Cheap Thoughts on Thrifty Thinking

Especially after the previous month’s very informative interview with Robert Higgs about the Great Depression, I was excited to hear Russ Roberts tear through the Keynesian policy prescriptions of professor Steve Fazzari on an old “EconTalk” podcast from early 2009.

However, Roberts stumbled to make a solid counter to Fazzari’s “paradox of thrift” argument, which goes on to say that less spending and investing result in smaller business profits and consequently a smaller pool of funds to save from. The paradox is that an individual’s attempt to increase his savings actually lessens the total, or aggregate, savings and spending of an economy. That cycle worsens and the economy slumps and looses more jobs, John Maynard Keynes argued, until some outside source (presumably government) spurs the economy with a sum of new spending or greater investment incentives.

That thinking falls flat on a few levels. The first of these errors is that money is not capital, and the creation of money cannot satisfy scarcity.

In “The Theory of Money and Credit”, Ludwig von Mises said:

The loss of a consumption good or production good results in a loss of human satisfaction; it makes mankind poorer. The gain of such a good results in an improvement of the human economic position; it makes mankind richer. The same cannot be said of the loss or gain of money. … An increase in the quantity of money can no more increase the welfare of the members of a community, than a diminution of it can decrease their welfare.

Now for sure, market-based sources of exchange like gold and silver are sought-after commodities, but they derive their market value from their universal exchangeability for other goods and services. Gold and silver are wealth to the extent they have value in the production of goods and services, but the value they trade for represents their higher use as a medium of exchange. So surely, dollars created out of thin air by the central bank are in no way the result of capital savings. Government has no resources of its own, only the power to confiscate wealth for the productive sector. So any government spending is transferred out of the pockets of existing taxpayers, future taxpayers in the form of deficit financing, or holders of dollars in the form of monetary inflation.

For illustration purposes, Fazzari said to imagine a small desert island where suddenly one inhabitant of the island refused to buy more goods or services. That would mean there would be less consumer demand, triggering less demand for labor and other capital inputs. Workers would be laid off and have less money for savings and consumption, which sets the savings paradox in motion again to incite a new round of lay offs, and on and on. Under this premise, temporary government spending would act as a backstop to prevent any further slide by boosting employment and propping up consumer demand.

In the aggregate, however, there is no reason to believe hoarding does injure the economy. By keeping money out of circulation, a hoarder increases the relative worth of all remaining money, which represents a claim on real capital. In a (flexible) market economy — prices for consumer products and labor and other capital inputs decrease proportionally to accommodate for the hoarder’s withdraw. Each dollar in circulation becomes more valuable since the demand for money has increased, thereby increasing the buying power of everyone else’s money in the market. The Keynesian model fails because it does not allow for flexible prices.

Second, most goods cannot be produced immediately on command. It is only with savings that capital can be invested to increase the productiveness of laborers. Without such an increase in productivity, wages would remain virtually stagnant. Increased wages and consequently increased future savings come about by present savings.

Third, artificially pumping fiat money into the economy will do nothing to improve the economy’s condition. Government manipulation of the value of money does not create capital, but it does misdirect investors to increasingly burn through existing capital savings — the life-blood of an economy — and misallocate production of present consumption from future consumption so that when consumers are ready to consume capital in the future there is less capital than anticipated and the bust sets in.

Instead of being vilified, the hoarder and saver should be welcomed as respected players in the market. Without such people looking to profit from their patience, we no doubt would still be living in cave dwellings and hunting with spears.

Further Resources
Image credit: wwarby, with a Creative Commons license