This article first appeared in The Crank Report, Issue #7 (29 June 2015).
In the previous issue of The Crank Report, an attempt
was made to reintroduce the very old notion of “forced saving” (The Crank Report, Issue #6, 3 June 2015).
In this section, we’ll take a closer look at “good old-fashioned” saving and why
saving is as timeless as the most novel Shakespearean ideas.
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| Source: www.drinkteatravel.com |
Saving is defined as a surplus of production over
consumption; it is the difference between what we earn and what we spend. It is
the portion of income not spent or deferred to a later period which is why
saving can also be referred to as deferred
consumption. Saving therefore always requires a restriction in consumption
compared to what can be consumed. Increased saving thus means decreased
consumption in the near term (compared to potential) so that resources that
could have been consumed are instead made available for investments (Garrison, 2002) . Furthermore, as
Garrison states, increased saving now means increased consumption sometime in
the future. Saving can come about through any combination of these two factors
determining it, production and consumption, as long as former exceeds the
latter. For example, saving can be brought about simply by reducing consumption
if production remains unchanged. Savings can also be accumulated even if
production falls as long as consumption falls more.
We may broadly divide saving into two parts;
voluntary saving and involuntary (“forced”) saving. Voluntary saving can
loosely be defined as the savings set aside by the savers’ own free will and
which the saver controls. Involuntary saving on the other hand is the opposite.
It is characterised as an involuntary transfer of purchasing power from
consumers to investors by means of a money and credit expansion. This important
concept, referred to as “forced saving”, was discussed in the previous issue of
The Crank Report as mentioned above.
In general, the accumulation of voluntary saving
indicates increased economic progress and prosperity; it is the result of
excesses and plenty assuming it is driven more by production rather than an
overall abstention, for whatever reason, from consumption. Just like an
increase in excess revenues over costs signals economic progress for a company,
an excess of income over general living expenses signals economic progress for
individuals. The greater the overall ability
of people in any society to increase savings, all other factors remaining the
same, the more this indicates increased economic prosperity. On the other hand,
people in a society whom spend all their income on general living expenses,
including taxes, or where involuntary (“forced”) saving makes up a major share
of total savings, indicates a lack of economic progress, stagnation or even
downright deterioration or in the worst case, poverty (when income does not
cover basic living expenses). An increase in the ability to save is brought
about by real increases in income relative to the costs of living. The ability
to save can also be brought about by an increase in the purchasing power of
money (assuming it is not offset by a corresponding decline in income).
Conversely, a decrease in the ability to save can be brought about by real
decreases in income relative to living expenses or a decline in the purchasing
power of money.
Mises lists three ways in which saving can be
brought about by an increase in net production, but “...without a further
restriction in consumption and without a change in the input of capital goods…”
(Mises, 2008, pp. 512-513) :
- 1) Natural conditions have become more propitious. Examples include better harvests appearing naturally (e.g. better weather conditions, fewer plagues).
- 2) Production processes become more efficient without further investment and without further lengthening the production process (e.g. improved skills from learning, ideas).
- 3) Less frequent external disturbances of production (e.g. wars, revolutions, strikes and crimes).
Saving will increase as long as all of the
additional production brought about by any (combination) of these three factors
is not consumed. In the end however, it is always a surplus of production over
consumption that results in saving, to which there are no short cuts. The
issuance of more fiat money and the increase in saving deposits that often
result must not be confused with saving as the issuance of new money results in
both an asset and a liability being recorded since money is created as debt.
Saving on the other hand, generated from production exceeding consumption, is
an asset only. As de Soto explains,
“Saving always requires that an economic agent
reduce his consumption (i.e. sacrifice), thus freeing real goods. Saving does
not arise from a simple increase in monetary units. That is, the mere fact that
the new money is not immediately spent on consumer goods does not mean it is
saved” (de Soto, 2012, p. 697) .
Confusing an increased amount of money for saving
(or capital) is not uncommon and is perhaps caused by the fact that saving is
usually measured in monetary terms. Shostak describes the effect of monetary
expansion on savings as follows (Shostak, 2015) ,
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.
