The War on Savings

LAW & ECONOMICS, Misc, MONEY / Sunday, November 10th, 2019

By Henry Hazllit

From time immemorial proverbial wisdom has taught the virtues of saving, and warned against the consequences of prodigality and waste. This proverbial wisdom has reflected the common ethical as well as the merely prudential judgments of mankind. But there have always been squanderers, and there have apparently always been theorists to rationalize their squandering.

The classical economists, refuting the fallacies of their own day, showed that the saving policy that was in the best interests of the individual was also in the best interests of the nation. They showed that the rational saver, in making provision for his own future, was not hurting, but helping, the whole community. But today the ancient virtue of thrift, as well as its defense by the classical economists, is once more under attack, for allegedly new reasons, while the opposite doctrine of spending is in fashion.

In order to make the fundamental issue as clear as possible, we cannot do better, I think, than to start with the classic example used by Bastiat. Let us imagine two brothers, then, one a spendthrift and the other a prudent man, each of whom has inherited a sum to yield him an income of $50,000 a year. We shall disregard the income tax, and the question whether both brothers really ought to work for a living, because such questions are irrelevant to our present purpose.

Alvin, then, the first brother, is a lavish spender. He spends not only by temperament, but on principle. He is a disciple (to go no further back) of Rodbertus, who declared in the middle of the nineteenth century that capitalists “must expend their income to the last penny in comforts and luxuries,” for if they “determine to save . . . goods accumulate, and part of the workmen will have no work.”[1] Alvin is always seen at the night clubs; he tips handsomely; he maintains a pretentious establishment, with plenty of servants; he has a couple of chauffeurs and doesn’t stint himself in the number of cars he owns; he keeps a racing stable; he runs a yacht; he travels; he loads his wife down with diamond bracelets and fur coats; he gives expensive and useless presents to his friends.

To do all this he has to dig into his capital. But what of it? If saving is a sin, dissaving must be a virtue; and in any case he is simply making up for the harm being done by the saving of his pinchpenny brother Benjamin.

It need hardly be said that Alvin is a great favorite with the hat check girls, the waiters, the restaurateurs, the furriers, the jewelers, the luxury establishments of all kinds. They regard him as a public benefactor. Certainly it is obvious to everyone that he is giving employment and spreading his money around.

Compared with him brother Benjamin is much less popular. He is seldom seen at the jewelers, the furriers or the night clubs, and he does not call the head waiters by their first names. Whereas Alvin spends not only the full $50,000 income each year but is digging into capital besides, Benjamin lives much more modestly and spends only about $25,000. Obviously, think the people who see only what hits them in the eye, he is providing less than half as much employment as Alvin, and the other $25,000 is as useless as if it did not exist.

But let us see what Benjamin actually does with this other $25,000. On the average he gives $5,000 of it to charitable causes, including help to friends in need. The families who are helped by these funds in turn spend them on groceries or clothing or living quarters. So the funds create as much employment as if Benjamin had spent them directly on himself. The difference is that more people are made happy as consumers, and that production is going more into essential goods and less into luxuries and superfluities.

This last point is one that often gives Benjamin concern. His conscience sometimes troubles him even about the $25,000 he spends. The kind of vulgar display and reckless spending that Alvin indulges in, he thinks, not only helps to breed dissatisfaction and envy in those who find it hard to make a decent living, but actually increases their difficulties. At any given moment, as Benjamin sees it, the actual producing power of the nation is limited. The more of it that is diverted to producing frivolities and luxuries, the less there is left for producing the essentials of life for those who are in need of them.[2] The less he withdraws from the existing stock of wealth for his own use, the more he leaves for others. Prudence in consumptive spending, he feels, mitigates the problems raised by the inequalities of wealth and income. He realizes that this consumptive restraint can be carried too far; but there ought to be some of it, he feels, in everyone whose income is substantially above the average.

