Destroying an Economy to Save It
From either side of the Atlantic, two of the more influential proselytes of that degenerate old collectivist, John Maynard Keynes, have chosen to re-iterate all the old myths once again.
'Now the corporate sector at large doesn't merely want to reduce its net borrowings but actually in many cases wants to become a net saver. In the language of corporate finance that is becoming cash flow positive. Again, from a micro perspective, that is good for an individual company. But if everybody wants to become cash flow positive at the same time, you get the corporate version of the paradox of thrift. Remember, one man's spending is another man's income. The risk is that we get into a Keynesian-Minsky-type of debt deflation loop.' Paul McCulley, April 2003 PIMCO Fed Focus
'Until the threat of a world recession has clearly been averted, economic policy in both the United States and Britain should do its (sic) utmost to maintain the strength of housing and consumer spending. Saddam Hussein and Osama bin Laden must not be allowed to win their war against civilisation by plunging the world into a catastrophic recession. Maintaining the strength of demand in the British economy is the biggest contribution that Gordon Brown could possibly make to the war effort in Iraq.' Anatole Kaletsky, Times Economic View, April 8th 2003
Thus we are told that spending builds wealth and saving is folly. A little inflation is a good thing. Government must step in to order what individual men and women choose not to do. And, naturally, they say, ignoring the advice of these pundits and planners on how to repair the "failures of capitalism" in this way risks turning the current recession into a 1930s-style depression.
You have only to consider your own individual circumstances to see that all of this is a clear affront to common sense.
If you suffer a loss of income, does it make sense to live frugally, or to push your credit card to its limit, temporarily maintaining a standard of living you can't really justify?
Worse: rather than being self-denying while you retrain for more lucrative employment, should you put the contents of your workshop in hock and live it up at the nearest Ritz-Carlton?
Finally, if the mix of goods and services on offer and the prices paid to both the workers and owners who produce them is sufficiently out of line that there is variously a glut of existing capacity, inventories, or labor, what should we do? Should we ask those wise, paternal shepherds in government (few of whom have ever held down a decent job and fewer still have ever run a genuine entrepreneurial business) to make up for our supposed folly through price supports, tariffs, welfare, recruitment and sequestration?
Should this, in turn, be financed through higher borrowing (ideally largely monetized), so as to penalize those of us prudent enough find a more sustainable lifestyle to go along with our newly-reduced means?
Of course not. But somehow we must believe that there is a reverse quantum threshold in economics in which when you proceed from the micro world to the macro, common sense no longer rules and you enter instead into a shadowy realm populated by paradoxes and counter-intuitive phenomena.
Let's deal first of all with the idea that spending creates jobs whereas saving destroys them.
Now, we know that the Austrian School economists are often accused by their critics of taking one set of logical consequences and magnifying them into inescapable necessities. But, honestly, this whole concept offered by our opponents requires a confluence of such bizarre and improbable circumstances to occur, that only an addle-headed, statist dilettante could put such a scenario of mass asceticism before us with a straight face.
Rather than wasting time on its detailed refutation, let us present a simple model to show that, at the very least, spending does not have to create jobs and saving does not have to destroy them.
Imagine a simple economy where a community of workers labor together co-operatively to produce just sufficient goods to satisfy their combined daily wants. Let us say there are 10 ordinary workers and one more important character who contributes his share of the toil, plus he owns the land or the materials which the other workers employ. Between them they put in $110 worth of labor and produce $110 worth of goods each day. Income equals consumption and no goods are left to rot on the shelves. Full employment obtains and so, even for social democrats, bliss momentarily prevails.
But now suppose one of the workers has a son who has grown to maturity and presents himself for a job. Yet all the resources in Company-A have been fully allocated between his father and his peers, so there seems no prospect of providing him with one.
The collectivists would say that either we should make the others share the work (and its output) with him by giving him a fictitious, but equal, claim on the day's produce by printing up some money for him to spend (inflationary credit creation), or they should be forced by regulation to restrict their work so as to make room for his (dirigisme), or the State should directly confiscate a portion from every man's just allotment and transfer it to this importunate by force majeure (welfarism).
(In practice, the state will usually manage to commandeer two such portions this last way, since it will naturally employ a bureaucrat directly to oversee the enforced redistribution, so further adding to the burden of all).
