On Savings & Capital Structure
One of the key fallacies in finance today is that interest rates for savers are “too low”. An interest rate is simply the cost of money between a borrower and a lender. In an entirely laissez faire market, this notion is clear and undisputed. Yet in a market with a central bank both setting the quantity of base money, and setting interest rates on lending to banks, many conclude that interest rates are being set as policy. Today, many savers are upset that interest rates by the central bank are unusually low. The lobby group Save Our Savers represents this view, complaining about low interest rates as if they are set as a government policy. In reality (as I have noted before) central banks react more to market demand for money than anything else. They can certainly set lending rates to banks, and they can certainly increase the quantity of the monetary base (though not, it should be noted, the money supply). Yet the market for money is a complex and reactive thing; too much money and price indices will see soaring inflation, too little and they will see deflation. Central banks are constrained to adjusting to market demand; anything else risks a highly adverse reaction. That means that if central banks were really setting rates “too low” relative to market demand, inflation would be soaring far above the target 2% rate — 5%, 7%, 10%, 50%, or even 100%. That is the case in neither the United States nor the United Kingdom.
Yet eviscerating the fallacious notion of “excessively low rates” is not sufficient, for it does not challenge the underlying core assumptions of groups such as Save Our Savers such as that “[s]avings are vital to our society in good times and bad. They fuel the engine of future economic growth and provide a safety net for families.” This sounds suspiciously like Ludwig von Mises, who noted in The Anti-Capitalistic Mentality: “Capital is not a free gift of God or of nature. It is the outcome of a provident restriction of consumption on the part of man. It is created and increased by saving and maintained by the abstention from dissaving.”
This takes us deep into the terrain of capital theory. What is capital? Mises, Hayek and the modern Austrian school define capital as the structure of production. I find this to be an agreeable first definition. When looking at or measuring an economy, it is critical to differentiate between stocks and flows. The flow of goods and services through an economy is relatively simpler to measure — it can be measured as gross domestic product, the amount of goods and services produced by the economy in a specified period (usually a year). While we can argue about which activities should or should not be counted — for instance, activity in the black market — it is clear what we mean by gross domestic product. The capital stock — the structure of production — is much more elusive. Another Austrian School economist, Ludwig Lachmann noted in his work Capital & Its Structure that capital is “radically heterogeneous”. That is, capital — the source of production — can take many forms from labour, to resources, to money, to goods, to promises, to weather, to dreams and ideas.
Von Mises’ view compared to Lachmann’s is grossly simplistic. Von Mises seems to see capital as something physical and concrete that can only come about through saving from past production. That is, the first agriculturalists might produce a bushel of wheat a year, consume three-fourths of that, and save the rest for future use — for barter, for emergency consumption, for replanting. Hunter-gatherers might chop down one hundred trees, use twenty for firewood, and use eighty more to manufacture spears, boats or homes. To Mises the saved product is the origin of capital. But this raises the question of whether or not the initial resources that were used to produce were capital or not. If capital is the means of production, this must surely include non-human means of production — sunlight, rain, hydrocarbons, soil, bacteria, animals, metallic elements cooked up in the heart of stars that went supernova. Production certainly has human factors, but humans — ourselves the product of billions of years of evolution — work capital that is precisely a “free gift” of God or nature. Von Mises’ definition of capital simply pays no attention to the vast and sprawling heterogeneity of factors of production. Certainly, saving the fruits of production may be a good idea — not least as insurance against rainy days — yet it is entirely fallacious to ignore the immeasurably vast pools of capital that are not a product of saving.
It is also important to highlight the monetary factors of production, too. All of the factors necessary to produce and sell — ideas, resources, labourers, a willing market — may be available to an entrepreneur, but without a source of money to lubricate production that potential is often unfulfillable. So in periods of large and growing savings demand, the flow of money through the economy is all else being equal reduced — the paradox of thrift. Additionally, in today’s state fiat-based economic system, money is no longer the product of saving past production as it was in the days of commodity money. It is simply the product of a central banker pressing a button on a keyboard. Certainly in the long run, markets may find a way around a freeze in the availability of money — new market-created currencies or credits and barter are just two of the possible solutions — but it remains true that a debt-deflationary collapse in production can be averted through simply increasing the availability of money and credit. And whether or not the money involved in production was saved over months and years or printed and thrown out of a helicopter has no bearing on the matter.
Moreover, sitting on money and saving the fruits of production are nothing like the same thing. Money today is not the fruit of production, it is merely a placeholder, an intermediary. Growing the fruits of production — capital goods, resources, etc — while at the same time running an annual net profit of zero (or even a loss) is perfectly possible. In fact, it is the present business model of some large businesses like Amazon. Modern state fiat money is not designed as a store of value but simply as a medium of exchange and unit of account. This is clear from the explicit 2% inflationary targets of central banks. Sitting on a pile of monetary tokens — either literally in the form of mattress-stuffing, or in the form of holding it in a bank account from which the bank may or may not use for lending — is simply asking to have your purchasing power confiscated. It may be a safety net, but it is a leaky one. The reasoning behind this is entirely sound. While the capital stock — the true wealth of humanity — is difficult to accurately measure (should we include natural resources? How can we measure the value of land and real estate? How about potential labour? How can we even come close to including ideas?) the actual flow of production is relatively simple to measure as gross domestic product. And lapses in the growth of the flow of production are correlated to higher unemployment and economic stagnation. This means that the flow of production is the significant indicator. The depreciation of monetary tokens is simply an incentive to keep the flow of production flowing, and mass unemployment and stagnation at bay. It is true that this incentivises activities that might not otherwise take place. But the structure of production eventually adjusts to the real wants and needs of humanity, and away from unwanted malinvestments whether those malinvestments were initially spurred by negative real interest rates (etc), or simply by the irrational animal spirits of investors in the marketplace.
In conclusion, the notion of putting savers on some sort of pedestal as an engine of growth, and especially the notion of rigging the economic system to favour them are entirely unjustified. Mass saving of monetary tokens is unnecessary for capital formation, and the saving of the fruits of production is not the only source of capital. Worst of all, saving money is a leaky safety net for families and businesses next to the comparative safety of owning productive assets.