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Cause Of Today's Economic Crises: Too Much Thrift


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In this essay I want to propose that the ultimate of cause of today's economic crises is that we have too much thrift. This view is very similar to John Maynard Keynes' Paradox of Thrift. What I want to show is that this is not a paradox at all but confusion about what saving money really means and what consequences it has. I want to explain this confusion by way of examples and not using technical economic jargon usually used by economists. But before I can go into why too much savings leads to a disaster in the modern economy I need to clarify what I mean by savings and what money is by way of an example:

A baker produces ten loaves of bread. He consumes one loaf of bread. He barters one loaf of bread with his neighbor, the dairy farmer, for one gallon of milk. He barters three loaves of bread for one bushel of wheat with his other neighbor, the wheat farmer for wheat for next batch of loaves he will produce tomorrow. He gives one loaf of bread to the poor. He is now left with four loaves of bread. Now, he wants to be able save these loaves for his old age. So he goes to the market and sells his excess four loaves of bread for four pieces of gold. He saves the gold in his mattress. He does this because he will need loaves of bread in old age when he is physically unable to work.

Note that I am going to define pieces of gold as money for now. Because it is easier to understand. We will then expand the discussion to include fiat money. The baker saved four loaves of bread. That is his savings. Note that it is more proper to think of savings as the loaves of bread rather than the pieces of gold under his matteress. The baker is not really interested in pieces of gold but he is convinced that he can exchange them for loaves of bread when he retires. Because of this belief the pieces of gold give him psychological comfort and peace of mind that he physically owns the asset which he can exchange for loaves of bread.

Note that when he gets to his old age and goes back to the market and attempts to exchange the pieces of gold for loaves of bread he will get back loaves of bread based on the market price (in terms of pieces of gold) at the time of exchange. By acquiring pieces of gold (which is the most liquid asset in the baker's civilization) he has effectively acquired equity shares in the world economy (at least in his gold based money example economy of the baker). The market price (in terms of pieces of gold) of the loaf of bread at the future time will depend on the balance of equity shares (money) trying to purchase (bid up the price) of loaves of bread and the supply of loaves of bread at that time. Note that it is not the absolute supply of equity shares (pieces of gold) that matters what matters is the number of equity shares trying to chase (purchase) the supply of loaves of bread at that time. Another way to make the same point is this: The price of loaves of bread will not increase even if more equity shares are created and handed out unless receivers of the equity shares actually attempt to spend the newly created equity shares.

Another way our baker could have attempted to save his loaves of bread for the future is by exchanging his four pieces of gold for shares of Google stock. This gives our baker a chance to acquire even more loaves of bread if Google makes good profits in the future. Of course, the baker is taking a risk. Google may not be able to make good profits.

Now apply this situation to all excess producers participating in the world markets (by excess producers I mean people like our baker who produce more loaves of bread than they need for current consumption but would like to consume their output in the future). As people become more and more productive there is more and more excess production (if consumption does not increase in tandem with efficiency increases) then this excess production will be directed (by capital markets) to produce more and more assets which can be exchanged ultimately for consumer goods in the future. This is how we get a boom. Bust happens when excess producers realize their assets (like dot com company shares or residential and commercial real estate holdings) will not yield as much return as they expected and may even give a negative return. Rightly, excess producers then rush to safety of the most liquid asset (cash). This causes asset prices to fall and induces managers to reduce investment spending causing unemployment. But this does not mean our ability to produce goods and services has diminished.

If investment slows down and consumption does not increase production must decrease to match the new level of investment. But what usually happens during a period of reduced investment is that consumption slows down as well (unemployed and those fearing unemployment spend less) reducing demand even more and reducing production even more even though our capacity to produce has not diminished during a bust. Slow down of economic activity feeds on itself devastating the economy. In short, too much thrift devastates the economy.

