I am a layperson. I have a question which I have been thinking about.
Does savings = investment? If not, how are we sure that deficit spending won’t “smooth the bump?” In other words, why won’t deficit spending take that unused savings and put it into productive use?
Thank you.
Because deficit spending is mostly just money out of thin air, not actual savings, so there are all sorts of distortions that come about. And it’s the government spending it, so there’s no profit-and-loss accounting to show us that the money is being put to its best use.
I don’t disagree with you on any of your points. I am just looking for a more nuanced answer, perhaps even a mathematical explanation.
Your question doesn’t make any sense, it has an inherent logical contradiction in it.
If saving equals investment, then, BY DEFINITION, saving is productive, since investment is productive. In fact, saving would be MORE productive than consumption, since investment is more productive than consumption. When you invest your money, you are directly or indirectly purchasing or creating something that increases productivity, thereby increasing economic growth. For example, if I loan my money to a bank in the form of a certificate of deposit (CD), I am (indirectly) investing in the economy. That bank then takes that money, loans it out to a business, which then uses the funds to buy additional machinery, purchase land, build a factory, hire additional workers, etc. In other words, you are increasing economic productivity, and thereby creating economic growth.
Here’s the catch: saving does not equal investment. Saving can equal delayed consumption. For example, I might be saving money to buy a car for my personal use. That, arguably, is NOT investment. Likewise, I might take a consumer loan out. That too, is not investment. So saving is not always investment. This is why Austrians abandon the consumption/investment dichotomy and replace it with lower order/higher order goods. A lower order good is a product that takes less time to plan and build. For example, an apple is a lower order good. It didn’t require any significant planning on the part of the farmer to produce that single apple. A factory that processes apples and turns them into applesauce is a higher order good, since it took time and planning to create that factory. The applesauce, on the other hand, is a lower order good as well.
So more saving simply means that more higher order goods are being purchased, since those are the goods that need saving to be produced. For example, Robinsoe Crusoe cannot build a fishing pole unless he first saves food so he can take a day or two to build that fishing pole and not starve. Likewise, the applesauce factory needs beforehand saving to be able to sustain the planning and production process until the factory is built.
This leads us to conclude that saving is better than consumption. Without saving, we wouldn’t be able to fund any capital projects that “grow” the economy. By increasing deficits, the government is simply diverting funding away from these market-chosen capital projects and directing them toward non-market consumption projects. This hinders economic growth.
I appreciate your thoughtful response; however, I did not say that savings = investment. I asked whether it did. And then I asked about the implication of S =/= I as it relates to our current economic situation. I would like to know why, if people right now are hoarding money because of fear; and if investors are keeping money out of the market because of uncertainty, then how can we say that deficit spending is bad?
As I understand it, we are all better off when resources are best allocated. I do not mean to suggest that the government has any clue how to allocate resources efficiently. However, if people and investors are stuffing money in their mattresses, figuratively speaking, then why is it bad right now in our present situation for the government to take some of that capital and put it to a productive use?
As I said, I am a layperson, but from what I read in the news, what I am saying, perhaps poorly, is the argument that Keynesian economists are basically making. What I want to know is why this is wrong.
But without consumption there would be no reason to save in the first place.
Not to leave with an entire book on your hands, but I trust you can use the table of contents appropriately, so here you go: http://www.scribd.com/doc/10249437/Failure-of-the-New-Economics A refutation of Keynesian theory.
If you want a “mathematical” explanation then you’d probably appreciate Garrison’s powerpoint presentation:
http://www.auburn.edu/~garriro/ppsus.htm
It’ll take you about 15 minutes and is an excellent graphical foundation to understand Austrian capital theory.
Once you’ve gone through that, you can start to appreciate that there is a limited quantity of savings in existence. Adding government expenditure to the equations does not, in any way, magic new savings into existence to resolve this problem. All it does is modify how the limited savings are used - to what purposes they are put and in what they are invested. Generally speaking, government expenditure is less profitable and indeed most of the time unprofitable (if it was profitable then it would not have to be commanded by the guy with the gun - people would do it freely). Government expenditure does not “add” investment - it merely transfers control over capital from the private sector (which is driven by profit and loss and thus can only be sustained if profitable) to government (which is funded by force/taxation and so which has no requirement to be profitable).
Haha, actually, I misread your question. I didn’t read the “if not” part. My bad, sorry.
People aren’t hoarding money. However, if they were, it would mean that they are uncertain about the financial institutions they could put that money in. The proper solution would be to let those institutions fail, along with any businesses. This would quickly clear all malinvestments and allow us to go on a sustainable path of development.
