Savings and Investment

There is some illusion about people saving, for retirement, for example. People do not save for retirement. They may think they do. But the reality is society invests to support its people, of whom the retired are (will be) a part.

What do we mean? We mean that it is only in the present that society supports its members. It doesn’t ‘save up’ present production to support them in the future. It doesn’t take past production to support them in the present. In terms of what is being produced, it only has what is currently being produced, to support its economy. Yes it has inventories, but usually these are at most a few months. Society doesn’t accumulate (save) a 20 year supply of dishwashers, so it will have them when they are needed ‘down the road.’ Society doesn’t do this with anything.

The closest society does to this is invest in its productive structure. Roads, structures and machinery last a fair length of time. It builds these things in the present, so it will have their productive capacity in the future. It has built these things in the past, so that we have them now. This is physical capital. A society builds capital in the present, so it will have the productive facilities to support its people in the future. In order to do this, it takes away some of its current production from direct consumption, and invests it.

Now the more society builds these things in the present, the more productive capacity we will have in the future. The more productive capacity we will have in the future, the better off, materially, we will be. Assuming, of course, we have the energy to power it. And the labor to direct it.

In particular, the greater comfort we will be able to support our retirees, and the rest of the idle class. And of course, everyone else. And everything else. Because production must also be supported.

Now the way we decide how to divvy up this production is with money. Those who spend the most money get the most goods and services. Those who spend the most, in the long run, are those who have the most. So if you save money in the present, in the future you will have more money to spend.

Now the theory is that the banks will take this money and loan it to someone who will invest it. That is, take current production, and use it to build more productive capacity, so there will be more goods and services to divvy up in the future. This isn’t the only money that does this. Corporations make profits, which they may spend to increase their productive capacity. Some of government spending may go to increase productive capacity, as with some of the ’stimulus.‘

So what happens instead when the banks take your money and squirrel it away?
Well, you’re still saving, but society is not investing in its future. Its capital is not expanding. So the pie is not growing any bigger. So down the road, when you retire and spend your savings, you may have a bigger share of the pie. But since the pie will not be any bigger, everyone else will, on the average, have a smaller share. This includes other retirees, say those on social security, and those who still work, who are supporting you with their labor. It also includes those other things, the productive facilities which must be supported to maintain present production and expand production in the future. So your individual savings, when you spend it in the future, takes away from everything else, including supporting the production on which it depends.

Now, if this were just you, this would not be very significant. But if there is a substantial share of savers, and the banks are not investing the money, (or investing it badly, say in housing or commercial real estate) then all the other people will have a significantly smaller share. And so will production.

What does this mean? Well, under these circumstances, savings is deflationary in the present, and inflationary in the future. In the present, money is being taken out of the economy, and since it is not being invested, (spent on capital) and put back in the economy, there is continually less money, chasing a constant supply of goods. And since the money was not invested, but merely saved, productive capacity is not expanded, so the quantity of goods will not increase.

So when in the future the money is taken out of savings and spent, along with the money that was there before, we will have inflation. Over time, these two effects could be expected to cancel out. What won’t cancel out is a big increase in money supply caused by deficit spending. If this is invested to expand the pie, well and good. If squandered, so the pie still does not expand, much the worse for inflation. What also won’t cancel out is the contraction caused by the deflation, which is that the decreasing amount of money chases a quantity of goods which is also decreasing., though not as fast., which does tend to mitigate the deflation, at the expense of the destruction of productive capacity. The pie actually shrinks.

So this is what is caused by the financial industry doing its retrenchment thing. Now we have already pointed out that the financial ‘industry’ is much too big, so its hoarding of money (rather than investing it in real industry) can be expected to go on for a while. To the detriment of the rest of the economy, since it means that the money supply in the rest of the economy can be expected to decrease, thus robbing productive industries of their nominal profits. Since these industries are losing money, they are not investing, they are cutting back. Still. (Add to this the contraction brought about by the trade imbalance! See: April 2010 The Effects of Unbalanced Trade)

The problem, of course, is that as long as these banks are in business, they’re going to be sucking the money out of the economy, so destroying the economy on which they depend. The government with its stimulus tried to counteract this action. It didn’t, much. It can’t. The banks are sucking too much, too fast.

