Does Reduced Consumption, and Increased "Saving," Result in "Capital" Formation?

Matthew Yglesias riffs off my recent post, “Saving” ≠ “Saving Resources,” and there’s been quite a bit of commentary there, plus on Asymptosis and Angry Bear (plus a bit of twitter talk that I can’t figure out how to link to easily and usefully).

There are a dozen things I want to discuss on the topic, but I’d like to address the key belief underpinning much of the commentary (including Matthew’s). In my words:

If you don’t spend all your income, the unspent part is used by others to produce/purchase* “fixed” or “real” or “productive” assets. More money gets spent on investment, and less on consumption.

There are all sorts of problems with this notion, empirical and theoretical (notably the confusion of an accounting identity, “S is identical to I,” with economic incentives). I want to try and cut to the crux, with this:

A. If I transfer $100K from my bank to yours to purchase goods or labor, is there more money to produce/procure productive assets?

B. If I (or all of us) instead transfer $75K, leaving (“saving”) $25K in my bank, is there more money to produce/procure productive assets?

The answer to B is obviously “no.”

I hope not skipping too many steps here, so as to render this incomprehensible, I think Dan Kervick makes the key point in his comment on Matthew’s post:

a significant portion of monetary saving is just used to purchase government bonds

I would add, “directly or indirectly.” And: government bonds are only part of it.

This imparts the crucial understanding of aggregate, inter-sectoral balances that people lose sight of when thinking in terms of personal, individual “saving” of “money.” (Usually, implicitly, people are thinking about an isolated, domestic, private, non-financial sector — U.S. households and non-financial businesses.)

The financial system (including treasury and Fed) is constantly creating new, more, financial assets. New government bonds and currency, in particular, have no direct relationship to real investment. When you (or your bank) buy(s) a newly-issued government bond, you’re not funding/financing/incentivizing real private-sector investment in productive/useful capacity. (Though in one accounting view, you could argue that you’re “funding” government investment.)

So in a very real sense those financial assets (and arguably many [private-though-not-necessarily-“real”-sector] others) “absorb” “money” without creating new productive capacity. (This does not imply “crowding out.” Interest rates are at historic lows, and corporate cash hoards are at historic highs, even while government bond issuance has also been at historic highs.)

Funds flow from the private domestic nonfinancial sector into the the financial and government sectors (in return for an increased stock of IOUs). But absent intentional action (lending by the banks, deficit spending by government), they don’t flow back into the private domestic nonfinancial sector — and even less certainly into investment by that sector.

This is greatly simplified, and there’s much more I’d like to say, but I’m hoping to impart a straighforward (though incomplete) understanding of this view.

Here’s how I see it (this is the most important part of this post):

Production produces surplus. Output > Input.

That aggregate surplus is monetized by trade and a financial system (including treasury and fed), in a stunningly complex process that I won’t detail here. That’s why the quantity of financial assets (“money”) keeps increasing — because the surplus increases the stock of real assets, and the stock of financial assets (loosely) represents the value of those real assets.

If producers can’t sell (trade) their goods — in the process monetizing the value of the surplus created — they don’t produce them (as a successful serial entrepreneur, I’m here to tell you…), and you get less surplus. So less saving. My saving happened because people spent.

Spending causes saving. (Counterintuitive, huh?)

Though I prefer the term “accumulation.” The moral valences associated with “saving” — and the misunderstandings of its technical meaning(s?) in the national accounts — have resulted in no end of economic confusion (and confution*).

And yes: spending — and the production/trade/surplus-creation it spurs — causes monetary saving. The creation of surplus effectively forces the financial system to create new financial assets, so the producers of that surplus (workers and businesses) can monetize that surplus, and store it in their accounts. If the financial system doesn’t effectively monetize workers’ and producers’ surpluses via wages and profits, they have less incentive to work and produce, so a weak economy/slow growth results. Fed governors get replaced, politicians get voted out, and banks lose money or at least lose out to competitors who are willing to monetize the surplus.

I really have to finish this up by citing Dan Becker again, in a response to Pete Petepete at Angry Bear:

As I read your postings, it seems you are moving the discussion toward the chicken or the egg type.

But it’s not just Pete Petepete. We’re all really rehashing the old Say’s Law argument here: does production cause consumption (“demand creates its own supply”), or the reverse? The obvious answer is “Yes. Both.” But I think it’s clear which side I fall on, and I fall on that side because we have a sovereign-currency-issuing government, and a massive financial system which also constantly creates new financial assets. Say’s Law only makes sense if 1. there’s full employment***, and 2. there are no new financial assets to monetize/store/”hoard” the surplus from production and trade.

If all the “so-called” quotation marks in this post are driving you batty, my apologies. So many of the key terms in economics are used so sloppily and in so many ways, I often find it impossible to talk about the subject without constant parenthetical definitions of terms — which definitions themselves often deserve full blog posts. I hope this post will at least encourage my gentle readers to think very carefully about what I (and they) mean when using these terms.

* The produce/purchase distinction is conceptually problematic in itself (and as it’s tallied in the national accounts), as made clear by discussions among Kuznets and company back in the days when they were creating the national accounts; trade is the juncture where real surplus from production is monetized, which drops us into the thorny theoretical thickets of “value,” “capital,” and the mysteries of “money profits.”

** Yes I know that’s not a word. But it should be. Hey: good name for a new blog?!

*** Full employment is another problematic concept. Are there realistically imaginable scenarios — i.e. wage inflation without commensurate price inflation — in which large numbers of permanent non-workers would be coaxed into the work force, increasing employment without changing the percent “unemployed”? Full employment compared to what?

Cross-posted at Asymptosis.

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