Now let us see, apart from Benjamin’s ideas, what happens to the $20,000 that he neither spends nor gives away. He does not let it pile up in his pocketbook, his bureau drawers, or in his safe. He either deposits it in a hank or he invests it. If he puts it either into a commercial or a savings bank, the bank either lends it to going businesses on short term for working capital, or uses it to buy securities. In other words, Benjamin invests his money either directly or indirectly. But when money is invested it is used to buy capital goods—houses or office buildings or factories or ships or motor trucks or machines. Any one of these projects puts as much money into circulation and gives as much employment as the same amount of money spent directly on consumption.

“Saving,” in short, in the modern world, is only another form of spending. The usual difference is that the money is turned over to someone else to spend on means to increase production. So far as giving employment is concerned, Benjamin’s “saving” and spending combined give as much as Alvin’s spending alone, and put as much money in circulation. The chief difference is that the employment provided by Alvin’s spending can be seen by anyone with one eye; but it is necessary to look a little more carefully, and to think a moment, to recognize that every dollar of Benjamin’s saving gives as much employment as every dollar that Alvin throws around.

A dozen years roll by. Alvin is broke. He is no longer seen in the night clubs and at the fashionable shops; and those whom he formerly patronized, when they speak of him, refer to him as something of a fool. He writes begging letters to Benjamin. And Benjamin, who continues about the same ratio of spending to saving, provides more jobs than ever, because his income, through investment, has grown. His capital wealth is greater also. Moreover, because of his investments, the national wealth and income are greater; there are more factories and more production.

So many fallacies have grown up about saving in recent years that they cannot all be answered by our example of the two brothers. It is necessary to devote some further space to them. Many stem from confusions so elementary as to seem incredible, particularly when found in economic writers of wide repute. The word “saving,” for example, is used sometimes to mean mere hoarding of money, and sometimes to mean investment, with no clear distinction, consistently maintained, between the two uses.

Mere hoarding of hand-to-hand money, if it takes place irrationally, causelessly, and on a large scale, is in most economic situations harmful. But this sort of hoarding is extremely rare. Something that looks like this, but should be carefully distinguished from it, often occurs after a downturn in business has got under way. Consumptive spending and investment are then both contracted. Consumers reduce their buying. They do this partly, indeed, because they fear they may lose their jobs, and they wish to conserve their resources: they have contracted their buying not because they wish to consume less, but because they wish to make sure that their power to consume will be extended over a longer period if they do lose their jobs.

But consumers reduce their buying for another reason. Prices of goods have probably fallen, and they fear a further fall. If they defer spending, they believe they will get more for their money. They do not wish to have their resources in goods that are falling in value, but in money which they expect (relatively) to rise in value.

The same expectation prevents them from investing. They have lost their confidence in the profitability of business; or at least they believe that if they wait a few months they can buy stocks or bonds cheaper. We may think of them either as refusing to hold goods that may fall in value on their hands, or as holding money itself for a rise.

It is a misnomer to call this temporary refusal to buy “saving.” It does not spring from the same motives as normal saving. And it is a still more serious error to say that this sort of “saving” is the cause of depressions. It is, on the contrary, the consequence of depressions.

It is true that this refusal to buy may intensify and prolong a depression once begun. But it does not itself originate the depression. At times when there is capricious government intervention in business, and when business does not know what the government is going to do next, uncertainty is created. Profits are not reinvested. Firms and individuals allow cash balances to accumulate in their banks. They keep larger reserves against contingencies. This hoarding of cash may seem like the cause of a subsequent slowdown in business activity. The real cause, however, is the uncertainty brought about by the government policies. The larger cash balances of firms and individuals are merely one link in the chain of consequences from that uncertainty. To blame “excessive saving” for the business decline would be like blaming a fall in the price of apples not on a bumper crop but on the people who refuse to pay more for apples.

But when once people have decided to deride a practice or an institution, any argument against it, no matter how illogical, is considered good enough. It is said that the various consumers’ goods industries are built on the expectation of a certain demand, and that if people take to saving they will disappoint this expectation and start a depression. This assertion rests primarily on the error we have already examined—that of forgetting that what is saved on consumers’ goods is spent on capital goods, and that “saving” does not necessarily mean even a dollar’s contraction in total spending. The only element of truth in the contention is that any change that is sudden may be unsettling. It would be just as unsettling if consumers suddenly switched their demand from one consumers’ goods to another. It would be even more unsettling if former savers suddenly switched their demand from capital goods to consumers’ goods.