On top of this productivity (output per labor hour) is continually increasing (and has rocketed upwards in the past 100 years). We will have more and more unemployment unless one of following or combination of the following occurs to a sufficient degree to stem the tide of slowdown of investment activity and improving productivity.

1. Increase investment activity. But this won't occur unless #2 below occurs.

2. Increase our consumption. Increase demand for goods and services.

3. Decrease our labor hours. Work less.

4. Do projects which will "use up" excess production.

All the stuff about too much debt (public and private) , falling asset prices and printing money is just accounting entries. We should use accounting to manage the reality around us to improve our lives and not to get confused about what is going on with the production process itself. Bad private debt should simply be liquidated. Falling asset prices does not mean that our ability to produce real goods and services is diminishing. It is in fact it is steadily increasing and has been for hundreds of years. Federal debt can be paid off with newly printed money (this is akin to converting debt to equity). Inflation will only occur if receivers of the new money actually spend it and even then if we run-up against the capacity of the world economy to deliver the demanded output.

Transfer (sale of) of treasury debt to external entities will only become a problem when the United States dollar stops acting like a global currency.

Since the dollar is (at least right now) a defacto global currency it is acting like equity shares in the economic output of the world economy. Of course, United States will not be able to maintain the position of being the sole power to issue equity shares (money) as productive capacity of other major nations increases. There are several ways to resolve this:

1. Trade less. Yes, this will slow down productivity increases. USA will build up less national debt and there will be less unemployment in the U.S. This option is not a long term resolution.

2. Share the power to issue global equity with other major nations and/or major emerging nations on some kind of a formula which everybody is comfortable with. This is a long term solution but requires a major shift in thinking.

3. United States can try to maintain USD as the only legal tender in major international transactions by force (as it does for domestic economic transactions via legal tender laws). This is not a long term solution but may be useful in the short term.

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In this essay I want to propose that the ultimate of cause of today's economic crises is that we have too much thrift. This view is very similar to John Maynard Keynes' Paradox of Thrift. What I want to show is that this is not a paradox at all but confusion about what saving money really means and what consequences it has. I want to explain this confusion by way of examples and not using technical economic jargon usually used by economists. But before I can go into why too much savings leads to a disaster in the modern economy I need to clarify what I mean by savings and what money is by way of an example:

A baker produces ten loaves of bread. He consumes one loaf of bread. He barters one loaf of bread with his neighbor, the dairy farmer, for one gallon of milk. He barters three loaves of bread for one bushel of wheat with his other neighbor, the wheat farmer for wheat for next batch of loaves he will produce tomorrow. He gives one loaf of bread to the poor. He is now left with four loaves of bread. Now, he wants to be able save these loaves for his old age. So he goes to the market and sells his excess four loaves of bread for four pieces of gold. He saves the gold in his mattress. He does this because he will need loaves of bread in old age when he is physically unable to work.

Note that I am going to define pieces of gold as money for now. Because it is easier to understand. We will then expand the discussion to include fiat money. The baker saved four loaves of bread. That is his savings. Note that it is more proper to think of savings as the loaves of bread rather than the pieces of gold under his matteress. The baker is not really interested in pieces of gold but he is convinced that he can exchange them for loaves of bread when he retires. Because of this belief the pieces of gold give him psychological comfort and peace of mind that he physically owns the asset which he can exchange for loaves of bread.

Note that when he gets to his old age and goes back to the market and attempts to exchange the pieces of gold for loaves of bread he will get back loaves of bread based on the market price (in terms of pieces of gold) at the time of exchange. By acquiring pieces of gold (which is the most liquid asset in the baker's civilization) he has effectively acquired equity shares in the world economy (at least in his gold based money example economy of the baker). The market price (in terms of pieces of gold) of the loaf of bread at the future time will depend on the balance of equity shares (money) trying to purchase (bid up the price) of loaves of bread and the supply of loaves of bread at that time. Note that it is not the absolute supply of equity shares (pieces of gold) that matters what matters is the number of equity shares trying to chase (purchase) the supply of loaves of bread at that time. Another way to make the same point is this: The price of loaves of bread will not increase even if more equity shares are created and handed out unless receivers of the equity shares actually attempt to spend the newly created equity shares.

