This piece is part of a series discussing seemingly major misconceptions around economics and monetary and fiscal policies that are commonly believed by the investing public. Understanding these misconceptions may help improve investing outcomes and make better sense of the world we live in.
1/ “In Dollar We Trust (and Why China Would Prefer Otherwise)” discusses why the USD is unlike prior reserve currencies and hence more likely to be harder to displace than historical precedents.
2/ “24/7 Money Printing at the Fed? Misconceptions and Consequences.” discusses why monetary easing has led to limited inflation and why the popular assumption about “money printing” is incorrect.
3/ “Follow-Up: Gold and Inflation” discusses why the popular pursuit of gold as an inflation hedge is not optimal.
4/ “Chinese Capital Sustainability and the Power of Capital Controls” discusses why China’s financial system is different and more sustainable than it appears.
And this will be #5, which discusses the misconceptions around American savings.
It’s no longer contrarian to say that the US Dollar is reaching its twilight.
Many people say, and everyone that says “US Dollar hegemony is ending”, seems to think they are voicing a contrarian view.
But when was the last time you saw a high profile media piece argue the opposite? That the US Dollar is as strong as ever?
This is interesting because the USD is quite literally as strong as ever compared to a basket of global currencies, all of which could be an alternative to the USD but is not.
Here’s the chart of the DXY index (dollar spot index in comparison to a dynamic, leading basket of alternative currencies) over the last 10 years:
The USD has actually strengthened.
Despite infinite “money printing” and years and years of declining savings and overconsumption that everyone warned would end USD hegemony.
Okay, maybe we just need to go back further to see that the USD has and will continue to be in a downtrend?
Here’s the DXY index going back to 2000:
“See, now there is evidence that you are wrong, Capital Flywheels!”
It does look like I’m wrong and that the USD has weakened…but this was likely just an anomaly.
The weakness of the USD in the early 2000s likely has more to do with the fact that the EUR (the leading alternative to the USD) was created in 1999, which did indeed lead to some pressure on the USD, but not for the monetary and fiscal reasons that people fear.
However, the subsequent EU crises that have flared up again and again during the 2010s have at least temporarily ended the dreams of EUR dominance and strength against the USD.
In fact, let’s go all the way back to the beginning in which the USD unilaterally went off the gold standard in 1971, declaring to the rest of the world, full of ego and confidence, that it would dominate as a fiat currency backed only by the power and will of the American government, state, and the people…and not by gold (or silver) as has been the case for thousands and thousands of years for effectively every civilization that had come before it.
It’s been volatile, for sure…but USD value against leading alternative currencies has almost remained unchanged over 5 decades!
This is despite: 1/ Going off the gold standard, 2/ Facing years of hyperinflation in the late 70s and early 80s (of which interestingly saw significant dollar strengthening), 3/ Fearing the rise and presumed inevitable dominance of the Japanese economy and technology, 4/ Whiplashing through the tech boom / bust of the 90s, 5/ Falling into the financial hurricane of the housing boom / bust of the 2000s, and 6/ Going into overdrive through infinite “money printing” and decades and decades of declining savings and overconsumption.
Despite all of that, the USD is basically flat.
While everyone that argues “US Dollar hegemony is ending” thinks they are contrarian, they fail to recognize that these arguments have been argued for a very long time (and thus hardly contrarian) and have not proven true for a very, very long time either.
This does not mean that it can’t eventually change, but when something is a certain way for 50 years, it only seems to make sense to try to understand why it has been this way for so long, and, therefore, why it might remain true for longer.
One of the most prominent arguments for why USD hegemony will end rests on the fact that our Federal Reserve is “printing” a lot of money.
Capital Flywheels has previously argued that this line of thinking is incorrect because people misunderstand what the Fed means by “printing” money.
A second line of argument tends to rely on the long-term decline in American savings.
Americans have reduced their savings rate over the last five decades, while consumption continued to grow. This meant Americans needed to borrow from foreigners (first with the Japanese and now the Chinese…but, really, we are just borrowing from everyone and their uncles). And as a result, many people argue that we have effectively mortgaged our future, which will inevitably lead to the loss of USD hegemony / reserve currency status because the only way to pay it back is to debase our currency.
Plenty of investors and common citizens around the world, both American and otherwise, believe the US Dollar is in secular decline for this reason.
For example:
The decline in domestic saving in the U.S. and its “squandered global leadership” have put the U.S. dollar under pressure, says former Morgan Stanley Asia chairman Stephen Roach. He predicts the broad dollar index will drop by 35% and foresees legitimate challenges to the greenback’s status as the world’s dominant reserve currency.