Still another objection is made against saving. It is said to be just downright silly. The Nineteenth Century is derided for its supposed inculcation of the doctrine that mankind through saving should go on making itself a larger and larger cake without ever eating the cake. This picture of the process is itself naive and childish. It can best be disposed of, perhaps, by putting before ourselves a somewhat more realistic picture of what actually takes place.

Let us picture to ourselves, then, a nation that collectively saves every year about 20 per cent of all it produces in that year. This figure greatly overstates the amount of net saving that has occurred historically in the United States,[3] but it is a round figure that is easily handled, and it gives the benefit of every doubt to those who believe that we have been “oversaving.”

Now as a result of this annual saving and investment, the total annual production of the country will increase each year. (To isolate the problem we are ignoring for the moment booms, slumps, or other fluctuations.) Let us say that this annual increase in production is 2 1/2 percentage points. (Percentage points are taken instead of a compounded percentage merely to simplify the arithmetic.) The picture that we get for an eleven-year period, say, would then run something like this in terms of index numbers:

YearTotal ProductionConsumers’ Goods ProducedCapital Goods Produced

* This of course assumes the process of saving and investment to have been already under way at the same rate.

The first thing to be noticed about this table is that total production increases each year because of the saving, and would not have increased without it. (It is possible no doubt to imagine that improvements and new inventions merely in replaced machinery and other capital goods of a value no greater than the old would increase the national productivity; but this increase would amount to very little, and the argument in any case assumes enough prior investment to have made the existing machinery possible.) The saving has been used year after year to increase the quantity or improve the quality of existing machinery, and so to increase the nation’s output of goods. There is, it is true (if that for some strange reason is considered an objection), a larger and larger “cake” each year. Each year, it is true, not all of the currently produced “cake” is consumed. But there is no irrational or cumulative consumer restraint. For each year a larger and larger cake is in fact consumed; until, at the end of eleven years (in our illustration), the annual consumers’ cake alone is equal to the combined consumers’ and producers’ cakes of the first year. Moreover, the capital equipment, the ability to produce goods, is itself 25 per cent greater than in the first year.

Let us observe a few other points. The fact that 20 per cent of the national income goes each year for saving does not upset the consumers’ goods industries in the least. If they sold only the 80 units they produced in the first year (and there were no rise in prices caused by unsatisfied demand) they would certainly not be foolish enough to build their production plans on the assumption that they were going to sell 100 units in the second year. The consumers’ goods industries, in other words, are already geared to the assumption that the past situation in regard to the rate of savings will continue. Only an unexpected sudden and substantial increase in savings would unsettle them and leave them with unsold goods.

But the same unsettlement, as we have already observed, would be caused in the capital goods industries by a sudden and substantial decrease in savings. If money that would previously have been used for savings were thrown into the purchase of consumers’ goods, it would not increase employment but merely lead to an increase in the price of consumption goods and to a decrease in the price of capital goods. Its first effect on net balance would be to force shifts in employment and temporarily to decrease employment by its effect on the capital goods industries. And its long-run effect would be to reduce production below the level that would otherwise have been achieved.

The enemies of saving are not through. They begin by drawing a distinction, which is proper enough, between “savings” and “investment.” But then they start to talk as if the two were independent variables and as if it were merely an accident that they should ever equal each other. These writers paint a portentous picture. On the one side are savers automatically, pointlessly, stupidly continuing to save; on the other side are limited “investment opportunities” that cannot absorb this saving. The result, alas, is stagnation. The only solution, they declare, is for the government to expropriate these stupid and harmful savings and to invent its own projects, even if these are only useless ditches or pyramids, to use up the money and provide employment.