Another way our baker could have attempted to save his loaves of bread for the future is by exchanging his four pieces of gold for shares of Google stock. This gives our baker a chance to acquire even more loaves of bread if Google makes good profits in the future. Of course, the baker is taking a risk. Google may not be able to make good profits.

Now apply this situation to all excess producers participating in the world markets (by excess producers I mean people like our baker who produce more loaves of bread than they need for current consumption but would like to consume their output in the future). As people become more and more productive there is more and more excess production (if consumption does not increase in tandem with efficiency increases) then this excess production will be directed (by capital markets) to produce more and more assets which can be exchanged ultimately for consumer goods in the future. This is how we get a boom. Bust happens when excess producers realize their assets (like dot com company shares or residential and commercial real estate holdings) will not yield as much return as they expected and may even give a negative return. Rightly, excess producers then rush to safety of the most liquid asset (cash). This causes asset prices to fall and induces managers to reduce investment spending causing unemployment. But this does not mean our ability to produce goods and services has diminished.

If investment slows down and consumption does not increase production must decrease to match the new level of investment. But what usually happens during a period of reduced investment is that consumption slows down as well (unemployed and those fearing unemployment spend less) reducing demand even more and reducing production even more even though our capacity to produce has not diminished during a bust. Slow down of economic activity feeds on itself devastating the economy. In short, too much thrift devastates the economy.

On top of this productivity (output per labor hour) is continually increasing (and has rocketed upwards in the past 100 years). We will have more and more unemployment unless one of following or combination of the following occurs to a sufficient degree to stem the tide of slowdown of investment activity and improving productivity.

1. Increase investment activity. But this won't occur unless #2 below occurs.

2. Increase our consumption. Increase demand for goods and services.

3. Decrease our labor hours. Work less.

4. Do projects which will "use up" excess production.

All the stuff about too much debt (public and private) , falling asset prices and printing money is just accounting entries. We should use accounting to manage the reality around us to improve our lives and not to get confused about what is going on with the production process itself. Bad private debt should simply be liquidated. Falling asset prices does not mean that our ability to produce real goods and services is diminishing. It is in fact it is steadily increasing and has been for hundreds of years. Federal debt can be paid off with newly printed money (this is akin to converting debt to equity). Inflation will only occur if receivers of the new money actually spend it and even then if we run-up against the capacity of the world economy to deliver the demanded output.

Transfer (sale of) of treasury debt to external entities will only become a problem when the United States dollar stops acting like a global currency.

Since the dollar is (at least right now) a defacto global currency it is acting like equity shares in the economic output of the world economy. Of course, United States will not be able to maintain the position of being the sole power to issue equity shares (money) as productive capacity of other major nations increases. There are several ways to resolve this:

1. Trade less. Yes, this will slow down productivity increases. USA will build up less national debt and there will be less unemployment in the U.S. This option is not a long term resolution.

2. Share the power to issue global equity with other major nations and/or major emerging nations on some kind of a formula which everybody is comfortable with. This is a long term solution but requires a major shift in thinking.

3. United States can try to maintain USD as the only legal tender in major international transactions by force (as it does for domestic economic transactions via legal tender laws). This is not a long term solution but may be useful in the short term.

No disrespect intended, but have you been on this planet for the last decade?

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Mansoor,

You can't just print base money to pay off nominal debts without consequences. I agree that all of the money system is first and foremost an accounting system, but it is also a control system. Accounting deals with measuring, not control.

If you create much base money, and later face some inflationary pressure it will be required to pay interest on all that base money to retain control of inflation. Interest paid on base money would in this case have to come from taxation, and it is functionally equivalent to taxation to simply reduce the stock of base money.

