Savings, not consumption, grows the economy

It’s hard to believe, but in a country where thrift was once a virtue, it’s become a vice in the view of many.

The blame lies clearly with economists and politicians who try to reverse cause and effect.  Their attempt fails when confronting the facts.

Imagine yourself on an island in the Pacific Ocean without any outside contact.  Do you think you could grow your standard of living by eating more, or by storing food?

The answer is obvious.  You can’t consume what you haven’t produced.  You can’t live in the shelter you haven’t built, you can’t eat the fish you haven’t caught, and you can’t escape on the boat you haven’t constructed.

To have the time to build the shelter and boat, you’d have to put enough fish aside so you could build instead of fishing.  You can’t both build and go fishing, and without fish you’d starve.  To grow your standard of living, you have to forgo consumption by eating less, which then becomes savings.  The savings then allows you to build shelter and a boat.  Savings is what leads to growth, not consumption.

And, so it is in the world economy.  To get to the point where we have shelter, transportation, clothes, etc., we need to first save up enough food to have the time and resources to devote to building the other things we need.

Here’s another example.  Assume you want to open a store that sells clothes.  To rent the store, purchase inventory and pay employees, you need money.  You can’t use the sales revenue you haven’t gotten yet.  You need to use someone else’s savings.  Once those savings are used to rent the store, buy the inventory and pay employees, you can pay back the person you borrowed from.  But, you can’t borrow what’s been consumed–it must be saved first.  The lender has to save instead of consuming in order for the store, the jobs or the clothes to ever exist.

Once again, so it is with the world economy.  To create growth, hire new employees, etc., you need savings first.  Savings that are invested create growth.  Consumption can’t do it.

If you spend more than you produce, your standard of living will go down.  That’s just a fact.  You can’t spend your way to prosperity.  You have to save first.  But, to save, you need to spend less than you make.

Sometimes, savings doesn’t produce growth.  As illustration, suppose you put enough fish aside to build some shelter, but a storm comes along and blows it away.  Now, you have to save enough fish up, again, so you have enough to get by as you rebuild a new shelter.  Consumption won’t fix the problem, only more saving. 

Using my second example from above, suppose the clothes store fails–suppose buyers are not interested enough in the clothes to pay as much as the rent, employees and inventory cost?  Then you won’t have enough to pay back the person you borrowed from.  To build back to the point the lender started from, more savings will be required–which means the lender will have to consume less and save more.

Once again, so it is with the world or national economy.  Bad loans are solved by more saving, not consumption.  Destruction by mother nature requires more saving, not more spending. 

More spending than production leads to lower standards of living.  The solution, once again, is savings, not consumption.

Don’t be fooled by those who say the U.S., or China, or Europe, or Japan, or anyone else can create prosperity or growth by borrowing to consume.  Growth comes from savings, not consumption.  And borrowing to consume requires even more savings to get back to break even.

Next time you hear someone prattle on about how we need more consumption to get growth “going” (I don’t care if they have a Nobel prize in economics–that just means they should know better!), think about an island in the Pacific and that consuming fish doesn’t create shelter or boats.

It’s time to go back to our country’s roots, it’s time to tear down the over-worship of consumption and spending and replace it with a reverence for savings and investment. 

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Savings, not consumption, grows the economy

The economy’s white knight

There’s been a lot of talk about what will pull the world economy out of the funk it entered a year ago.

Most of the focus has been on the U.S. consumer and what they can do to pull us out of our economic malaise. After all, consumer spending is usually 60%-70% of the economy.

Others, instead, focus on the governments of the world, whether U.S., Chinese or European. To this way of thinking, the economies of the world have come off the tracks, and only government can get them back on the again and moving forward.

But, I think this misses the most likely source of future economic growth: businesses.

Consumers are tapped out, they have to pay off debt and build up savings. Most governments are tapped out, too, they are simply borrowing from others in hopes that spending now will produce growth sooner rather than later. The financial sector, which can usually spur growth with lending and investment, is even more highly in debt than consumers or governments, so they don’t seem likely to be the impetus for growth.

Businesses, on the other hand, are in relatively good shape. Businesses faced a very tough recession in 2000-2002, and they have since lowered their debt and learned to react quickly and decisively to tougher economic times. They tend to be leaner and more flexible than they were a decade ago, and many have large cash hordes they can put to work.

In my opinion, this is where growth will come from sooner than any other place. In fact, I believe it’s already happening.

Now that demand seems to be stabilizing, businesses will start hiring again. The U.S. economy needs to shift from a consumption to a production focus. China needs to shift from a production to a consumption focus. Businesses will lead the way in this shift because they will see the most profitable ways to benefit from the new landscape. The smart businesses, the lean and flexible ones who see the future first, will expand production and meet business demand first. They will then have the profits to hire and expand more. And, thus, the upward cycle will grow and expand.

This will not happen quickly. Production won’t go from 30% of the U.S. economy to 50% overnight. And, 30% of the economy will not make up for the 70% of consumption all at once. It will be a slow, steady growth that will build a more stable, more production focused economy.

This will be a good thing. For, as Jean-Baptiste Say said almost 200 years ago, supply creates its own demand. Production, after all, must precede consumption–you can’t consume what hasn’t been produced. Having an economy more focused on production than consumption will grow more steadily and resiliently.

The economy’s white knight is riding to the rescue, and below the radar of almost everyone. Businesses will lead the way.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Higher saving rates are a GOOD thing!

The U.S. saving rate recently hit 5.7%, and all types of commentators have been saying this is bad for the economy. I think this is a load of hooey!

One of the most famous economists of the last century, John Maynard Keynes, made this fallacy main stream with his “Paradox of Thrift.”

I’ll spare you the details, but the gist is that savings aren’t spent in the economy, and therefore prevent growth, employment, all good things.

This fallacy has all kinds of people, including economists and commentators with IQs that are much higher than mine, saying that more savings will crush the economy.

But, I think they are full of baloney. Saving stuffed under a mattress, as they were during Keynes time, aren’t spent in the economy. But who puts their savings under a mattress nowadays?

No, most people put their saving into the bank, bonds or stocks.

If savings go to the bank, they are lent out again and used for consumption or investment in productive capacity. I call that spending.

If the money goes into bonds, then whoever sold the bond will either spend the money, which is consumption, or invest the money elsewhere, which will turn into an investment in productive capacity.

If the money goes into stocks, you get the same thing as with bonds.

If people save their money (and don’t stick it under the mattress), it gets invested. Investment is where higher productivity, new jobs, and growth come from.

We shouldn’t be encouraging people to spend, we should be encouraging them to save and invest. Consumption, especially consumption paid for with debt, is what got us into this economic mess to begin with!

What we need is more, not less savings. That will create new jobs, higher productivity and higher growth. This will not prevent growth, but is the necessary precursor to growth.

Okay, I’ll get off my soap-box now…

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.