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Have We Saved Enough?

Tags Money and BanksCapital and Interest Theory

05/18/2005Frank Shostak

According to official data last year the personal saving rate stood at around 1%. Some commentators have questioned the validity of this figure. It is argued that there is in fact plenty of savings in the US.

For instance, it is held that if the 2004 appreciation in the value of homes and equities are counted in the calculation of disposable income then the 2004 saving rate would have been 46% and not 1%.

In other words, disposable income (which is the income that is available to individuals after paying taxes and contribution to social insurance) is understated. Obviously then, saving  (which is disposable income minus consumer outlays) must also be understated.

It is further held that another important piece of evidence that shows there is plenty of savings in the US is the fact that the size of time and savings accounts stood at $4.3 trillion last year.1 Note that saving in this way of thinking is the amount of money left after monetary income was used for consumer outlays which implies that saving is synonymous with money.

Hence for a given amount of spending an increase in money income implies more saving and thus more funding for investment. This in turn sets the platform for higher economic growth.

Following this logic one can also establish that increases in money supply are beneficial to the entire process of capital formation and economic growth. This is in fact the logic that the Fed Chairman and various Fed officials continuously employ. For instance, it is maintained that the low interest rate policy of the Fed has allowed individuals and corporations to strengthen their financial positions.

What is wrong with this way of thinking?

Relation between saving and money

Saving as such has nothing to do with money. For instance, if a baker produces ten loaves of bread and consumes one loaf his saving is nine loaves of bread. In other words, saving is the baker’s real income (his production of bread) minus the amount of bread that the baker consumed. The baker’s saving now permits him to secure other goods and services.

For instance, the baker can now exchange his saved bread for a pair of shoes with a shoemaker. Observe that the baker’s saving is his realmeans of payment—he pays for the shoes with the saved bread. Likewise, the shoemaker pays for the nine loaves of bread with the shoes that are his real saving.

The introduction of money doesn’t alter what we have so far said. When a baker sells his bread for money to a shoemaker, he has supplied the shoemaker with his saved unconsumed bread. The supplied bread sustains the shoemaker and allows him to continue making shoes. Note that the money received by the baker is fully backed up by his unconsumed production of bread.

Without the medium of exchange i.e., money, no market economy and hence division of labor could take place. Money enables the goods of one specialist to be exchanged for the goods of another specialist. In short, by means of money people can channel real savings, which in turn permits the widening of the process of real wealth generation.

Also, in a world without money it would be impossible to save various final goods like perishable goods for a long period of time. So the introduction of money solves this problem. Instead of storing his bread, the baker can now exchange his bread for money.

In other words, his unconsumed production of bread is now "stored," so to speak, in money. There is, however, one proviso in all of this: that the flow of the production of goods and services continues unabated. This means that whenever a holder of money decides to exchange some money for goods, these goods are there for him.

Money can be seen as a receipt, as it were, given to producers of final goods and services that are ready for human consumption. Thus, when a baker exchanges his money for apples the baker has already paid for them with the bread produced and saved prior to this exchange. Money therefore is the baker’s claim on real savings. It is not, however, savings.

Now what about the case where money is used to buy unprocessed material—is the unprocessed material real saving? The answer is no. The raw material must be processed and then converted into a piece of equipment, which in turn can be employed in the production of final goods and services that are ready for human consumption. In this sense the buyer of unprocessed material transfers his claims on real savings to the seller of material in return for the prospect that the transformed material some time in the future will generate benefits far in excess the cost incurred.

Furthermore, the buyer of material also buys time, i.e., by having the material readily available he can proceed immediately with the stages of making the final tool. If the material wouldn’t be available he would have to extract it himself, which of course would delay the making of the final tool.

Once real savings are exchanged for money the recipient of money can exercise his demand for money in a variety of ways. This however will not have any effect on the existent pool of real savings. An individual can exercise his demand for money either by holding it in his pocket or in his house or by placing it in the custody of a bank in a demand deposit or even in a safe deposit box.

Also, whether he uses it immediately in exchange for other goods, or lends it out, or puts it under the mattress it does not alter the given pool of real savings. Thus, by putting the money under the mattress an individual doesn’t engage in the act of saving; he is just exercising a demand for money.

What individuals do with money cannot alter the fact that real savings are already funding a particular activity. Whether individuals decide to hold onto the money or lend it out alters their demand for money, but this has nothing to do with savings.

Whenever an individual lends some of his money he in fact transfers his claims on real goods to a borrower. By lending money the individual has in fact lowered the demand for it. Note that the act of lending money, i.e., the transferring of the claim, doesn’t alter the existent pool of real savings. Likewise if the owner of money decides to buy a financial asset like a bond or a stock he simply transfers his claims on real savings to the seller of financial assets—no present real savings are affected as a result of these transactions.

