By Frank Shostak on the Mises Wire
Conventional wisdom holds that savings is the amount of money left after monetary income was used for consumer outlays. Hence, for a given outlay, an increase in money income implies more savings and thus more funding for investment. This in turn sets the platform for higher economic growth.
Following this logic, one could also establish that increases in money supply are beneficial to the entire process of capital formation and economic growth. (Note: increases in money supply result in increases in monetary income and this, for a given consumer outlay, implies an increase in savings).
How Savings Support Goods Production
Savings are the amount of consumer goods produced in excess of the consumption of these goods. For instance, if a baker produces ten loaves of bread and consumes two loaves his savings are eight loaves of bread.
Now, let’s say that the baker exchanges his saved bread for the services of a technician in order to enhance his oven. With an improved oven, the baker could increase his production of bread. Note that the saved bread, i.e., the baker’s savings, paid to the technician enables him to maintain his life and well-being while he is improving the oven. Likewise, the other producers of consumer goods, by exchanging these consumer goods for the services or the products of various other producers, are supplying the latter with the means that support their life and well-being.
The producers of consumer goods can exchange saved goods with each other, with the producers of raw materials, the producers of tools and machinery, or the suppliers of various services. The saved consumer goods support all the stages of production, from the production of consumer goods to the production of raw materials, tools, and machinery, and all intermediate stages. (Note that individuals do not want various tools and machinery as such but rather as consumer goods. In order to maintain their lives and wellbeing, people require access to consumer goods.)
If the production of consumer goods were to increase all other things being equal (i.e., the pool of savings increases), it would permit the enhancement and the expansion of the infrastructure. Individuals could now be employed in the building of new stages of production, which prior to the expansion in the pool of savings could not be undertaken. This, in turn, would permit the production of a greater variety of consumer goods.
But the introduction of the new stages of production requires time. While in the process of enhancing the infrastructure, the various individuals employed must be supplied with consumer goods.
Once there has been a sufficient increase in the pool of consumer goods, individuals will be in a position to aim at further enhancing their well-being by seeking goods related to entertainment, for example, and services such as medical treatment.
The saved consumer goods support the various individuals that are providing entertainment and various services.
The introduction of money does not alter what we have said so far. Now the producer of a consumer good exchanges his saved goods for money. But by exchanging his savings for money, he has still supplied the other producer with his saved goods. The money received by the producer is fully backed by his unconsumed production.
Whenever people acquire capital goods such as machinery, they transfer money to the individuals who are employed in making it. The machinery makers can choose to exchange the money not only for consumer goods but also for various services. The service provider who receives the money could in turn exchange it for consumer goods and services for himself.
Without the medium of exchange, money, no market economy and hence no division of labor could take place. But money is not the means of payment but the means of exchange.
Individuals pay with the goods and services they produce—they do not pay with money. Money only helps facilitate payments. Money enables the goods of one specialist to be exchanged for the goods of another specialist.
In Planning for Freedom (p. 66) Mises wrote,
Commodities, says Say, are ultimately paid for not by money, but by other commodities. Money is merely the commonly used medium of exchange; it plays only an intermediary role. What the seller wants ultimately to receive in exchange for the commodities sold is other commodities.
By means of money, an individual can channel savings, i.e., unconsumed consumer goods, to other individuals, which in turn permits the widening of the process of wealth generation. Whenever he deems it necessary, the individual can always exchange his money for goods.
There is, however, one provision in all this: the flow of the production of goods continues unabated. This means that whenever a holder of money decides to exchange some money for goods, these goods are there for him.
Despite its importance as the medium of exchange, according to Rothbard,
Money, per se, cannot be consumed and cannot be used directly as a producers’ good in the productive process. Money per se is therefore unproductive; it is dead stock and produces nothing.1
Again, money’s main job is simply to fulfill the role of medium of exchange. Money does not sustain or fund real economic activity.
Do People Save Money?
People do not save money but rather exchange it for goods and services. Once savings (saved consumer goods) are exchanged for money, the holder of the money can employ it immediately in an exchange for other goods or he may hold it temporarily.
Whether he uses it immediately in an exchange for other goods, puts it under the mattress, or keeps it in his pocket will not alter the given pool of savings. How individuals decide to employ their money will only alter their demand for money. This, however, has nothing to do with savings. (Note: by lending money, individuals in fact lower their demand for money. The act of lending does not alter the existing pool of savings, either.)
Likewise, if the owner of money decides to acquire a financial asset such as a bond or a stock, he simply transfers his money to the seller of financial assets—no present savings are affected by these transactions.
Problems emerge, however, whenever central banks embark on loose monetary policies. The expanded money supply is not backed by more consumer goods. When such money is exchanged for consumer goods, it amounts to consumption that is not supported by production. We now have more money chasing the same amount of goods.
Consequently, a holder of honest money, i.e., an individual who has produced real wealth, discovers that he cannot now get the equivalent value of all the goods he previously produced and exchanged for money all other things being equal. He discovers that the purchasing power of his money has fallen.
Any so-called economic growth within the framework of loose monetary policy can only take place if the private sector manages to grow the pool of savings despite the such policy undermining this process.
Remember that loose monetary policies give rise to non-wealth generating activities. Once the pace of non-wealth generating activities starts to exceed the pace of wealth generating activities the pool of savings comes under pressure. This sets the platform for a severe economic decline. (Both wealth generating and non-wealth generating activities require savings to support the various individuals engaged in these activities.)
We can thus conclude that savings is about consumer goods production in excess of the consumption of these goods. It is not about money, but about final consumer goods that support the individuals engaged in the various stages of production.
It is not money that funds economic activity, but the saved pool of consumer goods. The existence of money only facilitates the flow of savings. Any attempt to replace savings with money ends in economic disaster.
- 1. Murray N. Rothbard, Man, Economy, and State (Los Angeles: Nash Publishing, 1970), p. 670.