Thursday, January 22, 2009

Saving Part 2: Introducing Inflation

In my previous entry, I made the following comment.
When the saver finally does begin spending his savings for consumption, there is more wealth available for purchase than there was when he began saving.
To see this principle in action, one need look no further than the emerging technology industry. If one buys his computer, video game system, or plasma TV today, he'll pay a higher price than if he saved his money and bought it at some future date. He can then spend the rest on something else. The reason one is able to buy more later than earlier is because the available wealth in that sector, both in terms of quantity and quality, has increased over time. New, more efficient ways of producing these items have been implemented. Less materials, less space, and/or less work are required to produce them, so his share of it has increased in size, though not necessarily in proportion.

The same principle is constantly operating in every area of a healthy economy. Those few areas for which new processes are not developed can also be increased if necessary, as resources from other areas can be freed up via efficiency improvements in those sectors.

However, this probably doesn't coincide with the average person's experience. "Prices always go up over time," I so often hear. How can prices go up when the general stock of wealth is increasing, and production methods improving? One word: inflation.

I can hear it now. "Well, duh!" one might say. "Prices go up because prices go up? That reasoning is so circular the circle can be seen in a single statement!"

Inflation is NOT rising prices. Inflation can CAUSE rising prices, but the term itself refers to an increase in the money supply, and more specifically, an expansion of the supply of money beyond the basic commodity upon which it is based. Imagine increasing the size of a balloon by filling it with air. The quantity of rubber has not been increased, but the size of the balloon has. "Inflation" as a term was coined in an era when money was based upon a supply of gold, and referred to the increase in the supply of gold-based negotiable instruments relative to the actual quantity of gold. And, much like the balloon, if the money supply were expanded too far, it could, and did, pop.

Of course, these days, we don't use gold for money, and the "base" upon which our money is built is the decisions of the federal reserve banks, growing and shrinking the monetary base at will, which banks are able to issue additional drafts against much the same way they once did with gold. The term "inflation" isn't quite so illustrative or literal as it was under the "gold standard," but it should still be reserved for changes in the size of the money supply, rather than being transferred wholesale from cause to effect... because if we call the effect "inflation," what do we call the cause? Nothing... and that is precisely how the apologists for the current system would have it.

I'm rambling.

To return to today's topic (now that' I've defined what I mean by "inflation"), inflation is the reason that, despite increasing efficiency, prices continue to rise. For however fast the overall supply of goods and services grows, the money supply grows faster. If it did not, prices would go down over time. What would this mean?

This would mean that the benefits of economic growth would be shared among all responsible people. Anyone who was saving money against a rainy day, or for their future, or for their kids' future, or for whatever purpose, rather than spending it all and ending up down on their luck at the first sign of disaster, would benefit from overall economic growth, because when the day came to spend it, they could get more for it than if they had spent it right away. This is justified, because if nobody labored without immediately consuming (ie. saved nothing for the future), that extra wealth would never have existed. Saving money is a socially beneficial act, and with non-inflatable money supply, this benefit goes to the saver. It also goes to the non-saver, since even he benefits from lower prices, but the saver benefits even more.

By saying that savers would benefit under another system, am I suggesting that savers are NOT the ones reaping the benefits of economic growth under our system? I am. And the answer to the question, "But who DOES reap the benefits under our current system" is to be found in the answer to another question. "Where does the new money come from?"

This, I shall explore in my next post.

Thursday, January 15, 2009

In Defense of Saving

I read too often about this economist or that denigrating saving as a drag on the economy. People "oversave." The idea, of course, is if you don't spend all your money, someone is going to go out of business. If you don't buy that extra toy... if everybody is forgoing that extra toy... the toymaker goes out of business. Now he can't buy as much, which means the people he (and everyone like him) previously spent his money with will get less, which means they'll have to reduce their spending, on into a ZOMG DEATH SPIRAL OF DOOM which DESTROYS THE ECONOMEH!!!

Therefore, everybody must go continually into debt if production is going to go on, and because they won't, the Government must.


Saving is a necessary component of any growing economy. Without saving, there cannot be growth. The saver doesn't necessarily have to be you or me, but, on the aggregate, wealth must accumulate. Consumption must be less than production, because if all production is consumed, what's left for capital improvement? Allow me to illustrate, with the simplest of economies: the subsistence farm.

