Why Saving Is Right and Economists Are Wrong (Consumer spending is NOT the way to recovery)

Minyanville ^ | 09/02/2010 | Jeff Harding

[SeekAndFind]

In George Orwell’s brilliant novel Nineteen Eighty-Four, one of the characters, Syme, in discussing the nature of Newspeak, says “It’s a beautiful thing, the destruction of words.” Newspeak was a systematic attempt by the dictators of Oceania, a totalitarian society eerily similar to North Korea, to control thought by eliminating words that gave rise to ideas they disapproved. What Syme and Orwell are talking about is that the destruction of words is the destruction of ideas.

There is a parallel to this in contemporary economic thought. Mainstream economists, Keynesians, Neo-Keynesians, and Neoclassicists, would have you believe that what common sense would call “good” is now “bad.” Conversely, “bad” is the new “good.” I don’t mean to suggest that the US is heading toward becoming a North Korea. My point is that that the experts seem to abandon common sense and yet most people instinctively understand that good is good.

Common sense is the crux of Austrian theory economics. Austrians look at how individuals act, not how "economies" or "nations" act or behave. Ludwig von Mises, the greatest Austrian thinker, and in my opinion the greatest economist, entitled his great work, Human Action not National Action. The Austrian School was referred to by the Germans as the Psychological School because its analysis started with individual action and how those actions would either attain or fail to attain the goals sought by individuals. In other words, it involves a lot of the "common sense" that guides human behavior most of the time. It's comforting to know there's a philosophy of economics that conforms to what human beings actually do rather than how some economist thinks we ought to behave.

Examples of economic Newspeak flourish, especially if you listen to President Obama’s economic team. My favorite example is the present conflict between consumer spending and consumer saving. Since the crash, consumers have cut back on spending and are increasing their savings. Most economists are saying this is bad for the economy; they urge us to spend, spend, spend to save the economy.

Actually, it's just the opposite: Saving is the road to recovery.

It seems rather obvious that during a downturn of the economy it would be natural for people to save more and spend less: They're uncertain about their jobs; the values of their homes have plummeted (about 30% since the peak in 2006); their stocks have declined, and their debts are high. Isn’t it common sense that people are doing the rational thing by saving? This is something our parents and grandparents understood well.

Yet Keynesian economists, the dominant economic theory today, tell us that consumers should be spending rather than saving. “Don’t you realize,” they say, “that 70% of our economy is based on consumer spending. Why do you think we have all that unemployment? We won’t recover until we can get people to starting buying stuff again!” Since we aren’t spending they've got the government to do our spending for us. Paying one man to dig a hole and paying another man to fill it is, under Keynesian theory, the path to recovery.

According to their logic, we had the biggest financial bust in world history because consumers wrongfully just stopped spending. If that was the case, it’s funny we didn’t hear these people warn us about too much consumer spending during the housing bubble. To explain why saving is good and why economists are wrong, we have to ask why we keep having these boom-bust cycles. Here's where common sense really has been thrown out the window by mainstream economists. Almost all economists believe that you can make the economy prosper by printing huge amounts of new money and throwing it at the economy to make it grow.

Does it make sense that by printing more pieces of impressive looking green paper that you can create wealth? If that were the case, why aren’t the Zimbabweans the richest people on the planet? Yet, this is what economists believe and this is what the Fed practices.

To cut this short, this is exactly what the Federal Reserve did starting in 2001. Over a five-year period, the Fed reduced its federal funds rate from 6% to 1%. Money flooded the economy. Housing projects that made no sense but for the cheap money and the false appearance of paper prosperity, were hugely over produced. When the Fed stopped the gusher of money in 2006, the whole thing collapsed and pulled the economy down in the biggest bust the world has ever experienced.

Consumers, as we're referred to by economists, lost $10 trillion of wealth in the bust, and were left with huge debts from their wild spending. We borrowed against the value of our homes, we borrowed on our credit cards, and we borrowed to buy big new cars. Now about 25% of Americans have more debt on their homes than the homes are worth.

So what would you do in those circumstances? Spend more? I don’t think so. And that's why consumers are saving. Yes, it reduces consumer spending, but how else are we going to save when unemployment is high and wages are stagnant? Savers are making rational, informed choices and economists just can’t see that.

There are two major benefits from savings. You could say that reduced spending doesn’t boost the economy and it causes housing and other asset values to decline. But that ignores a critical point, and one that's hindering recovery: How else are you going to get rid of the homes and commercial real estate that were overproduced during the fake boom? This really is simple economics -- supply and demand. As prices fall, buyers will be attracted to the market, and gradually the excess disappears. The longer those assets and their related debts hang around, the longer this recession will last. This, I believe, is the most critical issue in the economy right now; by letting the economy solve the problem of all these overproduced assets, credit will start flowing again.

Another critical benefit is that new savings build up capital for future expansion. In addition to the $10 trillion lost by us consumers, the entire wealth of this country was reduced by maybe another $30 to $50 trillion (these numbers are hard to pin down). With all that capital wiped out, you may ask where the capital will come from to finance a revival of the economy once the dead wood is cleared away. We already know that it can’t be done by printing money. It can only be done by savings.

