Sunday, February 08, 2009

The Assault on Saving, II of II

I left off yesterday arguing that consumer spending is the result of economic prosperity instead of the cause. The misunderstandings surrounding this issue are like most in economics: people are short-sighted and only tend focus on what is seen in the immediate sense, not on what is unseen. This is why it's not immediately apparent how savings are what fuel greater economic prosperity that later allows for more spending and higher living standards.

To illustrate, let us consider the story of two friends: one is named Hank, the other Snuffy. Snuffy and Hank must both be blessed by the luck of the Irish because an anonymous wealthy benefactor at Blessed Sacrament School has passed away and left both with an annuity of $100,000 in dedication for their lifelong service and support of that renowned institution.

Snuffy is a lavish spender with the new income. And he spends not only based on desire, but on principle. He is a firm believer in the theory that every penny must be spent or else goods will accumulate and people will be out of work. So he goes all out in redecorating his home, and buys a few luxury sports cars and a yacht. He dines at the finest restaurants, drinks top-shelf liquor at elite establishments, and goes on numerous vacations at exotic locales. He buys the finest diamonds and jewelry for his girlfriend. He tips very handsomely and keeps a large staff of chauffeurs and servants.

In this way, Snuffy feels he is not only serving his own immediate wants and desires, but is helping others through his generous spending. And it certainly appears this way, because Snuffy is extremely popular with the Lexus car dealers, the bartenders at the Mansion, the bellhops at the Westin, the strippers at Temptations, the wait staff at Ruth's Chris and the Yacht Club, and the entourage he keeps. Everyone around Snuffy see him as a public benefactor for his liberal indulgences. His extravagance keeps these people fat, happy, and employed because he pays for their services; that is what is seen.

Hank, on the other hand, is an entirely different story. His spending habits are quite austere. Unlike Snuffy, Hank decides to only spend half ($50,000) the income each year. Sure, Hank splurges on the occasional Outback steak or Captain's Platter at Hilliard's, but for the most part his spending habits remain the same as before the bequest. He lives a much more modest lifestyle and is rarely seen making it rain at the jewelers, the nightclubs, and the strip clubs. He still eats bologne sandwiches, sneaks peanuts and Sam's cola into the movie theatres, and brings flasks into bars. For this reason, many view Hank as overly stern and stingy. With Snuffy being the city's Santa, Hank is seen as its Scrooge. By withholding potential spending dollars, he deprives retail and services sector additional income or employment; that is what is seen.

But what of the $50,000 Hank chooses not to spend? Where does it go? Does he just stuff it under his mattress or allow it to pile up in his closet? What happens to it? This is the part of the equation this is not seen. Hank decides to take his cash and deposit it into a savings account at First Chatham Bank. And when Hank does this, the Bank uses that money to loan to businesses. The businesses can employ Hank's savings in a variety of ways: maybe as short-term working capital, maybe to expand production, maybe to invest in new and better equipment, maybe to hire additional workers.

In this way, saving is really just another form of spending. The chief difference is the spending Snuffy engages in can be easily seen with the naked eye, while the result of Hank's investing is harder to grasp because it goes unseen. When people like Hank save, it increases the supply of money capital in the economy, which lowers real interest rates. And when interest rates are lowered, it allows for the production and purchase of capital goods like new houses, factories, office buildings, equipment, and high-tech tools. Businesses are more willing and able to invest because loan payments are cheaper than before. More projects can now be undertaken because interest payments no longer exceed the potential and projected revenues from such projects.

20 years pass. The trust fund becomes exhausted. Snuffy, having spent every dime, is now broke. His former colleagues now think of him as a fool, and he begs his friend Hank for money, who is meanwhile rolling in dough from the interest income he now receives from his investments. And not only has his fiscal prudence secured his own personal financial well-being, but his savings have provided and will continue to provide better, high-paying, and more productive jobs.

In this way, Hank has done far more good for the economy through saving than Snuffy did with his spending. When a company invests in new equipment or better machines, it helps raise living standards by lowering the costs of production. There are two ways in which this happens: (1) workers are provided with higher wages, because they are now able to produce more per hour and thus create more value for their employer, and (2) it allows the business to reduce the price per unit, which translates into more money into consumer's pockets. So not only is Hank's personal income and wealth greater than Snuffy's, but he has added to the economy's productive capacity while Snuffy has not.

