INTEGRAL ECONOMICS

Temporal Conundrum

Daniel O'Connor | Integral Ventures, LLC

A growing distortion in the temporal dimension of ourmarket economy, driven by the monetary policies of ourcentral banks, has implications for our economic future.

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Temporal Conundrum

Daniel O'Connor | Integral Ventures, LLC

We finally did it. This past year, for the first timesince the pit of the Great Depression, we in theUnited States managed to drive our annual personalsaving rate below zero. What this basically means,on the surface, is that all of us together, as agroup, spent every dollar of household income wehad leftover after taxes, plus another half a centthat we must have borrowed. Of course, some of usdid manage to save something last year. But all of this saving was more than offset by all thedissaving the rest of us did. Of course, this wasn't agreat surprise. The trend has been clear for a goodmany years and I've even discussed it in someprevious essays, like Saving Ourselves

and SavingThemselves?

What does it mean on a deeper level?To answer this question, let's review some just-in-time theory. The personal saving rate is a derivativeof the fundamental trade-off for every household—

consumption

versus

saving

—and it reflects house-holders' preferences for allocating their scarceresources over time. Given a flow of after-taxincome, householders can either use the money for

current consumption

or save it for

futureconsumption

.This temporal trade-off is known as

time preference

because it expresses a preferential relationshipbetween a particular good in the

present

versusthat same good in the

future

. It is consideredby economists of the Austrian School to be the

subjective origin of the interest rate

, because thegreater our valuation of a good in the presentrelative to our valuation of the same good in thefuture—i.e., the higher our time preference—thegreater the implied interest rate in our valuefunction and the greater the interest rate must beto induce us to defer enjoyment of this goodthrough saving.

Time preference may also have a neurologicalconnection, as I proposed in The Neuroeconomics of Time.

According to recent research into the idea of

time inconsistency

, people use completely differentparts of their brains to process decisions in thepresent versus the distant future.

When it comesto making decisions about the distant future, peopledo so in a relatively rational way using theprefrontal cortex. But when making decisions aboutthe present that entail a choice of whether toconsume something now or later, the emotionallimbic system takes over and prefers immediategratification. Whether this neurological time incon-sistency causes psychological time preference orthe other way around is uncertain, so perhaps wecan just think of them as

mutual causal

.So how can these ideas help us interpret thenegative personal saving rate?When we see householders as a group choosing tosave none of their current income, preferringinstead to use it all for current consumption, we caninfer that they do not value the future enough tosave for it. Perhaps they imagine that they do notneed to save for the future because they alreadyhave enough savings in the form of assets (likehome equity) or because someone else is doing itfor them (like a government or corporate pension).Perhaps they have carefully planned to save for thefuture using their prefrontal cortexes, but thenwhen they must make their monthly decisions toconsume now or save for later, their limbic systemsundermine their long-term plans. Either way, it'spretty much the same implication:

no savingimplies no future

.When people lower their valuation of the future orthe goods they might buy in the future, they areexpressing what is known as

higher time preference

, which is consistent with the

higher interest rate

that is required to induce them to save

On one hand, the trend in personalsaving suggests that we place solittle value on our economic futurethat we'd rather just consumeeverything we possibly canin the present, without regardfor future consequences.

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enough to satisfy investors' demand for funds. Tosee what I mean, just think of how we compute thepresent value of a future cash flow by applying adiscount rate. The higher the discount rate weapply, the lower the present value of the futurecash flow. Thus, the lower our present valuation of our collective economic future, the higher is theimplied interest rate that should prevail in themarkets for money, credit, savings, andinvestment. This is how markets work, like adynamic system seeking a reasonable balance. Inthis case, the balance being sought is that betweenthe supply of funds and the demand for funds beingsaved by households.But if there is one thing to which we've all grownaccustomed in the past several years, it is

lower interest rates

. According to the theory of timepreference, lower interest rates imply

lower time preference

and therefore a relatively highervaluation of the future in relation to the present. Alower discount rate applied to the future cash flowin our example will generate a higher present valueof that future cash flow. So the relatively lowinterest rates in recent years would seem to be anindication that we householders value our collectiveeconomic future rather highly—as if we are saving agreat deal more than we really are.Thus, we have a sort of

temporal conundrum

.On one hand, the trend in personal saving suggeststhat we place so little value on our economic futurethat we'd rather just consume everything wepossibly can in the present, without regard forfuture consequences. On the other hand, the trendin interest rates suggests that we value the futurerather highly and therefore save a significantportion of our income so that businesses can investin the creation of the economic product that weexpect to enjoy in the future.How can we resolve this temporal conundrum?By recognizing that the monetary policies of ourown central bank and the central banks of ourtrading partners have been distorting marketinterest rates to such an extent that wehouseholders are literally behaving as if we canconsume all our income today, while simultaneouslysaving enough for the future we value—

consumingour cake and saving it too

.In recent years, the Federal Reserve's inflationarymonetary policy of lower short-term interest rateshas been met by similarly inflationary policies of some other central banks (e.g., China) who, inorder to support their respective export sectors,have attempted to stem the dollar's naturaldepreciation in relation to their own currencies byaggressively purchasing US dollar-denominatedTreasury securities. By increasing the demand forUS Treasury bonds, notes, and bills, these foreigncentral banks have bid US interest rates down tolevels that would not have existed in the absence of the policy interventions.This multi-lateral strategy of

competitive currency devaluation

has produced

lower-than-market interest rates

all along the yield curve, from short-term rates to long-term rates, which, in turn, havecreated valuable incentives for households to

saveless

borrow more

, and

consume more

. Theselower-than-market interest rates have resultedin

higher-than-market rates of borrowing

through-out the economy and

higher-than-market rates of appreciation

in the prices of many assets—stocks,bonds, houses—which are often touted by govern-ment-paid economists as the

increasing savings

balances that more than offset any downsideassociated with the

decreasing saving

rates. To theextent that the value functions among householdershave remained relatively stable, we can be surethat we have all saved less, borrowed more, andconsumed more than we would have if the centralbanks had maintained policy neutrality.Therefore, the inflationary monetary policies of theFed and other central banks have inducedprogressively higher time preferences among UShouseholders, who have responded with a predict-ably emotional rationalization that appreciatingstocks, bonds, and houses, even in the absence of any saving from year to year, can somehowcompensate for excessive borrowing and spendingin the present.

This multi-lateral strategy of

competitive currency devaluation

has produced

lower-than-market interest rates

, which, in turn, havecreated valuable incentives forhouseholds to

save less

borrow more

, and

consume more

On the other hand, the trend ininterest rates suggests that wevalue the future rather highly andtherefore save a significant portionof our income so that businessescan invest in the creation of theeconomic product that weexpect to enjoy in the future.