If people are “stuffing money in their matresses” it means that many financial institutions have made bad decisions, and thus, people do not want to keep their money with them. So instead of keeping money in banks where they could accrue interest and be loaned out, helping the economy, people are keeping their money separate from society. This allows all of the bad investment decisions of the past to be thoroughly liquidated, which creates a base for sustainable growth in the future.
Be deficit spending, the government simply makes the problem worse. First, it props up businesses that are unprofitable without government intervention, and thus MUST be liquidated for sound economic growth. Second, it increases the consumption to investment ratio, thereby slowing economic recovery, since more savings and investments are needed to “grow” the economy. Consumption does not lead to economic growth. Thirdly, government spending crowds out private spending: every government dollar must be taxed, borrowed, or printed, inevitably taking money from the private sector to the public sector either directly or through higher interest rates or higher inflation. Either way, that government spending has a negative effect on economic recovery.
Thank you, all, for your replies. The slides are a great resource. And Failure of the New Economics is on my reading list. I wonder, is it necessary to read The General Theory of Employment, Interest and Money in order to benefit from Failure of the New Economics?
No, you don’t have to read The General Theory first. Keynes is such a horrible writer it will probably fry your brain anyway, so better keep away from it. [:P] Seriously though, I’ve read it, and it is nearly incomprehensible. It’s hard to get beyond his basic contradictions and inventions of new, unnecessary terms. In any case, Economics for Real People should be the first book you read. It’s available for free here. de Soto’s Money, Bank Credit, and Economic Cycles is a good introduction behind the legal, moral, and economic problems that lay behind central and fractional reserve banking. It’s available for free here.
I see it like this.
When you save something, it is a speculative investment. Even if you consume what you save, you are speculating that you will enjoy the consumption more in the future than you would now. You can save domestic currency, foreign currency, gold, certificates of deposit, stocks, commodites, etc. in this manner.
When you purchase capital to increase productivity (or efficiency of productivity), it is a capital investment. You are speculating that your investment will increase profitability (perhaps simply mentally by easing one’s workload). You make a capital investment when you buy a wrench, or build a factory.
It is ambiguous to refer to either one of these as “productive” or “economical”.
One can surely save something that loses value. It would obviously be foolish if everyone tried to save perishable food indefinitely. However, when one earns money through speculation, he is generally performing a noble service (although distortions in money and credit can contradict this, such as the housing bubble, etc). His speculation helps find the true equilibrium price between producers and consumers, which coordinates production. When one saves money in this manner, he is helping to coordinate production according to the supply and demand for money. In a deflationary period, it makes sense and is economical to save until prices adjust. Government plans to attempt to keep prices stable and decrease money saving are obviously deeply flawed with economic reality and lead to poor economy.
Similarly, one can invest in capital whose additional productivity is not as valuable as the cost of the capital. It is obviously foolish for myself as a computer programmer to purchase a modern supercomputer to assist my programming. Generally, however, it is plainly obvious to see why appropriate capital investments are economical.
Both carry risk. All action is speculative.
See, here is an example of misuse of the word “productive”.
Why would it be bad for an individual with money to spend it right now? Because he values the money more than he values the goods presently available in exchange for it at those prices. Perhaps he is speculating falling prices and wants a better deal. That’s not a bad thing. If everyone is doing this simultaneously, that would suggest there are fundamental changes in the supply and demand for money. If he is the only person saving in this manner, prices won’t fall, and he’ll learn his lesson. Rothbard does a good job of covering all possible changes in The Mystery of Banking.
Why would it be bad for him to put it into a bank? Because he values the certainty of having his fixed quantity of money readily available for use over the risks inherent in keeping it in a bank.
What about a capital investment? It is more difficult to determine if such an investment will be profitable. Consumer demand is waning. Producer prices must fall with consumer prices. Again, perhaps prices have not yet adjusted to changes in the supply and demand for money. Capital may be cheaper quite soon. Thus, it may be a better investment to hold money for the time being.
The problem with the economy is not that he is refusing to spend or invest. The problem is that fundamental changes in the supply and demand for money and credit have produced an environment not suitable to spending to investing. He, and everyone who feels similar, should save until prices are reduced to a new equilibrium and banks clean their balance sheets and reduce risk.
If the problem were simply that everybody decided to start saving at the same time for some unknown reason, the situation won’t last very long. Prices will fall until people start buying and inventories are cleared. Once prices are no longer falling, those saving money waiting for better prices no longer have any reason to save. Demand rises and prices rise back to their old levels. In any case, this NEVER happens. The only means by which people can switch from inflationary to deflationary price expectations in such great number is a sudden decrease in the money supply.