Clearly, the commonweal has not been served in this manner. Due to the inculcation of the bad habits of venality, to the opportunity for corruption and influence-peddling to arise, as well as to the frustration generated by the sheer invidiousness of it all, there will soon be a host of social problems to exacerbate the economic ones we have introduced.
So here is a better solution.
The workers and the boss each save one twelfth of their incomes and the sum realized is lent to the young man on condition he work at making something different—but hopefully valued—for them all to consume. Or he could repair their existing tools, or work to fashion new and better versions of these tools. Either way, the output wrested from the existing resources can be increased, either by specialization of function or through technological advance.
In other words, they save and invest in either a horizontal, or a vertical, extension of the structure of production.
Now watch this.
Previously, the initial firm, Company-A, paid out $110 (perhaps composed of $100 in salaries to the 'ordinary' workers and $10 in dividends to the owner of the capital stock) and it received $110 in revenues from the same for the wares they themselves produced, these all being consumed immediately.
Now, however, Company-A only gets $100.83 dollars back from this original set of worker-owner-customers and the residual $9.16 is spent instead by the newly-employed youth as he utilizes the compensation received for his role in his new employment at the just-formed Company-B.
But, lo, if we look at the aggregate personal income statistics, we see that Company-A's workers get $100, its owner $10, and Company-B's worker gets $9.16, for a total of $119.16—income has gone up because of, not despite, the exercise of thrift, as Mill long ago realized!
Company-A, for its part, recovers all of its initial $110 cash outlay (some of which was made above, some below, the line) and it has, accordingly, sold all its goods. Personal spending was $110, and therefore personal saving came to $9.16: the sums tally.
In turn, Company-B has temporarily transformed its monetary capital (and thus, ultimately, part of Company-A's output of consumer goods) into a stock of its new products—be they additional, new consumer items or productivity-enhancing capital goods.
These, it will hopefully exchange in the next round of the cycle of production, thus keeping its employee fed and watered as reward for his labors once more.
Thus, far from sending the economy into a deflationary spiral, the act of forbearance on the part of Company A's staff and owners, has led to capital formation, extra employment and the provision of more goods. Moreover, the act can mean an enhancement of the future production of all such goods to the extent that the new member of the labor force helped give rise to useful producer's, rather than consumer's, goods.
In other words, thrift has led to an expansion of the economy which even the crude and misleading measure of GDP cannot fail to capture. Moreover, it has quite possibly laid the groundwork for an enrichment of the capital structure and so paved the way for future advances into the bargain.
In passing, let us note that we have glossed over any monetary issues arising. However, if we had only a fixed amount of $110 cash in this little community (perhaps because we physically possess 4 Troy oz, 192 grains of gold coins at $25/oz), we now have 12 units of goods being produced where we had 11 before.
Thus, to the extent that there was no offsetting extension of self-liquidating trade credit between Companies-A and -B, or that barter did not re-emerge, we could expect prices to have fallen 8.3% on the average (and under the always-implied, but rarely-occurring, condition that one B is everywhere equal to one A).
Saving might have given rise to what is confused for deflation (i.e., a fall in the amount of money outstanding below the freely expressed demand for it), but which is really only a price decline. Yet this would in no way have been incompatible with a general increase in the supply of material goods, employment and a maintenance, if not a productivity-delivered augmentation, of real income.
We started by presenting this as a special case, as a counter-factual to see off the dismal scientists we quoted above, but, in fact, a little thought should see that this is, in fact, the route to prosperity which we have all travelled through the long ages of human progress.
Most of us ordinary folk today live far better than did the Sun King himself: we would certainly seem indescribably wealthy to an Alfred the Great.
That advance in prosperity has not been built on government intervention (for even such an absolute monarch as Louis could not keep France from spiralling into bankruptcy), nor was it built on needless consumption of the kind only his court knew how to practice, nor on monetary debasement or otherwise the bilking of ones' creditors—which is what McCulley and Kaletsky, et al, are effectively proposing and to which Louis was also no stranger.
No. It was built on savings being converted into capital and an assault on either, whether led by the persuasion of sophists or the pre-emption of the State, is only guaranteed to hamper our struggle towards greater future prosperity.
Sean Corrigan is a principal of www.capital-insight.com, a London-based economic consultancy. He is also co-manager of the Bermuda-based Edelweiss Fund. See his Mises.org Articles Archive, or send him MAIL. See also the Study Guide on Business Cycles.