The Value of Short-Term Savings Products

Part I of The Value of Financial Products and Assets

Previous Parts

• Introduction

The most common image that comes to mind when talking about savings is a piggy bank. It is a means to put away and save money. Of course, piggy banks aren’t where people store and save most of their money these days. Instead of a piggy bank for saving money, people tend to use savings accounts at banks to deposit some of their savings. Yet, bank accounts aren’t the only financial products that allow for accessible and stable savings. While they have different features, money market funds are also used for short-term savings in lieu of savings accounts offered by banks. With that said, do bank savings accounts and money market funds provide additional value beyond their function as a piggy bank? Do they have attributes that we inherently value? Do they have any instrumental or intrinsic value?

It must be highlighted that this part of the comparative analysis is focusing on what we’ll call short-term savings products. These savings are usually kept in accessible and stable accounts to ensure liquidity and minimize risk. Short-term savings are typically also referred to as cash and cash equivalent holdings. Long-term saving, which are outside of the cash and cash equivalent category, will be discussed in Part II of this series.

Bank Savings Accounts 

From a high-level, there are three main features of bank savings accounts that make them valuable to individuals and communities.

First, individuals and households entrust the banks and credit unions to hold their money securely. Rather than storing cash in one’s own place of residence or in a piggy bank, which would make the money vulnerable to being stolen or lost, the banks and credit unions specialize in storing their client’s money in a secure and effective manner.

Second, by holding other people’s money, the banks and credit unions are enabled to lend that money to productive initiatives in the community. The simplified and mainstream thinking about how banking works is that the deposits at the banks or credit unions act as a form of pooled funds in which they can be lent out to individuals and organizations to drive economic growth. For example, a credit union in an agricultural community typically provides checking and saving accounts for its members and uses the money deposited in those accounts to lend them to the farmer members for productive use, such as the purchase of new farming equipment. A bank also acts in a similar manner by using deposits as a source of funding to lend to local businesses that aim to use the funds for productive use or lend funds to individuals in the form of personal loans. This is a simplified and high-level description of how bank lending works; in fact, banks do not really lend out their depositors’ money, but the deposits play a role in the proper functioning of the banking system and allows them to lend out money (more on this later in the discussion).

Third, depositors earn interest on their cash held at the bank and credit union, which enables them to grow their savings, albeit modestly. The banks and credit unions can provide interest to their depositors because they are also earning interest on the funds lent out, and so they profit from the spread or difference between the interest they earn from the loans and the interest they provide to their depositors who are their source of funding.

Bank saving accounts thus provide additional value than a piggy bank – they securely and effectively store money for individuals and households, they act as a means for banks and credit unions to lend money to productive use cases, and they allow savers and depositors to put away money and modestly grow their savings over time in a more or less secure and accessible way; which allows them to withdraw money from their accounts when needed without uncertainty as to the value or amount of the money held. This last point is a very important feature of short-term savings that bank accounts offer – the money in such accounts can be accessed when needed with no uncertainty as to the value of the money.

There are a few caveats that must be highlighted to give a full picture of the nature of bank accounts though. These caveats revolve around inflation and fractional reserve banking. 

Due to inflation, the purchasing power of cash held in a savings account would lose value over time. That is true depending on the macroeconomic environment and if the interest being earned is less than the inflation rate. Nonetheless, the money is stored securely and grows according to the interest rate earned. Additionally, savings accounts provide a cushion for rainy days and hence why they are encouraged to be used as a vehicle for an emergency fund, for example. Savings accounts at banks are typically used to put away money and save in a secure manner that allows access to that money when needed. This is a fundamental feature of bank saving accounts as mentioned above; it is a place to store money that can be accessed when needed without uncertainty as to the value of the money being withdrawn. There is no expectation of high returns on those sums of money as investing in financial assets such as stocks; the goal is to preserve money and have a cushion of money for peace of mind. If there is no hyperinflation that significantly dilutes the value of the money held, the minimal loss in purchasing power caused by mild inflation isn’t usually a huge concern, as long as the money still has adequate purchasing power.

