoherent. The national debt is not equity. You cannot just print equity into existence. Equity is built through investment spending.

A more accurate depiction of this concept would do what Wynne Godley actually did and depict the sectoral balances model in a much more granular manner. After all, the “private sector” is not a homogeneous entity. It is specifically structured as thousands and even millions of separate sectors that net save against one another. The most important of these sectoral relationships is the household sector versus the corporate sector. Anyone who has a 401K can look at their account and see that it is comprised primarily of claims on corporations. Do these households lack “net financial assets” if the government didn’t deficit spend? Of course not. Imagine thinking that Bill Gates has no net financial assets because he holds claims against his own corporation. That is clearly absurd even though you could technically net all those financial assets to zero (because balance sheets balance at the aggregated level). There is absolutely, positively, emphatically, no need for the government to spend a single dime for the private sector and household sector to net save.

This doesn’t mean deficits are necessarily bad. Debt issuance is never necessarily good nor bad. But I am not going to start a new economic theory called Modern Corporate Theory just because I understand that corporations issue the most important net financial assets in the economy and I certainly wouldn’t promote that theory by implying that corporate borrowing is always good just because it might add to household net saving. But that’s what MMT is essentially doing here. They’ve constructed a narrative in which people end up thinking that deficits are not only necessary, but that the bigger the deficit is the more saving we can all do. It’s a typically lazy MMT style argument that lay people get tricked by because they’re being taught an incorrect understanding of the real-world economics at play.

The idea that all net financial wealth comes from the government is especially misleading. And once again, there’s no kind way of saying this – it’s based on an extraordinary misunderstanding of how financial wealth is actually created. In reality government money printing just creates money, not real financial wealth. That money is an asset for the aggregated domestic economy and a liability for the aggregated domestic economy. Whether that money is used to create real wealth depends on many factors. This doesn’t mean it cannot create real wealth, but the idea that money printing necessarily creates real wealth is like assuming that a fund raise by a start-up firm necessarily creates shareholder equity for the company. No, it depends on how the firm invests the money and whether they mobilize resources into more valuable resources.

Of course, you’ll never hear MMT advocates admit any of this because then they’d also have to admit that:

1. We don’t have a state money system, we have a predominantly bank money system. The government is not the “monopoly supplier” of money.
2. Government deficits add to corporate profits and can create inequality.
3. The state relies on the value creation of corporations and households to fund spending.
4. Households and corporations do not rely on the government to access net saving(s).
5. The government relies on the household and corporate sectors to innovate and produce so that the money printing of the government doesn’t cause excess inflation.

In short, don’t believe anyone who says net financial assets can only come from the government. They are intentionally distorting the accounting to present the economy as some sort of government centric creation that it is not.