So. In Economics, savings and investment are equal. At equilibrium. But not in the economy we are experiencing, where savings and investment are not equal.

Just by the way, elementary Keynesian theory predicts a reduction in a nation’s income with an increase in its ‘thrift.’ It assumes savings increases with income, but investment is relatively independent of income, or flat. How to explain the Chinese, though, eh? Next time.

What is valuable?

What is valuable? There seems to be some confusion here. This is because what is valuable to an individual need not be valuable to a society. For instance, money is wealth to an individual, but to a society, it is…. well, nothing. To an individual, it is demand over the production of an economy. For a society, its only use is as a means of allocating… real wealth.

How does it do this? Well, it does it in a most peculiar way: Money values most what is least valuable to an economy. And this is necessarily so.

Consider, for instance, which is more valuable, a dollar’s worth of gasoline, or a dollar’s worth of greeting cards. Well, as far as money, or the market, goes, they are the same value. But from the economy’s point of view, the dollar’s worth of gasoline is more valuable, because you can do more with it. For instance, you can have a modern economy without greeting cards, but you cannot have one with out gasoline. We’ll call this a real valuation, as opposed to the monetary one. The monetary valuation undervalues the real value of the gasoline, and overvalues the real value of the greeting cards.

Consider the resources that go into a car: the energy, the materials, the labor. In money terms, these things together add up to less than the price of the car. That is why we build the car. Because the maker of the car sells the car for more than the price of the resources .that go into the car. But in real terms the combined value of the energy, the materials, the labor, is greater than the car.

In particular, energy is, in monetary terms, undervalued. Its less now, but it used to be that 10 times the amount of energy came out of a gallon of oil than went into producing it. It is this real profit, this 10 to 1 ratio, that allows us, drives us, to use (burn) the oil. Suppose instead, there were no real profit: That the ratio was 1 to 1, that as much energy went in to producing the oil as was gotten out of it. Then, from an economic point of view there would be no point in producing the oil in the first place. (In particular, if we used the energy from the oil to produce the oil, nothing would be produced. Except waste.) Nothing is gained. (Of course, with subsidy, an uneconomic process may still go forward. Witness ethanol production from corn)

Allowing for profit, and neglecting things like taxes, that means that the monetary value of the oil was about 1/10 its real value. Suppose instead that it sold at its real value. Suppose your gallon of deisel sold at $30, or 10 times its current valuation. Then there would be no point for you to buy it, because you couldn’t make money off it. (at least using it for energy.) Its real cost to you, monetarily valued at $30, would be equal to the benefit you expected from it. (We’re not allowing for the induced inflation. With the price of oil going up, the real price, the price of everything will go up. More on that in a later post.)


Similarly, commodities are undervalued. Undervalued energy went into making and extracting them. But it is this monetary undervaluing that makes them more valuable in reality. Because they are undervalued, they can go into making things. For instance, you wouldn’t use gold to wire a house. Monetarily, it’s too valuable. You would use copper. Copper is more valuable here than gold, because if you used gold, you couldn’t sell the house for a profit. In fact, the less valuable it is, the more useful it is. If the price of copper were to double, you might still use it to wire the house, but you might not use it for the plumbing.. If the real price of copper were to halve, you would not only use it for the wiring and the plumbing, you might use it for the roof as well. So the lower its monetary valuation, the greater its real valuation.

Suppose now that copper was as rare as gold. Those who owned copper would be much richer, but society would be much poorer. They wouldn’t be able to use copper to wire houses. Indeed, the uses of copper would be few. It would have little real value. Just like gold. It would be too precious to be useful.*

Now if some things are undervalued, other things must be overvalued. That is the monetary value is more than the real value. Or, these things are worth less to society than they are to the individual. So what is overvalued? That is what is overpriced?