Note here there is not much point differentiating between base money and longer duration government debt, it is all money. This is a critical point to understand. To control inflation, interest would need to be paid on all government debt, including base money.

Don't forget that base money is debt secured on the future income of taxpayers. Bank capital is held as base money, yet the bank's loan assets are secured on the very same group of people that the assets that form its equity capital are secured on - the same population! This makes a mockery of the idea that banks have an independant capital base.

At the link below you will find in the comments section my views on these matters laid out in detail.

http://bilbo.economicoutlook.net/blog/?p=7838

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Mansoor,

You can't just print base money to pay off nominal debts without consequences. I agree that all of the money system is first and foremost an accounting system, but it is also a control system. Accounting deals with measuring, not control.

If you create much base money, and later face some inflationary pressure it will be required to pay interest on all that base money to retain control of inflation. Interest paid on base money would in this case have to come from taxation, and it is functionally equivalent to taxation to simply reduce the stock of base money.

Note here there is not much point differentiating between base money and longer duration government debt, it is all money. This is a critical point to understand. To control inflation, interest would need to be paid on all government debt, including base money.

Don't forget that base money is debt secured on the future income of taxpayers. Bank capital is held as base money, yet the bank's loan assets are secured on the very same group of people that the assets that form its equity capital are secured on - the same population! This makes a mockery of the idea that banks have an independant capital base.

At the link below you will find in the comments section my views on these matters laid out in detail.

http://bilbo.economicoutlook.net/blog/?p=7838

Ok. The most important issue at hand right now is widespread worldwide deflation. If it takes hold and spirals all bets are off! We will have collapse of the world economy and much, much, much chaos in the land.

Given this. There must be something wrong with how we look at all this. We are not that "screwed up". Our ability to physically produce goods and services has bolted at warp speed in the last twenty years. Due to the use of information technology (I am an ERP consultant) , best practices in business processes and modern ways of managing people. The most imporantant single missing element is: more demand for products and services

Yes. We need a control system. We have not created heaven on earth yet. But what I am saying is this intense desire on the part of the public to "save, save, save" is a false idea. One should only save until all investment opportunities have been used up. The excess should be re-directed to other uses via government spending where the government simply spends the money for approved public uses until there is no more deflation in the land (that is your control!).

Mansoor

Edited by mansoor_h_khan
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Ok. The most important issue at hand right now is widespread worldwide deflation. If it takes hold and spirals all bets are off! We will have collapse of the world economy and much, much, much chaos in the land.

Given this. There must be something wrong with how we look at all this. We are not that "screwed up".

I agree. The problem is just paper IOUs. The level of hysteria surrounding them is quite idiotic.

Our ability to physically produce goods and services has bolted at warp speed in the last twenty years. Due to the use of information technology (I am an ERP consultant) , best practices in business processes and modern ways of managing people. The most imporantant single missing element is: more demand for products and services

no, the missing important element is, why? why must we produce to consume? why is demand so important? this idea of being more productive every year as a goal in and of itself is a purely modern western conception deriving from the protestant religion and its time to call time on it.

the answer of course is that we use productivity as a means to distribute the surplus. what has happened is that now we are so productive using comparative productivity as a means for distributing access to goods is not working any more.

we don't need more demand and productivity, we need more happiness.

Yes. We need a control system. We have not created heaven on earth yet. But what I am saying is this intense desire on the part of the public to "save, save, save" is a false idea.

it is not false, because the degree of technological specialisation required to reach current levels of productivity exposes the specialists to uncertainty of income and requires them to move away from support of nuclear family and community to find work. This means they must save for their old age because there will be no-one to look after them.

in short, the excess saving desire is a sign that the technological and organisational complexity of our society has exceeded sustainable bounds. only when a good deal of unnecessary technical and social complexity is eliminated will the saving desire subside.

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Hard to know where to begin with this!

How about 'I havent read this much unadulterated crap in a long, long time'.