The other caveat is about the fractional reserve banking system. Technically, the bank is not strictly lending out money from the deposits at its disposal. Contrary to our description above, banks don’t actually lend out the money that their clients deposit with them. Banks create money by lending out money. So, one can argue that the feature of banking accounts that allow savings to be pooled and then allocated into productive use cases through lending is not accurate given our fractional reserve banking system. True, however, deposits still have a foundational role for banks to properly operate and fulfill their lending function. They rely on their clients’ deposits to balance their books and to maintain some of their required reserves. Deposits are the most affordable source of funding for banks, which enables the lending function of banks (see Why Do Banks Want Our Deposits? Hint: It's Not To Make Loans and Why Banks Don't Need Your Money to Make Loans). It is clear that banks still rely on depositor money that is saved in their accounts to be able to operate properly. It is also important to highlight that due to the fractional reserve system, bank runs occur, so one can argue that savings accounts at banks are risky due to the inherent vulnerability of the fractional reserve system. That is true, but it is important to remember that savings accounts are typically FDIC insured up to a certain threshold.

Nevertheless, the purpose here is not to defend and advocate for bank savings accounts and to claim that the banking system is good or perfect as it is. While there is much work that needs to be done to improve our banking system, the point here is to highlight the instrumental or intrinsic value of traditional bank savings accounts. Given the purpose that such bank accounts serve, one can safely say that bank accounts have instrumental value. Overall, traditional bank savings accounts provide value to individuals and communities since they are a means for individuals and households to store and modestly grow and accumulate their savings in a more or less secure and accessible way, as well as a vehicle that allows for funds to be put to productive use or to enable the banking system to operate smoothly. Being able to store one’s savings securely while earning a modest interest on that money allows for peace of mind and a way to establish a financial cushion for rainy days or to save for a specific goal in a stable and accessible way. The important point here from the perspective of the saver is that money can be withdrawn from the account without uncertainty as to the amount or value of the money (ignoring hyperinflation). On the other hand, the deposits held at banks through those savings accounts enable the banks to function properly and to lend money to productive use cases, which allows for growth and development. In other words, bank accounts enable collective savings to be allocated into productive initiatives or, more accurately, allow the banking system to work as an allocator of capital into productive initiatives.

The instrumental value of bank savings accounts is thus evident.  

Money Market Funds

Money market funds are funds that invest in low risk, short-term debt securities such as T-bills and municipal debt. Money market funds are a means to store savings since they typically earn higher interest than bank savings accounts while also providing liquidity, stability, and access to money in the short-term when needed. To be clear, money market funds consist of a basket of different short-term debt securities, and the money market fund is a form of mutual fund with pooled capital from multiple investors that have a stake in all the assets held in the fund. That said, money market funds are clearly different than bank savings accounts and are regulated and overseen in a different manner than bank savings accounts. So, what features make money market funds valuable?

As mentioned, the money held in such funds is used to invest in short-term debt securities. Debt securities are instruments used by governments, corporations, and other organizations to raise capital needed for specific operations – in the case of short-term debt securities, the capital is used for short-term needs and is paid back within a year. The type of short-term debt securities typically held in money market funds include municipal debt, commercial paper, and US government debt known as T-bills, which have a very low level of risk and are backed by the full faith and credit of the US government. So, the money held in money market funds is being used to hold assets that function to raise capital for specific organizations and for specific purposes. It is important to highlight that the capital raised from these securities is done in the primary markets. Holding those assets in a money market fund is just holding ownership of those assets in the secondary market; secondary markets are needed for liquidity, which allows for better pricing on such assets given that one can exit the position easily when needed for cash. Nonetheless, the money in the fund is still allocated to instruments that serve a valuable function and represent a claim on a productive use case or entity and on something of value. The value is that the securities in the money market funds are used as an instrument to raise capital for governments and institutions, and the buying and selling of such instruments is the buying and selling of an asset that represents a claim against the organization that used such instruments to raise money needed for a specific purpose. Keeping their promise and paying back the debt with interest allows the entities that use short-term debt securities to continue raising capital via such vehicles in the future since they build credibility by fulfilling their promise.

