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The Economy Isn’t Just Spending Money; We Need Savings

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Over the last several decades, the Federal Reserve and the US government have almost exclusively directed their policies toward “stimulating” spending. Artificially low interest rates incentivize borrowing and discourage savings.

But spending money isn’t the only thing that makes the economy go around. Savings are crucial and the lack of saving in America has hollowed out the US economy.

Modern economists trained in Keynesian thinking eschew savings. As economist Frank Shostak explains in an article published by the Mises Wire, “It is held by most mainstream economists that spending is the heart of economic activity. Economic activity is depicted as a circular flow of money. Spending by one individual becomes part of the earnings of another individual, and vice versa. In contrast, saving is viewed negatively as it weakens the potential demand for goods and services.”

Driven by this mainstream view, modern monetary policy almost always emphasizes economic stimulus. We see this in the unprecedented Federal Reserve money printing and the massive borrowing and spending binge by the US government in response to the coronavirus pandemic.

But this approach ignores the process of creating goods and services.

One undeniable truth is you have to produce before you can consume. Shostak offers a simple example.

For instance, when a baker produces bread, not everything he produces is for his own consumption. In fact, most of the bread he produces is exchanged for the goods and services of other producers, implying that through the production of bread, the baker generates an effective demand for other goods. In this sense, his demand is fully backed by the bread that he has produced.”

The development of capital goods  – tools and machinery – drives production. But these have to be produced as well. That requires some consumer goods to be sacrificed or diverted for the production of capital goods. As Shostak put it, “In order to make them, people must allocate consumer goods that will sustain those individuals engaged in the production of tools and machinery.”

This allocation of consumer goods is what savings is all about. Since saving enables the production of capital goods, saving is obviously at the heart of the economic growth that raises people’s living standards. Observe that the saved consumer goods support all the stages of production, from the producers of consumer goods to the producers of raw materials, the producers of tools and machinery, and all the other intermediate stages of production and services. Also, note that individuals do not want various tools and machinery as such but rather consumer goods. In order to maintain their life and wellbeing, people require access to consumer goods.”

The introduction of money into the economy tends to obscure this process. But as Shostak observes, it doesn’t fundamentally change the equation.

In the money economy, ultimate payment is made by exchanging real goods and services for other real goods and services, with this exchange simply being facilitated by money. Thus, a baker exchanges his bread for money and then employs that money to buy other goods and services, implying that he pays for other goods and services with his bread. Money only facilitates this payment.”

Peter Schiff has been saying that money printing doesn’t really add anything to the economy. As he explained in a podcast episode, in effect, money derives its value from the production of goods and services. Everything that’s produced gets divided up based on the amount of money in the system.

Well, if you just increase the supply of money, it doesn’t do anything to change the supply of goods and services. So now, when you divvy those goods and services up, you just have to assign a higher price to all of those goods and services so that the market clears. But nothing of real value is actually added.”

Shostak expands on this point, explaining how money-printing ultimately depletes savings and lowers production – and thus demand.

Contrary to popular thinking, it does not follow that one can lift economic growth via the printing presses. When money is printed—that is, created “out of thin air” by the central bank or through fractional reserve banking—it sets in motion an exchange of nothing for money and then money for something. This results in an exchange of nothing for something.

An exchange of nothing for something amounts to consumption that is not supported by production.

When money “out of thin air” gives rise to consumption that is not supported by preceding production, it lowers the amount of real savings that supports the production of goods of a wealth producer. This, in turn, undermines his production of goods, thereby weakening his effective demand for the goods of other wealth producers.

The other wealth producers are then forced to curtail their production of goods, thereby weakening their effective demand for the goods of yet other wealth producers. In this way, money “out of thin air” that destroys savings sets up the dynamics of the consequent shrinkage of the production flow.

Observe that what has weakened the demand for goods is not the sudden and capricious behavior of consumers, but the increase in money out of “thin air.” Every dollar that was created this way amounts to a corresponding dissaving by that amount.

As long as the pool of real savings is expanding, the central bank and government officials can give the impression that loose monetary and fiscal policies drive the economy. This illusion is shattered once the pool becomes stagnant or starts declining.

What enables the expansion of the flow of production of goods and services is savings. It is through savings, which give rise to production, that demand for goods can be exercised. There can be no effective demand without prior production. If it were otherwise, poverty in the world would have been eradicated a long time ago.

Saving is integral to a sound economy. But the government and central bank policies today undermine savings – and thus the overall economy. Instead of a robust economic system, we end up with a series of bubbles. We get the illusion of wealth without the actual wealth.

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