Ok. The most important issue at hand right now is widespread worldwide deflation. If it takes hold and spirals all bets are off! We will have collapse of the world economy and much, much, much chaos in the land.

1. US 1930s - deflation - no collapse in either world or US economy.

2. Where is this deflation? Have you got any figures stats to back it up?

As I understand it inflation in the UK is around 3%.

Given this. There must be something wrong with how we look at all this. We are not that "screwed up". Our ability to physically produce goods and services has bolted at warp speed in the last twenty years. Due to the use of information technology (I am an ERP consultant) , best practices in business processes and modern ways of managing people. The most imporantant single missing element is: more demand for products and services

Its not given though, its totally wrong.

If I have this right, you are suggesting that computers and machines assist us in making products more efficiently thus requiring less people.

Then you point out that demand isnt keeping up.

Ever think of adding 1 + 1?

Yes. We need a control system. We have not created heaven on earth yet. But what I am saying is this intense desire on the part of the public to "save, save, save" is a false idea. One should only save until all investment opportunities have been used up. The excess should be re-directed to other uses via government spending where the government simply spends the money for approved public uses until there is no more deflation in the land (that is your control!).

This is possibly the greatest load of nonsense I've ever read.

Almost every analysis of western economies show huge personal debts and minimal savings.

The problem is that we dont have enough savings to cover our future liabilities (corporate and personal).

Pension funds are running low because people are not saving enough, banks are in trouble with capital reserves because people arent saving enough.

Mansoor, you need concentrate on doing your homework or tidying your beedroom; this is a forum for grown-ups.

Edited by needle
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Hard to know where to begin with this!

How about 'I havent read this much unadulterated crap in a long, long time'.

1. US 1930s - deflation - no collapse in either world or US economy.

2. Where is this deflation? Have you got any figures stats to back it up?

As I understand it inflation in the UK is around 3%.

quote name='mansoor_h_khan' date='09 March 2010 - 01:58 PM' timestamp='1268143123' post='2420925']

Given this. There must be something wrong with how we look at all this. We are not that "screwed up". Our ability to physically produce goods and services has bolted at warp speed in the last twenty years. Due to the use of information technology (I am an ERP consultant) , best practices in business processes and modern ways of managing people. The most imporantant single missing element is: more demand for products and services

Its not given though, its totally wrong.

If I have this right, you are suggesting that computers and machines assist us in making products more efficiently thus requiring less people.

Then you point out that demand isnt keeping up.

Ever think of adding 1 + 1?

quote name='mansoor_h_khan' date='09 March 2010 - 01:58 PM' timestamp='1268143123' post='2420925']

Yes. We need a control system. We have not created heaven on earth yet. But what I am saying is this intense desire on the part of the public to "save, save, save" is a false idea. One should only save until all investment opportunities have been used up. The excess should be re-directed to other uses via government spending where the government simply spends the money for approved public uses until there is no more deflation in the land (that is your control!).

This is possibly the greatest load of nonsense I've ever read.

Almost every analysis of western economies show huge personal debts and minimal savings.

The problem is that we dont have enough savings to cover our future liabilities (corporate and personal).

Pension funds are running low because people are not saving enough, banks are in trouble with capital reserves because people arent saving enough.

Mansoor, you need concentrate on doing your homework or tidying your beedroom; this is a forum for grown-ups.

:lol:

Golden rule of posting on HPC: Nobody minds what you say, as long as it ain't total rubbish.

Edited by urban commando
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1. US 1930s - deflation - no collapse in either world or US economy.

what are you talking about you numpty, what do you call WWII?

2. Where is this deflation?

waiting. its patient.

If I have this right, you are suggesting that computers and machines assist us in making products more efficiently thus requiring less people.

Then you point out that demand isnt keeping up.

Ever think of adding 1 + 1?

yes that bit is slightly suspect. The problem is that the more productive machinery makes us, the more concentrated the wealth gets in the hands of the designers, operators and financers of said machinery. That's what is killing demand, not just the machines. There is also the issue that productivity increases now demand significant education to contribute to them, which again concentrates wealth in the hands of the, ahem, clever-er folks.

