Every so often I need to push back against common misconceptions regarding saving and investment. The comment section of my previous post provided a few examples, starting with “pyroseed13“:

In a less risk-averse and more economically free environment, savings would be flowing into new investments. But right now all that’s happening is that this savings is being used to bid up prices on existing assets, mainly housing. So this asset bubble is reducing investment in other areas of the economy.

Saving does not and indeed cannot flow into existing assets, at least in net terms. You might use $X of your income to buy a certain asset, like an existing house. But that’s offset by the fact that the person you buy the house from receives $X for selling the asset. In net terms, no saving has been absorbed in this transaction. In contrast, savings get absorbed when new capital goods are constructed, as when a new home is built. Because saving equals investment, we need never worry about saving being directed into non-investment uses, at least in aggregate terms.

Regarding existing assets, it’s more accurate to say that money flows through markets, not into markets.

Commenter LD said the following:

Fed policies that provide cheap credit to established (or politically favored) companies that use the money to buy back (thus raising the price of) their stock, make it more difficult for smaller, newer, or politically un-favored companies to compete in capital markets. This provides an advantage to the established companies and reduces their incentive to innovate since the more innovative companies have less access to credit.

This is a good example of Paul Krugman’s point about how arguments that might sound plausible using words, break down when you are forced to defend them mathematically. Actually, this argument is exactly backwards. Small firms find it easier to invest when big companies buy back their stock.

When companies earn profit, they can either re-invest those profits in new capital goods, or return the money to shareholders through stock buybacks or dividends. If they invest in new capital goods, those savings are not available for small firms to use. But if the money is returned to shareholders, then it is available to small firms via the credit markets. Just as government investment may “crowd out” private investment, the investment of big corporations may “crowd out” the investment of small firms. Hence if big firms refrain from investing, more of the savings pie is available for small firms to use.

PS. This assumes the Fed is targeting inflation. Under a different monetary regime the analysis might get more complicated, but I doubt you’d ever find small firms being hurt by the net saving of big firms. In any case, the article I was criticizing was certainly not relying on a Keynesian argument.