Why Savings Matter

Matthew Melchiorre has a great article up at Real Clear Markets discussing the European Central Bank's collision with reality. Here's a tidbit that really caught my eye.

The interest rate is the price of borrowing money. The amount of savings in an economy determines that price. But when central bankers set an interest rate, they decouple the interest rate from savings and replace it with politics.

The problem with an artificially created interest rate lies in the disruption of a basic economic principle. Savings equals investment. Peoples' savings are an economy's source of finance. The interest rate rises as savings become more scarce and falls as savings become more abundant.

But the interest rate has fallen despite a shrinking pool of real savings. The Euro Area savings rate persistently decreased from 7.5 percent in 2000 to 5.8 percent in 2007. Europeans are saving less, but the interest rate - controlled by the central bank instead of by market forces - says they are saving more. This paradox is fatal.

That's one of the clearest descriptions of that aspect of the problem yet. Borrowing is a substitute for saving. In essence, it's the savings you will have to make in the future. The low interest rates we enjoy today are the result of our future savings - savings we are now doomed to create whether we want to or not. We've chained ourselves to our oars for a long time to come.

Stop complaining! You're the one who voted for more debt!

Update: I know this seems like just another recital of the debt-is-bad theme, but the point that hit me was how interest rates price savings. If rates are low, it says the economy isn't looking for more savers. If they're high, it is. When savings and rates are low, then something is screwy with the pricing system.