Rebalancing, Trade, and the Silliness of Journalists

So I guess we’re punishing savers now?

BERLIN — Greek extravagance touched off the biggest crisis in the 11-year history of the euro. But the world’s most ambitious monetary union faces a less obvious problem that might be even harder to lick — German frugality.

via Germany’s frugality bemoaned for inhibiting euro zone growth – washingtonpost.com.

I’ve been reading this kind of drivel in the press for a while now. It has become quite popular these days to say the solution to our current downturn is simple: debtor nations need to save while thrifty nations need to spend. You can read about it here, here and here. But it’s not just journalists taking the idea and running with it, economists are too. Just look here, here, or here. A lot of the recent focus has been on China with its huge foreign currency reserves, but they’re not the only ones being picked on. Just the ones getting picked on the most. Also, the U.S. government is putting forth this idea to the rest of the world here. But this WaPo article is the latest and greatest to champion the idea of rebalancing, so I’m going to use it the most.

So what is this rebalancing that everyone speaks of? Well, take this snippet dealing with Germany and Greece for example:

The economic imbalances in Europe underscore a broader global problem, the solving of which President Obama and others have called key to laying a path to sustained growth in the wake of the financial crisis. They argue that nations like Germany, China and Japan must do more to open the wallets of their consumers, who have some of the highest savings rates in the world, just as nations like United States, Britain and Greece must begin to export more while weaning themselves off the kind of credit-fueled spending sprees that have generated the economic bubbles of recent years.

So it requires nothing, really. Just ask countries that have perpetually had saving and fiscal discipline ingrained in their thinking to magically and mystically do away with it. At the same time, countries like ours  just need to go cold turkey on consumption. Well done. Good luck making that work.

Because you see, there’s this small thing you have to worry about called psychology. Here’s a case in point from the article:

Like many Germans, Rosi Wicher, 40, a preschool teacher and single mother of one, got minimal wage increases over the last decade, with aggressive cost-cutting by German companies and government policies holding the line on private- and public-sector salaries.

And like many of her peers in this shabby chic capital where ostentation is frowned upon, she prides herself on being thrifty. She has used the same stereo set for 12 years, runs no credit card debt, does not own a car and happily gets by with furniture purchased back in the 1980s. “Why do I need more?” she asked. “My child is happy with a DS Lite instead of a PlayStation. And my stereo still works fine. It don’t think it’s a sign of progress to run yourself into debt.”

Ah, yes. The mindset of the consumer. See, this where the script calls on me to break out the fancy maths and talk about elasticity of demand. So I shall. Here’s the mandatory equations to look at and think about (h/t: Wikipedia):

They actually mean the same thing, I just included two representations of the idea. Basically, you use elasticity to determine if price has a big effect on demand or not. The bigger effect price has on demand, the more elastic demand is.

But that’s assuming consumer preferences (i.e. consumer psychology) is the same. Which we know is not the case. Take Ms. Wicher and compare her to an American. I can tell you the preferences/behaviors of the two people will not be the same.

Which explains our seemingly insatiable appetite for tacky designer sunglasses so big they can double as welding shields.

Or crappy over-logoed handbags.

Or SUVs so big they double as school buses.

Or school buses with 26’s or spinners for that matter.

The point I’m trying to make is the elasticities are not the same. Nor are they likely to change in a weekend or two, no matter how much politicians may want them to.

And there’s this one little market mechanism that all of these people either seem to forget about or conveniently ignore. It’s a mechanism I like to call a price.

If you’re going to understand the differences between thrifty and consumptive behaviors, the foundation to the analysis is in knowing how each group views the price of an item. Thrifty folks are more likely to view prices for goods and services as being expensive or the utility they get from buying a good/service to not be worth the price (i.e. they value the money more than the product). Consumptive folks are pretty much the opposite. They prefer stuff over cash. So the thrifty probably exhibit higher elasticities than their more-frequent consuming counterparts.

And that’s telling. Because if price is the key differentiator between the thrifty and the spend-thrifts, then the thrifty are holding out for prices to fall further.

And they should. Because we’re not done with deleveraging…

And as prices fall, capital is then re-applied to the economy.

But without letting prices fall, the governments are not committed to the things they say they are committed to, like letting markets work. So in the meantime, the savers will continue to hold out on their spending.

So the capital never gets plowed back into anything.

And creative destruction is never allowed to occur.

And we never find our way out of this mess…

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Filed under finance, government, International, macro, Way Forward, You're kidding

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