If we look at production, at each step, resources are destroyed. Energy and labor are destroyed at all steps. Now the irony is, that the more resources are destroyed in making something, the more (monetarily) valuable it becomes. (This is in a well functioning economy. Under subsidy, resources can go into making something that is less monetarily valuable. For instance, the subsidy of corn production makes possible the production of hamburgers at less than would be their monetary cost.) But as those resources are destroyed, the real cost of the thing goes up. So its real value goes down. The more resources are destroyed making a thing, the less valuable it is. To society. Suppose 10 times the resources as now go into making an automobile are used. Automobiles would cost 10 times as much. There would be many fewer of them. They would be less useful to society. Conversely, if automobiles cost one tenth the resources to make, there might not be more of them, but the resources freed up which would otherwise go to their production could be destroyed to other use. In that sense, they would still have a greater value to society.

But, at each step in the destruction of resources, that is, the destruction of real value, “value is added.” Monetarily. The thing becomes monetarily more valuable, and can be sold at a profit. So in general, resources, which are undervalued, are converted to finished goods, which are overvalued, and it is this twist in valuation which drives economic process. (We can even go a little further, and say that those goods which are most overvalued will be preferentially produced. They will have the highest profit margins in the conversion process. Goods under subsidy will be preferentially produced, for instance.)

Now the economy does need finished goods. Indeed, that is the whole point of an economy: To create goods and services to the benefit of the individual. But economically speaking, most finished goods are useless to an economy. A dishwasher, for instance is economically useless. (It may benefit the individual. It does free up leisure. Depending on how much one valued that, one can calculate the benefits one would get from buying a dishwasher.) The end result of economic process, the conversion of resources, in particular the destruction of energy, is a finished good or service. (Actually, since energy can neither be created of destroyed, we really mean the conversion of energy from useful forms to useless forms. So for instance, one could say the dishwasher was worse than economically useless, since the power it consumes when operating increases the conversion of energy to useless forms.)

So where does money fit into this? Well, in real terms it is worthless, so we can say it is most overvalued. If government printed up a room full of money, society would be no better off. More on this later. Energy, which drives the modern economy, is most undervalued. Some labor is also undervalued. (Some is overvalued.) Some has to be exploited, for the manufacturer to make his profit. This is not a bad thing. But because labor is also the ultimate market, (all economic processes are ultimately for the benefit of individuals,) it does create a problem. So does overvalued labor. For a later post.

So what is valuable? To a society, the resources, and the means to convert those resources to goods and services desired by individuals. To an individual, these desired goods and services. It is the difference between these two valuations that drives an economy.
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*There is an ironic phrase which refers to extraction of minerals: ‘The riches of the earth.’ However, it is the poverty of the earth, the scarcity of what is extracted, which makes it monetarily valuable, and reduces the real value to society. But, it is this relative scarcity that makes extracting the minerals profitable to the individual in the first place.

That Bloated Financial Sector

Suppose the auto industry was twice the size it was now. That means it would have to sell twice as many cars, AT THE SAME PRICE, to stay in business. Naturally, it couldn’t do this by itself. It would either be forced to contract, or it would require government support to stay in business. It would have to do sneaky and unethical things, like sell fraudulent products. Its companies would have to collude, to hold prices high. It would have to hold its customers hostage, one way or another, to stay in business. And the fact is, we should expect this. It would merely be doing what it had to do to survive, in the bloated and destructive form, it had become.

Consider now the financial sector. Historically, even during times of prosperity, it had ‘produced’ under 3% of GDP. But as of 2006, it has ‘produced’ 8% GDP. I put ‘produced’ in quotes, because the financial sector produces nothing. It is merely there to allocate resources. It does not make things. It is overhead to the economy. It rearranges money. And instead of arranging money to encourage productive industries, it seems to be allocating much of these resources to itself: Its profits, in recent years, have been over 40% of the total profits of all US businesses, despite the fact that it ‘produces’ only 8% of the GDP.

How does it do this? How does it ‘sell’ almost 3 times as much ‘services’ as in the past, and make more money than ever doing it? After all, we would expect that if it had more services to sell, their price, and their profits,would go down.

Well, it has government support. It has its bailouts, and the government has gone through agonizing contortions to see that the banks' mortgage income and value are maintained. The Fed also supports the industry with low interest loans. And the government throws business its way by selling bonds at a higher interest rate.