Saving can be utilised in two main ways in addition
to future consumption expenditures: investment or as an addition to cash
balances. Investments, either directly (e.g. a business buying producer goods)
or indirectly (e.g. a person buying listed company shares) lead to capital
accumulation. The effect of adding savings to one’s cash balance is however
slightly more subtle. If the savings are deposited with a bank, this has the
effect of increasing that banks’ ability to lend to businesses seeking funds to
invest. This way, the savings still lead to capital accumulation, but it does
so in a two-step process (indirectly via the bank instead of directly via the
saver). An increase in saving also has the added benefit of
lowering interest rates in the loan market as the supply of available funds
increases. Even if the saver was to store (hoard) the savings under the mattress, they
would still serve a purpose. Firstly, the saver does so for a reason and is
better off (or less worse off), for whatever purpose, as a result. Secondly, the effect of the savings does not simply
disappear as a result of this “hoarding” as the surplus of production over
consumption is still maintained. To fully grasp what is going on here, it
is important to think in real terms, i.e. ignore the money involved for a
moment. It is the act of producing something and consuming less than is
produced that is the deciding factor of whether saving has taken place or not.
Whether the money representing those savings is stuck under the mattress or
deposited in a bank account is in this sense completely irrelevant. As
Mises explains “The act of saving always has its counterpart in a supply of
goods produced and not consumed, of goods available for further production
activities” (Mises, 2008, p. 519) . The money surplus
is simply a receipt, if you like, for purchasing power earned and as Garrison
explains “Saving in capital-based macroeconomics means the accumulation of
purchasing power to be exercised sometime in the future” (Garrison, 2002, p. 40) . To illustrate,
assume that people on an isolated island feed on fish only, the only food item available
on the island. For each fish caught (produced) the catcher receives a sea shell
(money) that he or she can later cash in for a fish. Each sea shell therefore
represents saving. The important point to note is that no matter what the owner
of the sea shell does with it, other than claim a fish with it, savings have
taken place as more has been produced that consumed.
When savings are deposited in a bank, it increases
the bank’s ability to lend to consumers or businesses. Under normal
circumstances, the bank will quickly lend the money in order to earn interest
on it and thereby increase profits. On the other hand, when the money is kept
under the mattress they become unavailable to others. This however has the
effect of increasing the purchasing power of money as those stuffed in the
mattress are not being used to compete for goods and services. As long as the
pricing mechanisms are allowed to work freely, the reduction in money
“circulating” therefore serve to reduce prices. Any amount of money will be
sufficient to clear the market as prices will simply adjust to the existing
quantity of money.
As customer deposits are an important source of
financing bank operations and funding increased lending, cash stuffed away in
mattresses is bad business for the banking system. The less cash (notes and
coins) there are, the better for banks as a bigger proportion of the total
money supply ends up deposited with banks. And the more money deposited, the
more banks can lend as deposits adds to a bank’s reserves. This is why banks
will always push toward a “cash-less” society (e.g. credit cards, debit cards,
internet banking etc) as this ensures less cash is kept outside the banking
system. In short, fractional reserve banking (our current banking system) would
be able to create even more money (a feature of an elastic money supply) and
experience no overall bank-run in a cash-less society. With an inelastic
monetary system on the other hand, the monetary amount of saving in effect works as a scorecard, in
monetary terms, of the amount of “excess” resources available for investments
or for consumption later on. When there are no savings available, further
investment will become impossible as no resources are freed or made available.
Investments will only be possible to the extent of prior saving. Otherwise,
there are simply no funds available to finance the investments. This ensures the savings-investment
relation is fully working and operating within the means of reality instead of
within the sphere of some economic policy doctrine. It also ensures the
investment-consumption relation is kept in line with people’s (time)
preferences as market participants vote with their spending and saving
decisions: do they prefer to consume less goods and services today or do they
prefer to sacrifice consumption now in order to consume more tomorrow? In
short, checks and balances are allowed to work in a monetary system based on an
inelastic money supply.