This is why a nation's wealth and prosperity depends not on the public's willingness to spend money on consumer goods, but on the amount of accumulated capital the public has at its disposal in its production of such goods. This is why it makes little sense for our government to continue coercing consumers to engage in spendthrift behavior (just so we can get nice, big, fat GDP figures!) instead of allowing the market to adjust and the economy to recapitalize itself. By continuing to inflate the currency and holding down nominal interest rates (now at a ridiculous 0%), people have little, if any, incentive to save their money. Washington is doing everything in its power right now to turn us into a nation of Snuffys, but the road to prosperity lies in having more Hanks.

7 comments:

Snuffy said...

Counterpoint:

In a nation full of Hanks, demand would be non-existent, meaning supply would be drastically reduced, meaning businesses would not be looking to borrow money, meaning banks would not pay any interest, meaning consumers would have no incentive to save.

It's all about the yin and the yang. You can't have the Hank without the Snuffy.

Patrick said...

I am going to have to start calling you Snuffy P. Keynes. Don't feel offended because you have fallen for a trap that 97% of the population does. It is typical and expected.

There will always be demand for things because we live in a world with unlimited wants and scarce resources. Supply creates its own demand. The Hank is just as selfish as the Snuffy; the only difference is his time preferences; or his "demand" for more long-term capital goods. And he we still always need food to eat, a roof over his head, clothes to wear, and a car to drive.

It is true that if we all turned into Hanks tomorrow, painful adjustments in the economy would take place. Millions of folks that work at Ruth's Chris, Best Buy, and Disney Land would be forced out of work. Consumer goods would take a big hit, and places like Cold Stone Creamery and Vanilla Day Spa would close up shop immediately.

On the other hand, the capital goods industries (the products involved in making the goods that Hank actually does consume) would undergo an unprecedented boom. Lawnmower, microwave, car, refrigerator, and computer manufacturers; banks; residential and commercial real estate; construction firms would experience an unprecedented boom and gradually absorb all the previously displaced workers. As banks are flooded with new savings, real interest rates would plunge and provide for fantastic productivity gains: imagine pimento cheese costing 5 cents per gallon or going to a newly remodeled and refurbished 5-story Pinkie Masters where robots serve you PBR tall boys for 2 cents.

The moral of the story is, as productivity surges and the cost of everything plunges, the Hanks will reach a point where they can consume just as much, and eventually more, than the Snuffys originally did and still be able to maintain their 50/50 savings/spending ratio.

China is a good example of this. While I deride its leaders for (what's left of) their socialist policies, China is basically a nation of 1 billion Hanks: they save, on average, nearly half their paychecks, and as a result their economy has experienced double-digit growth rates over the last 3 decades and their productive capacity has increased exponentially, leading to drastically higher living standards.

These points are not meant to deride Snuffy or anyone else for their spending habits, as mine are even worse than his. Nor is it to suggest we could all follow Hank's lead. Lord knows I could not. It is simply an academic exercise meant to demonstrate what makes an economy grow and expand.

HANK said...

If anyone wants to increase their savings, visit the Red and White on Habersham this Wednesday night.

Overall, the R&W is not a cheap store, but sometimes you can find great deals, especially on Oscar Myer products... I have seen 3 for 1 offers.

One night, Vienna sausage was $0.25 a can!

Joe said...

I'd rather just eat the 25 cents.

Patrick M said...

That place is still open? Damn

Snuffy said...

Pat, you're forgetting the 10% that Hanks would give to the IRA. Also, the only companies that would survive in a nation full of Hanks would be Nathan's Hot Dogs and Catlebury's Chili.

HANK said...

The IRA is in a state of hibernation right now.

Since the emergence of the Celtic Tiger, the Republican movement has lost steam. Just like any revolution, despair and misery are needed to round up support.

The pinnacle of IRA activity was in the early 1980s, when Ireland and England both were in a severe economic plight. The Catholics of Northern Ireland lived in slums, much like Hitch Village. The Papists came out in droves to support the IRA.

As we saw the economic situation turn around, so did the support of the IRA take a nose dive.

We may see an increase in IRA activity in the next decade if economic conditions deteriorate even more. There are signs that this recession, pound for pound, is more hard hitting in Ireland and England as compared to the US.