As for the savers, allocating their savings and having a stake in a money market fund allows them to earn interest on their money from the entities that raised capital through the short-term debt securities held in the fund. This feature allows them to maintain, preserve, and grow the value of their savings in a more or less secure, stable, and liquid way. The returns, liquidity, and stability of money market funds encourage people to allocate savings in such funds as part of their short-term savings portfolio. It is such assets that are termed cash equivalent, since they aren’t cash holdings per se, but are assets that are as stable and liquid as cash, but with a benefit of slightly higher yields. In fact, many would argue that money market funds are even less risky than storing money in a bank given the risk of bank runs, even though money market funds are not FDIC insured. Similar to bank savings accounts, one can withdraw money from a money market fund easily and without uncertainty as to the value or the amount of the money at the time of withdrawal – again, this is a vital feature of short-term saving products.

It is important to highlight that from the perspective of Modern Monetary Theory (MMT), T-bills or debt securities issued by a government that issues its own fiat currency don’t necessarily serve the function of raising capital for a specific use case (see The Deficit Myth by Stephanie Kelton). Nonetheless, from a MMT perspective, T-bills have historically acted as an instrument to manage interest rates. Moreover, T-bills, from a MMT perspective, are utilized to manage the amount of money or reserves in the economy – they are another form of dollars (yellow dollars), which are interest bearing and are held to grow wealth and savings instead of holding everyday dollars (green dollars), as Kelton explains in The Deficit Myth. This is important to highlight so that we have a full picture of the function of T-bills, and it points out that even if they aren’t used for raising capital by currency issuing governments such as the USA, there is still an instrumental use case for such assets that allow for the proper functioning of markets. 

Based on the above features of money market funds and the assets they consist of, the instrumental value of such vehicles is clear and evident. The short-term debt securities held in money market funds allow entities to raise capital for short-term needs and allow the smooth operation of the financial markets. Moreover, money market funds are considered as cash equivalents and are a vehicle to save and preserve one’s money while earning interest on the money saved, given that the assets held in money market funds are interest bearing because they are a vehicle for entities to raise capital. More importantly, the money in such funds is accessible when needed without risk as to the value of the funds at the time of withdrawal; that is why money market funds, similar to bank savings accounts, are a good vehicle for emergency funds or for saving money for a specific goal in a low-risk, stable, and accessible way.

Based on the discussion, the instrumental value of money market funds is clear.

The Value of Short-Term Savings Products

In sum, short-term savings products have a function beyond a typical piggy bank. Even with a piggy bank, it is used to put money aside and to grow the stash by depositing a meager sum into the piggy bank on a regular basis to accumulate savings and preserve money (ignoring inflation and the effect it has on purchasing power). The money in the piggy bank is accessible and can be used when needed. While bank accounts and money market funds also serve the piggy bank function, they also allow for the money held in these accounts to be used for productive means by enabling the allocation of money through loans (in the case of the bank) into the community for economic growth or (in the case of money market funds) by holding short-term, low-risk securities used by organizations and institutions to raise capital for specific purposes. If not directly being used for loans or capital raising as we’ve explained in terms of fractional reserve banking and an MMT perspective on T-bills, these saving products still play a major role in the proper functioning of the banking system and financial markets. Additionally, savings products are designed to accumulate interest and grow one’s savings (even if modestly) in a low-risk, stable, liquid, and secure way – albeit, with some limits in terms of security and risk if we want to be conservative and factor in potential bank runs (even though many savings products have insurance on them) and defaults on short-term securities, especially the risk of municipal or corporate short-term debt securities. Nevertheless, one main theme in short-term saving products is that they allow easy access to withdraw the money saved without the uncertainty of the value of the money at the time of withdrawal; due to that feature, they act as a financial cushion for many, and hence why they are considered as short-term savings products.

Given the above attributes of bank savings accounts and money market funds, they clearly hold instrumental value for both individuals and communities.

As mentioned, there are other financial products out there that are used for savings, especially for long-term savings, such as stocks and bonds. These assets are perceived as riskier investments as opposed to savings in the traditional piggy bank sense. Part II of this series will examine the value of long-term savings products and assets.