Basically, I am asking the fellow Austrians on this board to proof my email response (Collective knowledge, right ), and let me know if I answer her question accurately, completely, and understandibly!
Email from my mother: I keep reading that our economy is fueled by people shopping. Well, how is any economy able to sustain itself if the only way it can keep going is for people to borrow money to buy stuff? What should an economy be based on?
My tenative response:(My mom is a well-educated free marketer)
In a market economy, successful firms are able to forecast what consumers will demand. Thus firms will invest in capital, hire labor, buy raw materials and produce a good or service to meet this demand.
The whole “consumer spending” debate is focused on the wrong idea. It is focused on the “uses” of consumer spending (ie buying goods to ‘bolster’ the economy) rather than the source of consumer spending.
Consumers can spend if they have income. They have income only if business is profitable, and profitability is partly a function of profit margins. So, if business wisely forecasted what consumers would buy, and appropriately measured this risk vs return, they will be rewarded.
This corroborates what the Mises article touches on… and that is, that ‘Supply creates its own demand”. What we are seeing now is sectors of the economy which (mostly due to the Fed’s easy money and low interest rate policies) misallocated billions of dollars of resources.
How do these firms know they misallocated these resources? The consumer tells them using their dollar. All value is relative, and thus the dollar acts a proxy, telling firms the value of their goods vs the value of other firms’ goods. So in a recession, consumers make the decision to “spend later”, thus signaling to parts of the economy to release labor and capital to other parts of the economy.
So it’s foolish for government to “prime the pump”, “inject liquidity”, or “increase spending” because
1) Firms that lose money on every sale, aren’t going to make money by simply selling more. They need the consumer’s dollar to signal to them to lay off workers and release capital.
2) Consumers cannot demand goods that have not been produced. It takes time. A pencil for example… the rubber is fabricated from trees in S. America, the timber is milled from forests in AZ, the graphite could be mined in UT… all of these inputs need to be trucked to the factory, assembled, shipped to wholesalers, shipped to retailers…etc………… This accumulation of capital does not occur overnight.
Go ahead, give consumers millions of dollars, but they can’t purchase what has not been made. And that which has not been made cannot come into existence until you allow other sectors of the economy to shrink.
When consumers save more, interest rates naturally fall, and other sectors of the economy can employ new labor and new resources as a result.
Lack of consumer spending is not the cause of recessions. It never is. Lack of consumer spending ends recessions.
MarkRussell: I keep reading that our economy is fueled by people shopping
Modern economics are distracted by the idea of money. Money is simply a tool humans use to transfer wealth.
The economy is driven by production, not consumption. In order for consumption to occur we must first produce. And if we consume everything we produce, without replenishing our capital stock, we will consume our way in to poverty. Economies are built on capital. The less of our production we consume the more capital we can accumulate, the more capital exists the more we can produce. The amount of consumer goods we produce relative to the amount of capital goods demonstrates our collective time preference, how we value present consumption compared to future consumption.
The people that say consuming is good for the economy are the same people who think war is good the economy. Both involve the depletion of the capital stock, meaning they both are bad for the economy. The only thing that can grow the economy is real savings, ie creation of capital.
MarkRussell:This corroborates what the Mises article touches on… and that is, that ‘Supply creates its own demand”
That's an inaccurate summation of Say's Law, one made popular by Keynes. Say's Law is actually "Markets clear," meaning once goods have been produced the price will be found where supply will equal demand.
Awesome! Thanks for the clarifications. I used to be a Keynes apologist... boy am I glad I have seen the light.
We're glad too Mark. Welcome.
If you find something evil that wobbles, push it. - Gary North
"Lack of consumer spending ends recessions." Rather, I'd say a recession begins to turn around once the malinvested resources have been put to profitable use.I would have put your mom's question in simpler terms: how would an individual seek to better his or her own well-being? You're right that consumption is only part of the picture. Before you can consume, you have to save your resources like time and money to invest in projects that will produce goods and services of value. In turn, we can trade those for something we personally find of greater value (like a paycheck), and the cycle continues. Now surely that individual can stop saving and spend his or her resources to appear to increase the standard of living for a short time, but in the long run it takes producing goods and services of value that builds an economy.
If the government interferes with that process by lowering interest rates to discouraging savings and encourage spending, then we will see the same outcome that we have today with people spending beyond their means. The sooner we nip that behavior, the sooner the recovery begins. How's that?
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