I say, “Thank you my fellow Americans for doing the right thing to help our economy recover. Please ignore the economists. Take care of yourselves and you’ll be taking care of the economy.” Good is good. Bad is bad.

[SwedishConservative]

“Savers are making rational, informed choices and economists just can’t see that”

Economists see that just fine, but they don’t work with individuals. Economic theory deals with economies the size of nations.

I think the author of the article is (purposefully?) mixing “good for the individual” and “good for the economy”. Even mildly intelligent people should agree that a cut in consumer spending will hurt an economy based largely on production and trading in consumer goods and services. So unless the idea is to revert to an economy based on agriculture and essential commodities only, saving may be good for the individual but not for the economy.

And btw, spending didn’t land us in the mess we’re in now, OVERspending and irresponsible borrowing did.

[vanilla swirl]

In many ways we are living in Orwell’s world.

[sickoflibs]

RE :”Yet Keynesian economists, the dominant economic theory today, tell us that consumers should be spending rather than saving. “Don’t you realize,” they say, “that 70% of our economy is based on consumer spending. Why do you think we have all that unemployment? We won’t recover until we can get people to starting buying stuff again!” Since we aren’t spending they've got the government to do our spending for us. Paying one man to dig a hole and paying another man to fill it is, under Keynesian theory, the path to recovery. According to their logic, we had the biggest financial bust in world history because consumers wrongfully just stopped spending. If that was the case, it’s funny we didn’t hear these people warn us about too much consumer spending during the housing bubble. To explain why saving is good and why economists are wrong, we have to ask why we keep having these boom-bust cycles. Here's where common sense really has been thrown out the window by mainstream economists. Almost all economists believe that you can make the economy prosper by printing huge amounts of new money and throwing it at the economy to make it grow. “

Of course then they complain that we are not saving enough. The truth is that personal debt based consumer spending helps those elected in power short term, the credit expansion sold as wealth creation..

Here is my theory on Krugman and other massive debt stimulus liberals. What they really mean when they say the stimulus wasnt big enough is that it wasnt big enough to get democrats through this years elections. It fizzled out during the summer. These debt and tax Keynesian's don't give a crap about this country long term, and I don't just mean democrats either.

[stephenjohnbanker]

” These debt and tax Keynesian’s don’t give a crap about this country long term, and I don’t just mean democrats either. “

Keynesian economics is so stupid on its face, only an America-hating leftist would ever advocate it.

[arthurus]

Savings is the source of capital. Period. End of sentence. End of savings means end of capital. Spending and borrowing can provide an illusion that capital is being created. It is only an illusion.

[arthurus]

“Keynesian economics” is not a true term. It can be Keynesian or it can be Economics. Keynesianism is a set of excuses for political control of the economy which is ultimately everything. It is political defiance of and evasion of Economics.

[stephenjohnbanker]

” “Keynesian economics” is not a true term. It can be Keynesian or it can be Economics. Keynesianism is a set of excuses for political control of the economy which is ultimately everything. It is political defiance of and evasion of Economics. “

You are, of course, correct.

[SonOfDarkSkies]

Paying one man to dig a hole and paying another man to fill it is, under Keynesian theory, the path to recovery.

They believe such crap because this is what human work looks like to people sitting high up in ivory towers. We look like ants, just digging holes.

I can't remember the number but I think it was like 5% of the people in the Obama administration have had any private sector experience. And his economic advisors are all from Harvard.

This explains their misunderstanding of economics and common (read practical) sense.

And also alien to Obama and his Keynesian advisors is that spending isn't just spending. If we all spend our discretionary income of pricey champagne, not only does our resulting hangover damage our productivity...but this acquisition has little or no local 'multiplier' effect attached.

On the other hand, spending on a freezer for example has the effect of increasing our family wealth by letting us cook in larger quantities, enjoy volume discounts in purchasing, and then freeze the extra food for another day. And the freezer has a long life expectancy.

Or perhaps Junior purchases a lawnmower that he can also use to create a summer job of mowing neighborhood lawns.

Or perhaps Mom and Dad buy a sewing machine that adds to the life of family clothing and, again, increases family disposable income by reducing costs of an expenditure segment.

BTW, notice the old-fashioned nature of the above mentioned expenditures. They are old-fashioned not because they are outdated in general concept because Americans have wandered so far away from practical living.

[Hop A Long Cassidy]

>>>Keynesianism is a set of excuses for political control of the economy which is ultimately everything.

Great Quote Bump

[arthurus]

It is an incoherent set of excuses. Try reading his Theory of etc. It does not hang together logically even within single paragraphs. It simply does not make sense in the English language. His disciples understood only JMKs conclusions because they could not have understood his arguments. It reads like an extended parody of the sort for which MIT students are famous for getting published in peer reviewed journals- all terminology and arguments that go in circles or simply do not connect one to another.