Summary:
Steve Waldman responds to yesterday's article by Paul McCully. Points out that under normal circumstances there is no paradox of thrift because savings is actually invested, i.e. spent on the current production of future capacity, and lays the groundwork for future consumption. Saving does not translate into a decrease of aggregate income. Issue only arises when the financial system breaks down: when investors lose faith in the quality of available investments or their ability to collect the proceeds (in real terms), they resort to precautionary storage (commodities, gold, art), i.e. saving of the wrong kind. Precautionary storage, not thrift itself, is the villain of the tale. Storage eats wealth. Encouraging consumption is not the solution. Feeds into a vibe that saving is so uncertain and money so volatile that one might as well spend. Much better to develop a financial system that actually performs, that identifies fruitful projects, puts current resources to work and allocates claims fairly. The financial system has failed because it erred grievously. Not a problem we can spend our way out of. To fix the financial system we have to change it, not rally to its support. (Published: 31/07/08)
Notes:
- paradox of thrift
- posits that if we all individually cut our spending in an attempt to increase individual savings, then our collective savings will paradoxically fall because one person’s spending is another’s income – the fountain from which savings flow
- often forgotten hidden assumption in the "paradox of thrift"
- true: one person's spending is another person's income
- but: does not follow that an increase in saving translates to a decrease in aggregate income
- two kinds of spending: consumption and investment
- e.g. buying Ferrari vs. laying a subway line
- nearly all savings are actually spent on investment goods
- what is "saved" is really spent on current production of future capacity
- plenty of paychecks to go around
- no "fallacy of composition": individually and in aggregate, today's thrift lays the groundwork for tomorrow's abundant consumption
- but: for this to work out, two things must be true:
- today's savings must be invested in projects that will actually generate future wealth
- savers must believe they will retain a stake in the increased wealth commensurate with the size and wisdom of their investments
- we have a financial system in order to make these facts true
- if the investment industry is capable of finding or initiating projects likely to satisfy future wants, and if financial claims are predictable and stable stores of value: no paradox of thrift
- issue only arises when the financial system breaks down
- when investors lose faith in the quality of available investments or their ability to collect the proceeds (in real terms), they pull out savers' Plan B: precautionary storage
- they buy gold, or oil, or art, or whatever, and they keep it, generating scarcity rents for those who can offer perceived value stores
- but very little in the way of general income and employment.
- precautionary storage, not thrift itself, is the villain of the tale
- when a dynamic of precautionary storage takes hold, vulgar Keynesian prescription is to encourage consumption
- in extremis that might be a good idea
- because if all everyone does is hoard, it's hard to figure what to invest in
- except maybe storage tanks
- but: it's much better to develop a financial system that actually performs, that identifies fruitful projects and allocates claims fairly
- storage eats wealth, while productive enterprise creates it
- people know this
- no one "invests" in gold or oil when a financial system is working
- they do so when it is broken: like now
- we're at a point where people are beginning to shift from investment to storage
- because of a well-deserved loss of confidence in the financial system
- but: not at a point where there's so little economic activity that we can't foresee future wants
- encouraging people to go shopping in order to help the economy?
- desperate last resort
- encouraging consumption now is nihilistic
- feeds into a vibe that saving is so uncertain and money so volatile that one might as well spend, 'cuz who knows what tomorrow might bring
- right way to sustain aggregate demand and maintain current income is to figure out what we should be investing in
- not: stocks, bonds, or CDOs
- but: factories, windmills, or schools
- and then to put current resources to work
- financial system is failing spectacularly
- because it erred grievously
- it built homes and roads and sewers that oughtn't have been built
- it "invested" in vacations and plasma televisions
- it paid itself handsomely for doing so
- not a problem we can spend our way out of
- to fix the financial system we have to change it
- we will know we've put things right when thrift is something we can celebrate
- when we save because we are excited about what we are creating rather than frightened by what we might lose
