The Godfather of Government Stimulus, J.M. Keynes, (General Theory, Chapter 7) defined Investment as “the increment of capital equipment, whether it consists of fixed capital, working capital or liquid capital” and noted that “exchanges of old investments necessarily cancel out”.  We should point out that although “liquid capital” is included in Keynes’ definition, this is not cash which can be withdrawn from the business without a reduction in investment. It is cash committed to enabling future production.

Some will argue with how we apply this definition, but let’s give it a whirl:  If I buy already-committed capital assets, that is, “old investments”, I have not made an investment (added to the capital stock).  So, to the extent that a share of stock (or a bond) represents ownership of previously committed capital, when I refrain from consuming some of my income to buy it, I have saved, but I have not invested. Sure, it is true that the companies whose shares I own are retaining earnings and thus making new investments, which, by the way, I could use to manufacture my own dividend income, but let’s keep this simple. I have truly “invested” only when I buy an asset that is newly issued to fund creation of new capital.

So, we have two choices for what to do with our savings:  1) we can “park it” in existing assets (stocks, bonds, mattresses), or 2) we can invest it in new capital formation.  What makes us choose one over the other? Answer: a sufficiently higher expected rate of return of the one over the other. When we park it, we hope to get a financial return, but part of the “return” from investing in new capital formation is real: new jobs.  Thus, for example, IF we can put my and your savings to work AND put our out-of-work sons and daughters to work too, that may represent a more attractive opportunity than the financial return of existing assets.  Actually, IF we can put enough of our out-of-work buddies to work, we may actually grow the number of customers for the product which our investment produces and “everybody wins”.

The keyword above is “IF”. There is more than the usual uncertainty “out there” right now and the IF’s are scary-big ones.  Should we make an investment or buy the relatively sure thing available in parking our savings in existing savings accounts, bonds, stocks, or even credit default swaps?  Which offers the best “risk adjusted return”?  No one, except perhaps, communists like the Chinese, wants to build new production capacity without a reasonable dependable market.   Brad Setzer has been saying for a while that there is a lot of savings floating around, but no investments.  Where is the savings being parked? Hmm…. The FED has made sure its owners, the banks, have plenty of reserves and, while they aren’t being lent, many are “somehow” being used to inflate existing financial asset prices.

When will existing asset returns become sufficiently less attractive so that new investments will be made and people will be put back to work? It looks like another existing asset bubble (or two) needs to pop first and the FED just needs to refrain from financing any more of them…