Start with a farming family, a stock of seed, tools, (both being capital) and arable land. The field is ploughed, seeds are planted, the crops watered, and ultimately the produce harvested. But they can't eat it all. If they do, they starve next year. Some of the produce must be saved for seeds, which can be planted next year. And if that's all they save, we're not talking about a growing economy, but rather a stagnant one. They're just barely making ends meet.

To truly grow, there has to be a positive wealth accumulation. Some of their resources must go toward things they can't consume, but will rather increase future harvests. Maybe a new fence needs to be built to keep a herd of animals out of the crops, increasing the yield. Maybe a new barn would enable them to better store their crops and tools, reducing loss and maintenance. Maybe they can devote some of their efforts to making better tools, or trade some of their crops for better tools. Take them out of subsistence farming and put them in a money economy (even if by "money" we're referring to grains of wheat, rice, or what have you, which are serving as a medium of exchange) and they can save money to buy even better tools in the future... maybe a tractor. Or, they can devote a part of their future produce to paying off a loan to buy the tractor. Either way, part of their produce is diverted from consumption to production of capital goods, with the main difference being that if one saves, one gets to keep the interest the creditor would otherwise collect. And even if the producer does not save, the creditor must: else what does he loan?

The principle can be abstracted to a full market.

When a laborer labors, he is adding to the economy's stock of wealth. When he spends his wages, he is withdrawing his share from that stock. If every individual spends his revenues the moment he acquires, that means all production is going to satisfy consumer desires. That's fine, if that's what people want, but productivity cannot increase unless some of that labor is going to improve the capital structure.

When someone saves money, he is effectively, in the short term, doing part of his work for nothing. He labors, but he does not consume the result of his labors. If that were the end of it, if he were burning the money rather than saving it, it'd be a recipe for a lot of waste: rotting uneaten food, ships rusting and rotting in harbor, houses falling apart from disuse... while for some bizarre reason, people slept outside and went hungry. But he WILL spend it in the future, and that future demand spurs today's capital development, to give the producer an edge in future production.

For when he saves money, he is also increasing the supply of investable funds. This signals the likelihood of future consumption to the entrepreneur in the form of lower interest rates. The lower the interest rate, the more likely a producer is to borrow in an effort to increase his productivity. When the saver finally does begin spending his savings for consumption, there is more wealth available for purchase than there was when he began saving. This can happen even if he doesn't make the funds available for lending, because either the cost of borrowing money goes down, or the cost of employing resources.

I shall use another illustration.

Suppose for a moment that a lot of people abruptly decide to stop buying their lunches at fast food places, and decide instead to make lunch at home, in an effort to save money. Let us also suppose, for simplicity's sake, that the saved money is not made available for lending, but is rather saved under their mattresses. The immediate impact is that, demand having shifted away from fast food restaurants, a number of fast food places go out of business. This is bad for them in the short term: they have to find new jobs. But it's good for people in the business of selling the stuff people make sandwiches out of, demand having shifted toward them.

The result is that available resources are going to shift into, for example, the bread making industry. Workers who previously flipped burgers now make bread (probably for less, the overall demand for labor being less). Makers of capital goods who previously made fast food equipment shift over to making bread making equipment. Entrepreneurs who previously attempted to dream up ways to break into the fast food market are now trying to figure out how to break into the bread market. Land that was previously devoted to fast food restaurants now is involved in making sandwich fixings. (And if that's too analogous for you, just imagine total resource allocation shifting to meet new demand conditions, rather than a direct conversion.)

The result: increased competition in the bread market results in bread that is either cheaper, or better, or sometimes both. The quality of life of those who like the new breads is improved. Those who are fine with the cheap bread now find themselves with extra spending money... which they devote to NEW demands. They are now able to consume more while maintaining the same level of saving!

Thus, drop in demand for available resources (including labor) is short term. In the long term, improvements in the efficiency of the production of necessities (which could not have occurred if resources were not made available for that purpose by savers declining to consume those resources immediately) enable resources to be shifted away from those areas, and into luxuries.

The problem with saving in our society isn't saving in and of itself, but rather the wild fluctuations in the rate of savings, which frustrate long term planning, and result from excessively elasticity in our money supply (not to mention its revenue-diverting effects). I'll try to tackle this element of this discussion in my next entry.