There is so much that is false in this picture and “solution” that we can here point only to some of the main fallacies. “Savings” can exceed “investment” only by the amounts that are actually hoarded in cash.[4] Few people nowadays, in a modern industrial community like the United States, hoard coins and bills in stockings or under mattresses. To the small extent that this may occur, it has already been reflected in the production plans of business and in the price level. It is not ordinarily even cumulative: dishoarding, as eccentric recluses die and their hoards are discovered and dissipated, probably offsets new hoarding. In fact, the whole amount involved is probably insignificant in its effect on business activity.

If money is kept either in savings banks or commercial banks, as we have already seen, the banks are eager to lend and invest it. They cannot afford to have idle funds. The only thing that will cause people generally to increase their holdings of cash, or that will cause banks to hold funds idle and lose the interest on them, is, as we have seen, either fear that prices of goods are going to fall or the fear of banks that they will be taking too great a risk with their principal. But this means that signs of a depression have already appeared, and have caused the hoarding, rather than that the hoarding has started the depression.

Apart from this negligible hoarding of cash, then (and even this exception might be thought of as a direct “investment” in money itself) “savings” and “investment” are brought into equilibrium with each other in the same way that the supply of and demand for any commodity are brought into equilibrium. For we may define “savings” and “investment” as constituting respectively the supply of and demand for new capital. And just as the supply of and demand for any other commodity are equalized by price, so the supply of and demand for capital are equalized by interest rates. The interest rate is merely the special name for the price of loaned capital. It is a price like any other.

This whole subject has been so appallingly confused in recent years by complicated sophistries and disastrous governmental policies based upon them that one almost despairs of getting back to common sense and sanity about it. There is a psychopathic fear of “excessive” interest rates. It is argued that if interest rates are too high it will not be profitable for industry to borrow and invest in new plants and machines. This argument has been so effective that governments everywhere in recent decades have pursued artificial “cheap money” policies. But the argument, in its concern with increasing the demand for capital, overlooks the effect of these policies on the supply of capital. It is one more example of the fallacy of looking at the effects of a policy only on one group and forgetting the effects on another.

If interest rates are artificially kept too low in relation to risks, funds will neither be saved nor lent. The cheap-money proponents believe that saving goes on automatically, regardless of the interest rate, because the sated rich have nothing else that they can do with their money. They do not stop to tell us at precisely what personal income level a man saves a fixed minimum amount regardless of the rate of interest or the risk at which he can lend it.

The fact is that, though the volume of saving of the very rich is doubtless affected much less proportionately than that of the moderately well-off by changes in the interest rate, practically everyone’s saving is affected in some degree. To argue, on the basis of an extreme example, that the volume of real savings would not be reduced by a substantial reduction in the interest rate, is like arguing that the total production of sugar would not be reduced by a substantial fall of its price because the efficient, low-cost producers would still raise as much as before. The argument overlooks the marginal saver, and even, indeed, the great majority of savers.

The effect of keeping interest rates artificially low, in fact, is eventually the same as that of keeping any other price below the natural market. It increases demand and reduces supply. It increases the demand for capital and reduces the supply of real capital. It brings about a scarcity. It creates economic distortions. It is true, no doubt, that an artificial reduction in the interest rate encourages increased borrowing. It tends, in fact, to encourage highly speculative ventures that cannot continue except under the artificial conditions that gave them birth. On the supply side, the artificial reduction of interest rates discourages normal thrift and saving. It brings about a comparative shortage of real capital.

The money rate can, indeed, be kept artificially low only by continuous new injections of currency or bank credit in place of real savings. This can create the illusion of more capital just as the addition of water can create the illusion of more milk. But it is a policy of continuous inflation. It is obviously a process involving cumulative danger. The money rate will rise and a crisis will develop if the inflation is reversed, or merely brought to a halt, or even continued at a diminished rate. Cheap money policies, in short, eventually bring about far more violent oscillations in business than those they are designed to remedy or prevent.

If no effort is made to tamper with money rates through inflationary governmental policies, increased savings create their own demand by lowering interest rates in a natural manner. The greater supply of savings seeking investment forces savers to accept lower rates. But lower rates also mean that more enterprises can afford to borrow because their prospective profit on the new machines or plants they buy with the proceeds seems likely to exceed what they have to pay for the borrowed funds.

