Posts Tagged ‘consumer goods’

The myth of financial asset ?investments? as savings

Friday, February 2nd, 2007

Today, the savings rate of the United States has never been lower since the Great Depression. This is a very serious concern that should never be underestimated. However, there are some who argued that if we include financial asset ?investments? such as home equity, pension and managed investment funds, stocks and so on, the savings rate is actually positive.

Here, we wish to dispel this myth.

First, we would need to understand what the true nature of savings is. In Chapter 15, Section 2 (Capital Goods and Capital) of Ludwig von Mises?s book, Human Action: A Treatise on Economics:

At the outset of every step forward on the road to a more plentiful existence is saving?the provisionment of products that makes it possible to prolong the average period of time elapsing between the beginning of the production process and its turning out of a product ready for use and consumption. The products accumulated for this purpose are either intermediary stages in the technological process, i.e. tools and half-finished products, or goods ready for consumption that make it possible for man to substitute, without suffering want during the waiting period, a more time-absorbing process for another absorbing a shorter time. These goods are called capital goods. Thus, saving and the resulting accumulation of capital goods are at the beginning of every attempt to improve the material conditions of man; they are the foundation of human civilization.

Goods that directly relieve a need or want are called consumer goods. Capital goods, on the other hand, are goods that help in the production of consumer goods?they increase the future productive capacity of the economy. As we all know, the economy has a finite quantity of resources. It has to choose between producing consumer goods for current consumption or capital goods which will help in producing future consumer goods. Furthermore, capital goods depreciate over time?resources are required to maintain them. The extent in which the people in the economy choose to produce (and maintain) capital goods over consumer goods constitutes the savings rate of the economy.

For example, let?s say we save $100 in the bank. The bank then lends out $90 to an entrepreneur who uses it to set up a business enterprise that will produce goods that consumers want down the track. In this case, the $100 that we save is a sacrifice on our current consumption. Part of that $100 of ours is then put in good use to add value to the economy in the future. In return for my sacrifice, we are paid interest.

In another example, let?s say a company decides to raise money in the stock market to fund its expansion plans. We invested $100 in that company?s IPO. That company then uses our $100 to build a new manufacturing plant that will produce consumer goods in the future. In this case, that $100 that we invest is considered savings since it involves us sacrificing current consumption worth $100. In return for our sacrifice, we are paid dividends from the company?s future earnings.

Now, based on this understanding on savings, can our home equity be considered savings? We have ‘equity’ in our homes if its current value exceeds the amount we owed. But the problem with such ‘equity’ is that it depends on the home’s current value, which is merely a paper value based on the principle of imputed valuation (see Spectre of deflation for the concept of imputed valuation). As we said before in The Bubble Economy, since the phenomena of inflating home values is mainly due to the increase in money supply (colloquially known as ?printing money?), they cannot be considered as savings as they do not have any resulting influence in the increase of capital goods in the economy. In the same way, if we buy and sell existing stocks (as opposed to newly issued ones in an IPO) in the stock market, are we in any way contributing to the accumulation of capital goods in the economy?

As the financial side of the economy (see Analysing recent falls in oil prices?real vs investment demand on the concept of the real and financial side of the economy) becomes increasingly influential in the economy, we wonder how much this side contributes to the amassing of capital goods, which is the foundation of building the future wealth of the nation? Can the printing of money, which spawns the growth of an industry to shuffle it, cause a nation to be richer in the long run?