It does sneaky and unethical things: It sells fraudulent products, CDO’s and CDS’s and dubious mortgages with teaser rates that balloon into unpayable amounts after a few years. The whole real estate bubble was an effort by the banks to generate profit, in fees and interest, sufficient to keep themselves in business. Now the bubble is gone, and the only way the banks can support themselves is to eat into the real economy, It withholds credit from the real economy until its bloated balance sheets will be 'repaired,' inflicting deflation on the economy. And where is the next bubble going to be? Perhaps we are looking at it: the debt bubble.

It colludes, with the combination of algorithmic trading and ‘front running,’ to effectively defraud legitimate traders of their just profits. In these it is explicitly self-serving, and not to the benefit of the rest of the economy.

It holds its customers hostage. With too big to fail banks that the government thinks it is obligated to maintain and foster. With fees and usurious interest rates on credit cards and payday loans.

Meanwhile, the financial sector uses its power to deflect the efforts of government to effectively regulate it. In fact, should the regulation the government is considering prove effective, it would cut into the financial sector’s profits, would tend to its ruin, and force the government, as it now conceives its duty, into even greater efforts to rescue and maintain it.

It siphons off from legitimate industry, and corrupts, some of the best minds of society with its disproportionate remuneration, and contributes to the country’s increasingly inequitable distribution of wealth and income.

And we should expect this. We should expect it to act, not to be benefit of society, but to its harm. It is merely doing what it has to do to survive, in its bloated and destructive form.

That this should lead to the destruction of the economy which supports it, it does not care. The people involved are either indifferent or oblivious to the damage they inflict.

I have painted all banks with the same brush. I'm mainly aiming at Wall Street, though many other banks were a party to the real estate bubble. To those that don’t deserve such a paint job, I apologize. I’m sure there are good banks out there. I hope mine, that is the bank I use, is one. But these banks are at a competitive disadvantage to the bad banks. And the absence of effective regulation reinforces this.

Yet I don’t hear the officers of good banks decrying the malfeasances of the officers of the bad banks. Is it because I just don’t hear, of is it because they do not. Perhaps they feel more a sense of community with those who work at the destruction of their society, than those of the communities they ostensibly serve.

Who do you owe?

There is much ado about debt, these days. The debt. Like it is owed to space aliens or something. It's not. It's some people 'owing' to other people. Lots of 'owing,' these days, which is why it is a 'problem.' This owing is kept track of in something called money, so it's some people owing lots of money to other people. The probelm is made worse by soemthing called 'interest,' which is the arrangement where, if you owe money for any length of time, then you owe more money. So if you owe money, and you don't pay it back, you owe more money, and MORE money, and MORE MONEY and, and...

Well, we'll get into that some other time. First, we ask the questions. And the first question we ask is, who owes what to whom? Which is really three questions, so let's first ask who is the money owed to. There are numerous possibilities. We can eliminate space aliens. We can also eliminate the poor. If they were owed the money, they would be rich. How about the middle class? No, they seem to be drowning in debt. How about our government. But we all know it's up to its ears in debt. Of course, there are also rich governments, who seem to be owed a lot of money. But that much? No.

So who does that leave us? Hmm? The rich. But we've got to be talking the really rich. Even the median of the top quintile, for which I have data (2004) owes $167K, though net worth of $318K. The really rich seem to be owed all that money.

And we've also answered the question of who owes. The poor, the middle class, and the government.

But what do they owe? Lots of money. Debt to GDP is at about 380%, of which 290% is
privately owed. So GDP ~$14T x 3.8 = $53T/300M people = $177K per capita, as of 2008. $354K per worker. Now $42K per capita of that is the public debt, so $354K - $84K = $270K per worker is the private debt. Now the interest on the public debt is (now) 0%, sort of, and let's figure the interest on the private debt to average out to 6%, which is probably low, since AAA bonds are yielding a little over 5% interest. So $16.2K in interest. $16,200. Interest per worker. That's all going where? The company store? Sixteen tons?

Take a step back: 6% on 290% of the GDP means $2.44T or 17% of the GDP goes to interest payments, aka debt service. Non wonder demand is somewhat contracted. And the interest on the US debt is not really 0%, so we probably should add a percent or two.