Almost every analysis of western economies show huge personal debts and minimal savings.

only made possible by currency manipulation of the exporters.

The problem is that we dont have enough savings to cover our future liabilities (corporate and personal).

try looking at things from a global perspective, which is what mansoor is doing, and stop being a little englander FFS.

Mansoor, you need concentrate on doing your homework or tidying your beedroom; this is a forum for grown-ups.

Mansoor is light years ahead of you in his understanding. I give him a B and you a D minus.

Dismissed.

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  • 4 weeks later...

@Mansoor:

Your assertions are not seems to be in accordance to the prevailing fact and trends.

May I correct your statement - "Your assertions are not it seems in accordance with the prevailing conventional wisdom on HPC".

What has really changed? The sun still rises in the East. Night turns to day. Spring follows winter. The numbers on the IOUs are larger. It seems the downside is those with savings are receiving a smaller yield from them.

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...

3. Decrease our labor hours. Work less.

.....

This is the easy solution. However it is not popular. Most people work more hours than they need to. The EU introduce maximum working hours and the right wing press go apeshit.

Ironically just as people start to think about the work-life balance along come a group of morons that want "globalisation" and we all have to work 8 days a week to compete with Chinese slave labour and 6 year old kids in Pakistan that are beaten with a stick when they stop working.

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The desire for growth is driven by increase in population and the human instinct to improve the world for our children. So the likelihood of people working less and not wanting growth is a small one.

There is also a bizarre obsession with wealth going on which is not all that helpful. Wealth is nowhere near as important in the everyday existence of people as their standard of living and that is what has been rising for the last 200 years or so.

The major hole in your argument Mansoor is that you say the printed money is no problem if people don't spend it, but people will.

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The desire for growth is driven by increase in population and the human instinct to improve the world for our children. So the likelihood of people working less and not wanting growth is a small one.

There is also a bizarre obsession with wealth going on which is not all that helpful. Wealth is nowhere near as important in the everyday existence of people as their standard of living and that is what has been rising for the last 200 years or so.

The major hole in your argument Mansoor is that you say the printed money is no problem if people don't spend it, but people will.

If people spend the money then there will be no deflation and government does not need to do anything (except possibly some re-distribution via taxes to feed the ones still unemployed and hungry).

If people don't spend the money they have and there exists deflation then the government should remedy the situation by printing and spending.

Mansoor

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If people spend the money then there will be no deflation and government does not need to do anything (except possibly some re-distribution via taxes to feed the ones still unemployed and hungry).

If people don't spend the money they have and there exists deflation then the government should remedy the situation by printing and spending.

Mansoor

End the monopoly on money creation.

Problem solved.

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  • 2 months later...

please expand on the dilemma.

Any agency that can externalise it's costs will over time out compete any other agency that can't.

Once a mechanism is in place for externalising costs, it will have to be used by you or you will be left behind.

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Any agency that can externalise it's costs will over time out compete any other agency that can't.

Once a mechanism is in place for externalising costs, it will have to be used by you or you will be left behind.

agreed, but I think we are finding that externalisatio of costs is increasingly difficult. The externalisation of costs is facing diminishing returns, so to speak. As long as that is the case, homegrown alternatives are more likely to bear fruit.

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agreed, but I think we are finding that externalisatio of costs is increasingly difficult. The externalisation of costs is facing diminishing returns, so to speak. As long as that is the case, homegrown alternatives are more likely to bear fruit.

What we are finding is that the whole of economci life is boiling down to a big fight over who controls the externalising agency.

lefties want the central bank to social engineer.

right wingers want it to wage war

business want access to it to beat their competitors

unions want wages to be printed up

etc etc

They gotta give it up - we need a seperation of business and state in the same way we sperarated church and state.

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