We come now to the last fallacy about saving with which I intend to deal. This is the frequent assumption that there is a fixed limit to the amount of new capital that can be absorbed, or even that the limit of capital expansion has already been reached. It is incredible that such a view could prevail even among the ignorant, let alone that it could be held by any trained economist. Almost the whole wealth of the modern world, nearly everything that distinguishes it from the pre-industrial world of the seventeenth century, consists of its accumulated capital.

This capital is made up in part of many things that might better be called consumers’ durable goods—automobiles, refrigerators, furniture, schools, colleges, churches, libraries, hospitals and above all private homes. Never in the history of the world has there been enough of these. There is still, with the postponed building and outright destruction of World War II, a desperate shortage of them. But even if there were enough homes from a purely numerical point of view, qualitative improvements are possible and desirable without definite limit in all but the very best houses.

The second part of capital is what we may call capital proper. It consists of the tools of production, including everything from the crudest axe, knife or plow to the finest machine tool, the greatest electric generator or cyclotron, or the most wonderfully equipped factory. Here, too, quantitatively and especially qualitatively, there is no limit to the expansion that is possible and desirable. There will not be a “surplus” of capital until the most backward country is as well equipped technologically as the most advanced, until the most inefficient factory in America is brought abreast of the factory with the latest and most elaborate equipment, and until the most modern tools of production have reached a point where human ingenuity is at a dead end, and can improve them no further. As long as any of these conditions remain unfulfilled, there will be indefinite room for more capital.

But how can the additional capital be “absorbed”? How can it be “paid for”? If it is set aside and saved, it will absorb itself and pay for itself. For producers invest in new capital goods—that is, they buy new and better and more ingenious tools—because these tools reduce cost of production. They either bring into existence goods that completely unaided hand labor could not bring into existence at all (and this now includes most of the goods around us—books, typewriters, automobiles, locomotives, suspension bridges); or they increase enormously the quantities in which these can be produced; or (and this is merely saying these things in a different way) they reduce unit costs of production. And as there is no assignable limit to the extent to which unit costs of production can be reduced—until everything can be produced at no cost at all—there is no assignable limit to the amount of new capital that can be absorbed.

The steady reduction of unit costs of production by the addition of new capital does either one of two things, or both. It reduces the costs of goods to consumers, and it increases the wages of the labor that uses the new machines because it increases the productive power of that labor. Thus a new machine benefits both the people who work on it directly and the great body of consumers. In the case of consumers we may say either that it supplies them with more and better goods for the same money, or, what is the same thing, that it increases their real incomes. In the case of the workers who use the new machines it increases their real wages in a double way by increasing their money wages as well. A typical illustration is the automobile business. The American automobile industry pays the highest wages in the world, and among the very highest even in America. Yet American motor car makers can undersell the rest of the world, because their unit cost is lower. And the secret is that the capital used in making American automobiles is greater per worker and per car than anywhere else in the world.

And yet there are people who think we have reached the end of this process,[5] and still others who think that even if we haven’t, the world is foolish to go on saving and adding to its stock of capital.

It should not be difficult to decide, after our analysis, with whom the real folly lies.

[1] Karl Rodbertus, Overproduction and Crises (1850), p. 51.

[2] Cf. Hartley Withers, Poverty and Waste (1914).

[3] Historically 20 per cent would represent approximately the gross amount of the gross national product devoted each year to capital formation (excluding consumers’ equipment). When allowance is made for capital consumption, however, net annual savings have been closer to 12 per cent. Cf. George Terborgh, The Bogey of Economic Maturity (1945).

[4] Many of the differences between economists in the diverse views now expressed on this subject are merely the result of differences in definition. “Savings” and “investment” may be so defined as to be identical, and therefore necessarily equal. Here I am choosing to define “savings” in terms of money and “investment” in terms of goods. This corresponds roughly with the common use of the words, which is, however, not always consistent.

[5] For a statistical refutation of this fallacy consult George Terborgh, The Bogey of Economic Maturity (1945).

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