May, 2023
The US has completely changed course from the laissez-faire economic policies - “the individualized decisions of those looking only at their private bottom lines” - of the last five decades as they have not been able to address income inequality, climate and China’s rise.
Decline in savings of the bottom 90% and the concurrent rise in inequality, has been the glaring failure of the US economy in the last five decades. An economy is judged by the vibrancy of its middle class, and America has failed in that regard. Washington is addressing that now.
Overall savings in the US have declined since the 1970s. Decline in savings can be defined as a rise in borrowing and/or a decline in the accumulation of financial assets.
However, if you look at the distribution, the top 1% have in fact increased their savings while the bottom 90% have significantly reduced theirs.
The decline in middle class savings was driven mainly by two things - (1) wealthy Americans (top 1%) funding US national and household debt instead of domestic investment and (2) excess foreign savings (e.g. Chinese surpluses) finding their way to the US, given it’s open economy and capital account, again resulting in an increase in US national and household debt.
Put another way, excess savings of rich Americans as well as foreign savings, coming from countries that run surpluses (e.g. China, Germany), have been associated with dissaving by the government and the bottom 90%, as US national and household debt rose and investment fell.
It’s important to note the relationship between savings and investment. Domestic savings and domestic investment are loosely correlated. So it’s fair that reduction in domestic savings caused a reduction in domestic investment. But why did domestic savings decline?
Now, the US economy in some way has to accommodate these inflows either via an increase in domestic investment, decline in domestic savings via increase in household debt or increase in government borrowing.
Since the 1970, most of the foreign inflows have been absorbed by households and the government in the form of higher debt, which is the primary reason for the reduction in domestic savings, thereby increasing income inequality. Domestic investment didn’t rise due to weak demand.
However, in the 19th century, net foreign inflows went towards domestic investment which is what allowed Americans to fund more investment than they otherwise could have managed with limited domestic savings.
The US is now trying to rebalance its economy with industrial policy, by forcing foreign savings to be directed towards domestic investment, while also keeping an open capital account. At some point, they can decide to restrict their capital account, resulting in dedollarisation.
The hope is that by directing net foreign inflows to domestic investment and not household debt, productivity will rise, resulting in more jobs and higher wages. Middle class Americans can gradually start saving more, ultimately leading to a reduction in inequality.