The most important theory about economics was probably wrong. Cast your mind back to 1798, and if you are not old enough to remember that far back, then lets just accept what the history books say. In that year, the first issue of ‘An Essay on the Principle of Population’ by Thomas Malthus was published. It made a dismal prediction: that the population will always grow such that the benefits of any innovation or stride forward will be cancelled out by a rising population; that we will always live on the breadline, and starvation for the masses is inevitable. If we produce more food, the population will increase such that the food production per head is no different from before.


Malthus’s essay was so dismal that it may have earned economics the moniker the ‘dismal science.’  It also supposedly got Darwin thinking, with his book ‘The Origin of Species’ being the result.

But Malthus was wrong in one key respect. What he did not realise is that once our income passes a certain level, once we start living in cities, once we start having better health care, and more equal rights for women, we have less children. There comes a point when innovation leads to fewer people, meaning there is more to go round.

Some argue that Malthus may have been right for a more complex reason; that there are time lags involved, and that the Earth’s population has already risen to an unsustainable level, but that is another story.

Right now  across much of the world we are seeing the opposite of what Malthus predicted. In Japan, the population is no longer increasing. Across much of Europe population trends are following a similar trajectory to that of Japan. In the UK, immigration has delayed this effect. In the US, the demographics are more complex. The US is becoming an increasingly less equal society; class mobility has deteriorated, and it is becoming harder for those at the poorer end of US society to make good. The American dream seems to have become little more than just that – a dream. But the population of the haves in the US is showing signs of following a Japanese style fall. The population of the have nots is growing. In China the policy of one child per family is set to create downward demographic pressures.

And what happens as a society ages and the proportion of those who are retired grows? Answer: we save more.In Japan savings have been growing for decades. Across much of Europe, especially the richer north, the need to save is growing. In fact, the UK the savings ratio has risen from around 1 per cent in 2008 to 9 per cent in 2009/10.

But it’s all very well saving more, but what do we do with the savings?

In Japan in the 1980s all the spare money floating around boosted asset prices until we had the eventual crash in Japanese equities and property. But what do you do if you want to save more, because you are worried about funding your retirement, but your wealth has fallen thanks to crashing share and property prices? Answer: you save even more, which is why Japan’s lost decade is now into its third decade.

In China, high savings – thanks in part to China’s policy of keeping a cheap currency relative to the dollar – found their way into the US. Asset prices in the US rose, creating a bubble. When that burst, just as happened in Japan twenty years earlier, the shock to the US economy was severe indeed. And partly because of demographics no matter how low the cost of borrowing is in the US, still US companies and consumers want to save more.

In the euro area, the single currency created a scenario in which money flooded from the north to the south.

In the UK, the FTSE 100 peaked on January 30 1999 and the baby boomers are worried about their retirement. They can no longer rely on pension schemes rising in value year in year out. House prices are over-valued, meaning this generation can no longer rely on spare equity in their homes to fund their retirement.

So across the developed World, and indeed in China, the thirst to save is unquenchable. If these savings then fund investment, this may not matter –although it can create overcapacity as happened in Japan and may be happening in China. But when the savings just swirl around the system, buying up gold, oil and certain government bonds, the economy effectively leaks. And that in part is what happening now, and that in part is why the economic crisis lingers on.

We are seeing the opposite of a Malthusian nightmare.

But that is one half of the story. There is another half, and this one relates to ideas and innovation. Read on, see Innovation can sometimes outpace demand

©2012 Investment and Business News.

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