Source: Fortune
That’s quite scary if it were to happen…especially since we live in a globally connected world with an economy that emphasizes consumption. A 35% decline in USD value would mean all of our imports become at least 35% more expensive.
But the decline in American savings is actually a myth.
And that myth is what Capital Flywheels aims to debunk in this post.
The reason why everyone thinks American savings rate has declined significantly is because they look at this chart from the Federal Reserve:
Source: Federal Reserve
This chart shows that American savings rate peaked in the mid-1970s at the mid-teens level before beginning a multi-decade decline.
American savings hit rock bottom in the mid-2000s at just 2.5%.
It has rebounded a bit after the 2008 recession since it forced banks and lenders to tighten up on lending standards, but it still remains far below where it once was (excluding for the temporary COVID-19 environment which has severely limited our ability to spend and hence has driven savings up significantly).
So US savings have gone down, right?
But that is a myth.
This is a myth because almost no one has bothered to look into how personal savings is defined by the government / Federal Reserve.
Much like how too many people assume QE (quantitative easing) and prevailing monetary policy is physically equivalent to printing more $100 bills (which is absolutely not the case), too many people have also looked at this savings rate chart without understanding that the Federal Reserve defines things differently from how you and I define things.
According to the Federal Reserve, the personal savings rate is defined as so:
Personal saving as a percentage of disposable personal income (DPI), frequently referred to as “the personal saving rate,” is calculated as the ratio of personal saving to DPI.
Personal saving is equal to personal income less personal outlays and personal taxes; it may generally be viewed as the portion of personal income that is used either to provide funds to capital markets or to invest in real assets such as residences.
Source: Federal Reserve
The tricky part is how personal income is defined.
Personal income is officially defined as:
The income that persons receive in return for their provision of labor, land, and capital used in current production, plus current transfer receipts less contributions for government social insurance (domestic). Personal income arising from current production consists of compensation of employees, proprietors’ income with inventory valuation adjustment and capital consumption adjustment (CCAdj), rental income of persons with CCAdj, and personal income receipts on assets (personal interest income and personal dividend income).
Source: Bureau of Economic Analysis
You probably got lost in there somewhere because it’s not written for human consumption. And that is precisely why no one reads what it means.
But let me help you: It says personal income = labor (wages), rental income, inventory valuation adjustments (if you own a business), and interest and dividend income.
You know what’s missing?
Capital gains! This includes both property capital gains and equity asset capital gains.
Similar to how “money” does NOT include equities when it comes to monetary policy discussions as discussed in my prior post, savings also do not include equity gains.
According to the government, even if your house or stocks double in value and your “savings” have doubled, your savings rate has not changed at all.
In fact, the official definition of the savings rate will not capture the growing value of your assets until you sell it and realize it (e.g. turn it into income).
There are good reasons why the definition is the way it is, but this means that the savings rate completely ignores what has become the primary method of savings and wealth generation in this country over the last 5 decades.
The decline in American savings that everyone sees and is referencing is as much a result of growth in consumption as well as a shift in savings from dividend and interest income towards appreciable assets, especially stocks.
How much “extra savings” are we talking about?
Economists estimate that accounting for equity gains is equivalent to adding another 7-8% to the official savings rate (which makes sense since equity markets have appreciated about 7% per year over the last 20 years):
This paper constructs a new data series on aggregate capital gains and their distribution, and documents that since 1980 capital gains have been the main driver of wealth accumulation. Over this period, capital gains averaged 8% of national income and comprised a third of total capital in- come. Capital gains are not included in the national income and prod- uct accounts, where the definition of national income reflects the goal of measuring current production. To explain the accumulation of household wealth and distribution of capital income, both of which are affected by changes in asset prices, this paper uses the Haig-Simons income concept, which includes capital gains. Accounting for capital gains increases the measured capital share of income by 5 p.p., increases the comprehensive savings rate (inclusive of capital gains) by 6 p.p., and leads to a greater measured increase in income inequality.
Source: Capital Gains and the Distribution of Income in the United States, Jacob A Robbins, 2018
This means American savings is actually closer to 15%, or as high as it has ever been.
Capital Flywheels believes it is always good to be vigilant and prudent when it comes to national and personal finances. Yes, we have become a little less prudent than before, but the apocalyptic world that many people seem to refer to, one in which Americans are effectively bankrupt, is a myth.
However, while it is a myth at a national level, there are major disparities within the country. Not everyone is saving. Not everyone owns equities. And that is a problem. And whether that problem spirals or whether this myth eventually becomes reality is something that we all need to work together to solve.
But it is not inevitable.
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