Just by the way $53T is slightly more than the value of all the assets in the US.

Now of course, this isn't owed one person to another, this is all owed to banks. $16.2K to the banks. But apparently many banks aren't doing all that well, so who do the banks owe? Well, they 'owe' their owners, they owe their bondholders, and they owe their depositors. Now their depositors aren't getting much in the way of interest. So all the interest must be going to the bondholders, and the owners. But if the banks are still in trouble, that means it must be the bondholeres who are getting all the money. Owners are just making up their losses, recapitalizing their balance sheets. (Are they? And who does own the banks?) Bondholders must just love this deflation we're having.

Well, we've spun our wheels a little bit here, and it's hard to find out who owns what. But if you own a lot, you're probably owed a lot. And you're rich.

So if you owe, you owe probably owe the rich. Or maybe some pension fund. Another possibility, among others.

The Interests of the Wealthy

When the wealthy seize control of government, the wealthy cannot help but destroy the society which supports them.

In the short term, it is in the separate interests of the wealthy to corrupt the system to their benefit. That is, they will seek their own benefits ahead of the people's, first by becoming the instruments of government policy, then by bending government policy to their interests. They will cooperate with each other to do this, and secure advantage over the people. Securing advantage, they will plunder the wealth of the people. This is what (most of) the national debt is. It is what the people 'owe' the rich. Instead of paying taxes, wealthy 'loan' the money to the government, which it then has to pay back. The wealthy have used their power to cause this.

In securing their separate interests, they will cooperate in gaining favors. They will trade for votes. This is not 'zero sum' as regular trade is, but each party gains, and both their influence on, and burden on, government and the people, will expand. That is, through the instrument of government, they each acquire disproportionate wealth. And since all resources are competed for, others, the people, are at a disadvantage. The system becomes rigged.

But then they will compete, they must compete, to secure advantage over each other, and further advantage over the people. The government becomes an instrument of their competition, as they compete for its favors. Those who do not compete will be at a competitive disadvantage.

So all the wealthy are forced to compete against each other. They will compete to cause the government to pursue purposes to their own separate ends,which is the very definition of corruption. These interests, the benefit of the wealthy, harm the system, and the people, necessarily, by the law of externality: Those costs which can be externalized, will be. Thus the costs of the benefits to the wealthy will be laid upon the people, until the wealth f the people is exhausted. We are seeing this happening in the present 'recession.'

But the welfare of the people is essential to the welfare of the wealthy, and where it is destroyed, so is their own welfare. If the destroy the income flow of the people, they destroy their own income flow as well.

A poor society has few rich people. Neither has it much power to project, or even protect its interests.

In the long term, an uncorrupted government serves the interests of the wealthy better. A government can only remain uncorrupted to such degree as the influence of the wealthy is limited.

The people have been losing the competition for their government. They have persistently elected the servants of the rich to office. Now the system is rigged in the favor of the wealthy. Not good.

Cross posted as comment to angrybearblog.com: Maule and Pappas on progressive taxation and the decreasing burden on the rich

The Greek Problem Again

Well, it's 12 days since my post on the Greek Debt. Euro 440B from the eurozone, euro 60B from the European Commission, and euro 250B from the International Monetary Fund. Never let it be said the IMF doesn't take care of its own. Plus the US and other countries are going to guarantee dollars. Couldn't find out how much.

So that's a lot of money. But it is all loans, and the fans are not impressed. A The markets seem to think that this is just pushing the problem down the road. And it is. Germany doesn't want to bite the bullet and let Greece, and the other countries it has a current accounts surplus with, off the hook. But it will let the bankers and other speculators off, and put the European taxpayers on instead. We are talking about a massive transfer of wealth here. And the problem: Still the producer-consumer problem. The only way out is to give the Greeks, and the other PIIGS for that matter, back their money, so they can spend it on German goods again, and keep those factories in the Ruhr humming. So, with the people of the European Union somewhat poorer from the experience, they can all go back to work. Will they be wiser?

Meanwhile, a trillion dollar contribution to sovereign debt. The wise banker should be shaking in his shoes, because bankers the world over are going to succeed beyond their wildest dreams. If things play out.. wrong, and this is a giant step in that direction, they're going to end up with all the money! What a happy day that will be for them!

