I was explaining this essay to my wife last night -- which forced me to think it through a bit more.
One significant nit I will pick with it is its confusing use of the term "savings". There are probably three definitions for "savings" used, and they contradict one another.
He is doing his part to confuse the issue, brothers with people like Bernanke and their theory of "global excess savings."
To clear things up I would prefer to hew to the classic definition of savings = under consumption.
So with that definition, let me summarize my takeaway here from this exceedingly important piece. I will try to avoid jargon
What I think Dr. Hudson is saying is that financial returns mostly from loans on real estate and equity are reinvested into more loans. So by savings he means retained earnings from the FIRE sector.
The financial sector grows and grows because all the interest is reinvested and so are the capital gains. Eventually this FIRE sector balloons to become a bigger and bigger piece of the total economy. It begins to dwarf the "real", e.g. non-financial economy.
Economists have usually assumed that loans would finance production, e.g. loans would be made to entrepreneurs to buy more equipment and increase production.
But in this FIRE-breathing economy, loans are made purely to acquire additional real estate and equities. So the "real" non-financial economy doesn't grow, but instead must sustain and bigger and bigger balance of interest due and payable.
Eventually this interest and interest on interest is so great in proportion to the "real" economy that it is unsustainable. Dr. Hudson alludes to deflation but doesn't spell out the aftermath except in labeling a "crash" in one of the diagrams.
Savings don't really enter into things here because by now savings are negative and smart people are distracted from bothering with the productive "real" economy due to the tempting enormous gains from the FIRE economy. Savings are stupid when there is this kind of money being made every day by lending and borrowing and M&A.
This whole thesis rings true in view of recent events. Homeowners getting rich because they were so clever to buy "more house" than they could afford is but one example. Dr. Hudson says that we were more or less saved from collapse by virtue of declining interest rates. Perhaps there is more cause than correlation here and the declining interest rates are due to the shrinking of "risk premiums". (Remember the warnings from Mr. Greenspan and various Davos bankers...risk premiums are liable to revert to the mean at any time.) Risk premiums shrink simply due to supply and demand -- an insatiable appetite for loans to invest in driven by the oversupply of ballooning amounts of FIRE credit seeking a return.
So what does it mean? What happens after the crash? Can a crash be averted by central banks stepping in and reinflating? Does the attempt by central banks to prevent collapse inevitably lead to hyperinflation and the death of the current fiat regime?
Stay tuned and thank you iTulip, Fred and Dr. Hudson for a remarkable piece.