Now, can a government make a contribution to savings by running a budget surplus? This is the view that most experts currently espouse. According to this way of thinking if the government runs a budget deficit then this lowers the pool of savings and hence a budget surplus contributes to the pool. Mises eloquently refuted this erroneous thinking.

Now, restriction of government expenditure may be a good thing. But it does not provide the funds a government needs for a later expansion of its expenditure. An individual may conduct his affairs in this way. He may accumulate savings when his income is high and spend them later when his income drops. But it is different with a nation or all nations together. The treasury may hoard a part of the lavish revenue from taxes, which flows into the public exchequer as a result of the boom. As far and as long as it withholds these funds from circulation, its policy is really deflationary and contra-cyclical and may to this extent weaken the boom created by credit expansion. But when these funds are spent again, they alter the money relation and create a cash-induced tendency toward a drop in the monetary unit's purchasing power. By no means can these funds provide the capital goods required for the execution of the shelved public works.2 

When the government runs a budget surplus it means that more money is taken by the government in relation to its spending. By running a surplus all that we have is the government exercising a greater demand for money. Now, if the government decides to give back the surplus, so to speak, to the people this act will do nothing to the present pool of real savings. It will only raise the amount of claims on real savings in the private sector.

Similarly, if the money raised by the Social Security tax is diverted from government into private accounts this will do nothing to the present pool of real savings. A positive effect may come only some time in the future. This implies that the employment of real savings in the hands of the private sector is likely to add to the pool of real wealth and, all other things being equal, will boost the pool of real savings.

In short, he discovers that the purchasing power of his money has fallen—he has in fact been robbed by means of loose monetary policy. The printing of money therefore cannot result in more savings as suggested by mainstream economists, but rather its redistribution, which in the process undermines wealth generators thereby weakening over time the pool of real savings. So any so called economic growth, in the framework of a loose monetary policy, can only be because of a private sector that manages to grow the pool of real savings despite the negative effects of the loose money policy.Now let us examine the effect of monetary expansion on the pool of real savings. Since the expanded money supply was never earned, goods and services therefore do not back it up, so to speak. When such money is exchanged for goods it in fact amounts to consumption that is not supported by production. Consequently a holder of honest money, i.e., an individual who has produced real wealth, that wants to exercise his claim over goods discovers that he cannot get back all the goods he previously produced and exchanged for money.

Monetary policies falsify economic data

In a true free market economy without the existence of the central bank and where no one prints money, calculations that are expressed in money terms provide an invaluable guide as far as the employment of scarce real funding is concerned. However, in the present framework this is not the case. On account of the central bank’s tampering by means of monetary policies various prices in money terms do not reflect the true state of the so-called fundamentals.

Let us take the official data that shows that consumer net worth last year stood at $48.5 trillion—an increase of $3.943 trillion. However, this increase is purely on account of loose monetary policy. In other words monetary pumping has boosted valuations expressed in inflated money terms. All this, however, doesn’t imply that the pool of real savings is in great shape. On the contrary, the so-called increase in net worth is just another indication of the erosion of the pool of real savings. If we could create real wealth by means of loose monetary policies then every central bank in the world would have fixed all known economic problems by now.

Also, a strong rise in savings accounts is not indicative of growing savings as some experts suggest, but just the outcome of loose monetary policy. We have however, shown that what matters for economic growth is the real pool of savings and not monetary pumping, which manifests through a rise in savings accounts. In short, the newly pumped money is now simply employed in various credit transactions.

Furthermore, why is it necessary to know what the state of savings is? In a real free market economy no one would be preoccupied with such an issue. It only becomes important because the central bank is responding to economic indicators by means of monetary policies. The importance here is on account of the impact of this response on various financial markets and individuals' well being.

Moreover, is it possible to ascertain the state of real savings? Because of the heterogenous nature of final goods it is not possible to quantify the size of the pool of real savings at any point in time. All that can be established is that in a really free market economy without the central bank where money is not printed, the pool of real savings is less likely to be threatened than in the framework of a central bank.

Based on this, we can suggest that on account of the aggressive lowering of interest rates between 2001 to June 2004 (the federal funds rate was lowered from 6.5% to 1%) there is a high likelihood that the pool of real savings has been put under severe strain. The fact that economic activity had difficulty in responding to such an aggressive lowering of interest rates may imply that the "kitty" is not in great shape.

We can thus conclude that savings is not about money as such but about final goods and services that support various individuals that are engaged in various stages of production. It is not money that funds economic activity but the flow of final consumer goods and services. The existence of money only facilitates the flow of the real stuff.

  • 1. David Malpass. "Running on empty." The Wall Street Journal. March 29, 2005.
  • 2. Ludwig von Mises. Human Action,chapter 31, "Currency and Credit manipulation".

Contact Frank Shostak

Frank Shostak's consulting firm, Applied Austrian School Economics, provides in-depth assessments of financial markets and global economies. Contact: email.

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