Why We Need Savings to Produce What We Need
Conventional wisdom says that savings is the amount of money left after monetary income was used for consumer outlays, implying that saving is synonymous with money. Hence, for a given consumer outlays 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 could also establish that increases in money supply are beneficial to the entire process of capital formation and economic growth. (Note increases in money supply result in increases in monetary income and this in turn for a given consumer outlays implies an increase in savings).
The Relationship Between Saving and Money
Saving as such has nothing to do with money. It is the amount of final consumer goods produced in excess of present consumption.
The producers of final consumer goods can trade saved goods with each other or for intermediate goods such as raw materials and services. Observe that the saved goods support all the stages of production, from the producers of final consumer goods down to the producers of raw materials, services and all other intermediate stages.
Support means that these savings enable all these producers to maintain their lives and wellbeing while they are busy producing things. Also, note that if the production of final consumer goods were to rise, all other things being equal, this would expand the pool of real savings and would increase the ability to further produce a greater variety of consumer goods i.e. wealth.
Note that people do not want various means as such but rather final consumer goods. This means that in order to maintain their life and wellbeing people require an access to consumer goods. Only once there has been a sufficient increase in the pool of consumer goods, people may aim at enhancing their wellbeing by seeking other things such as entertainment and services related products - such as medical treatment etc.
The introduction of money does not alter what we have said so far. When a final producer of a consumer good sells his saved goods for money to another producer, he has supplied the other producer with his saved goods.
The supplied good sustains the other producer and allows him to produce other goods. Note that the money received by the producer is fully backed by his unconsumed production. Whenever he deems it necessary, he can always exchange his money for goods.
Whenever people buy capital goods such as machinery they transfer money to the individuals who are employed in the making of the machinery, which in turn can be exchanged for consumer goods. With money, the machinery maker can choose to purchase not only final consumer goods but also various services. The services provider who receives the money could in turn acquire final consumer goods and services to support his life and well-being.
Without the medium of exchange i.e. money, no market economy and hence no division of labor could take place. Money enables the goods of one specialist to be exchanged for the goods of another specialist. This all that money can do.
By means of money, people can channel real savings i.e. unconsumed consumer goods to others, which in turn permits the widening of the process of real wealth generation.
In addition, in the world without money it will be impossible to save various final consumer goods like perishable goods for a long period. The introduction of money solves this problem.
There is however, one provision in all this: that the flow of the production of goods continues unabated. This means that whenever a holder of money decides to exchange some money for goods, these goods are there for him.
Do People save Money?
As we have seen above people do not save money but rather they exchange it for goods and services. Now, when a producer of a final consumer good exchanges his money for some other consumer good he has already paid for them with the goods he produced and saved prior to this exchange.
When a producer of final consumer goods buys an intermediate good he transfers his real savings to the seller of intermediate goods in return for the prospect that once he transforms the intermediate good into a future consumer good this will generate benefits far in excess of the cost incurred.
Once real savings are exchanged for money, it is of no consequence what the holder of the money does with it. Whether he uses it immediately in exchange for other goods or puts it under the mattress, it will not alter the given pool of real savings. How individuals decide to employ his money will only alter his demand for money, this however, has nothing to do with savings.
Individuals can exercise their demand for money either by holding it themselves or by placing it in the custody of a bank in a demand deposit or in a safe deposit box.
By lending money, individuals in fact lower their demand for money. Note that the act of lending does not alter the existing 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 money to the seller of financial assets – no present real savings affected because of these transactions.
Problems however, emerge whenever the central bank embarks on loose monetary policies. Since the expanded money supply was never earned, it therefore is not backed up so to speak by consumer goods. When such money is exchanged for consumer goods, it amounts to consumption that is not supported by production.
The printing of money therefore cannot result in more savings but on the contrary in the weakening of the pool of real savings. We now have more money chasing the same amount of goods.
Consequently, a holder of honest money, i.e. an individual who has produced real wealth discovers that he cannot get back the equivalent value of all the goods he previously produced and exchanged for money, all other things being equal. He discovers that his purchasing power of money has fallen.
Any so-called economic growth, in the framework of loose monetary policy can only be on account of the private sector that manages to grow the pool of real savings despite the loose monetary policy undermining this process.
Is it possible to ascertain the state of real savings? After all this is what drives economic growth? Because of the heterogeneous 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 true free market economy, without the central bank printing money, the pool of real savings is less likely to be threatened.
We can thus conclude that savings is not about money as such but about final consumer goods that support various individuals that are engaged in various stages of production. It is not money that funds economic activity but the saved pool of final consumer goods. The existence of money only facilitates the flow of the real savings.