All our banker has to do is give it away. But, like the monkey with his hand in the jar, he won't let go of the banana. And if the monkey won't let go of the banana, he can't get his hand out of the jar. So he's stuck there.

Clues you in to how smart our masters are. Unfortunately running a monetary system requires a little more intellect, and a lot more balls, and pandering to the powers isn't going to do it.

Greek Debt and the Producer-Consumer Problem

Well, I just looked it up and the Greek debt stands at euro 298 billion. Mostly goods. Mostly EU. (It joined the EU in 2001.) The EU is going to bail out Greece to the tune of euro 110 billion. Last I heard. As a loan. Basically this is really bailing out the people who loaned Greece money.

This will not solve the problem.

I figure the best thing for the EU to do is just give the money to the Greeks, and then they can go back to playing the same game. Give the Greeks back their money, so they can go back to spending it on imports from Germany, and the Germans can go back to making exports for Greece. Otherwise the interest on the loan is just going to come due, Greece won't be able to pay up, it will stop importing and put a little crimp in the German economy. And then the other little PIIGS come to market.

Another way to put this is just have Greece default on its debts.

The only other option is for Germany to buy up Greece. Which still won't solve the long range problem, which is maintaining Greece as a market for German goods.

Which is the general producer-consumer problem. No matter how much money the consumer starts with, eventually the producer ends up with all the money. Then the producer either has to give the money back to the consumer, stop producing, 'loan' the consumer the money, or buy the the consumer's assets. Buying the consumer's assets is just another step in the process, and doesn't work in the long run because eventually the producer will still end up with all the money. And the assets. And this chokes off demand. Loaning the money to the consumers doesn't solve the problem, because the loan compounds, and eventually the costs of servicing it chokes off demand. Only by giving back the money is demand maintained.

The only way for the game to continue is for the producer to work out a way to give the money back to the consumer. Otherwise the game comes to a stop. Chaos ensues. Anarchy. The death of millions, etc.

This is the general instability of the market system. This is important. Pay attention. This is the general instability of the market system. Especially under free trade, (ie a 'free' market.) And not just between countries, but between any organized entities, or any individuals. If any individual works just the slightest bit more than another, and there is free trade (exchange) between them, either the harder working individual trades down, that is accepts less that par value for what the other has to offer, and allows the other to trade up, or he eventually ends up with all the other's assets. The other ends up with no assets, and the harder worker ends up with it all.

And as between two, so between three or four or a million. The hardest worker(s) eventually end up with it all. And this might be called the most just result. Of course, it doesn't have to be the hardest worker. It could be the cleverest, or the luckiest. Or the one with the most leverage.

Because the producers don't necessarily end up with all the money. There is another class, whom we will call manipulators. The manipulators do not produce anything, but they control the money, and because they control the money, they can arrange it so that they themselves are the most efficient accumulators of money. More so even than the producers. So they are the ones who end up with all the money. And the assets.

And default will be prevented, the debts assumed by the people, so as not to offend the sensibilities of the manipulators.

Many libertarians go on about: "What ever arises from a just situation by just steps is itself just." (Nozick) Well, the end result of this 'justice' is the impoverishment of most of society, and ownership of everything in the hands of a very few. (Actually one, in the limit.) And not even those most 'deserving,' not even those who most contribute to the wealth of society, but the most skilled at manipulating. Horrorshow.

The generalization is mine, I think. The particular with reference to free trade, is: "Mathematical modeling reveals that under these conditions, outright Las Vegas decadence is not necessary for there to be a problem. It reveals that with free trade between nations with merely different discounts on consumption, the nation with the higher discount (more impatient) will tend to maximize present consumption by having past generations (who produced the assets that can be sold off) or future generations (who will service the debt) pay for present consumption. Various factors can interfere, but that's the underlying dynamic." Ian Fletcher, 'Free Trade Doesn't Work What Should Replace it and Why.' (p47) He includes this reference to Joseph Stiglitz: 'Factor Price Equalization in a Dynamic Economy,' Journal of Political Economy May/June 1970.