This seizes to be
the case under an elastic monetary system as an increased money supply is, in a
way, confused with real saving. A part of the discipline omnipresent in the
market place where people interact, brought about by checks and balances firmly
based on reality, is lost with an elastic money supply. This discipline is
attempted replaced with malfunctioning regulations, centrally imposed moral
standards, an influx of ethics doctrines and an overabundance of legislation
far removed from law proper. You cannot however substitute the self-restraint
inherent in a free market economy with centrally urged “confidence”, “ethics”
and “moral standards”. In an elastic monetary system, purchasing power not
previously made available through voluntary saving is made available instead
through the creation of new money by way of bank lending or the central bank
monetising government debt. Note that no initial sacrifice is made when
investments are financed with newly created money as opposed to when they are
financed with prior saving (through a restriction of consumption). As money
from savings is indistinguishable from money created through credit expansion
(they look the same, smell the same and work the same), the recipients of the
new money do not really care which it is. In fact, they have no idea, nor would
they probably care if they knew, if the money comes from prior savings or as
newly created money. Their primary concern is after all to acquire purchasing
power to realise their plans. If the resources committed to the additional
investments, which were paid for with the new money, do not come from prior
saving they must come from somewhere else and only at the expense of
alternative uses. Resources are after all scarce and newly created money is not
a real resource that has come to existence through some value creating
activity; printing money is not synonymous to printing resources (if it was,
there would be little need for anyone bar the printing press operators to go to
work). The inevitable result is a transfer of resources from current
consumption (current consumption is the will of the market as there are no
saving) to future consumption or from a subtraction in other investment
programs where these resources would have been allocated under an inelastic
monetary system. A shift in production in opposition to the market’s time
preference and wishes hence results and market forces are no longer in balance.
Whenever investments exceed prior saving, made possible only through an
expansion of credit and hence an increased money supply, distortions to the
economy are inevitable. The extent of these distortions will go hand in hand with
the extent of the increase in credit above and beyond prior savings (which is
what leads to an increase in the money supply); the larger the credit
expansion, the quicker it is undertaken and the smaller the savings, the larger
the distortions and vice versa. A slow and gradual expansion will create milder
distortions, but distortions will result nonetheless. Mises explains:
“The notion of
“normal” credit expansion is absurd. Issuance of additional fiduciary media, no
matter what its quantity may be, always sets in motion those changes in the
price structure the description of which is the task of the theory of the trade
cycle. Of course, if the additional amount issued is not large, neither are the
inevitable effects of the expansion” (Mises, 2008, pp. 439, footnote 17) .
In essence, what is happening when new money is
issued and used for investment purposes is this: as resources have not been
freed through the act of saving, the resources attracted and committed by the
new investment leads to a corresponding reduction in resources available
elsewhere. Other projects, including maintenance of capital, might suffer as a
result. In addition, the purchasing power of money falls (prices rise or fall
less than otherwise).
As money is created as debt (see TheEconomic Meaning and Consequences of Debt, The Crank Report, Issue #5), an ever growing mountain of money combined with
low saving is arguable the biggest issue facing our very civilisation today as
it negatively affects all in one way or more. Countries and regions all over
the world are now discovering the ills created by it; Greece is a current case
in hand. The only way to solve this greatest of problems longer term is to
reduce bureaucracy and let the private sector blossom with one goal in mind –
facilitate a substantial increase in voluntary saving.
References:
de Soto, J. H.
(2012). Money, Bank Credit, and
Economic Cycles, 3rd ed. Ludwig von
Mises Institute.
Garrison, R. W. (2002). Time and Money: The
macroeconomics of capital structure. Routledge.
Mises, L. v. (2008). Human Action, A Treatise on
Economics. Ludwig von Mises Institute.
Shostak, F. (2015). You Can't Create More Savings
by Printing More Money. Mises Daily, Ludwig von Mises Institute.
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