Savings - part 4

I talked about the savings part going towards value-adding investment projects in my last blog. When we are funding our savings towards investment projects, we are under-consuming in the present to be able to consume better stuff in the future. Take for example road building. It may be a road to connect two villages - tarred roads help us travel the distance between two points faster as it enables automobiles to ply on it in a fast and smooth fashion. We may fund our savings to build roads - the building of a road requires human resources to engineer the road, to build the road-laying machines,dig out the dirt and actually lay the road. The savings used to fund the roads are used to channel the human resources available in the economy towards this effort. Once the road is built, it will lead to more opportunities between the two villages to exchange goods and services and so the savings would earn a return from that road building investment. If the road was a road to nowhere, it wouldn't have much impact to future economic activity and so will not be a good use to savings except for keep some human resources busy during the present to build the road to nowhere.

Coming back to the second use of savings to fund retirement - when we retire, we want to consume without the ability to actually work in the economy. simple enough. How do you fund the retirement years. There are a number of ways. In the olden days, the societal value called for the kids to take care of their old parents. So the parents had to just support themselves, their kids and their old parents during their work life and then depend on the kids to support them when they were old. This is like giving fish to your old parents when you were able to catch it and then expect your kids to give you fish for survival when you are old and no longer able to catch it. works well if the local societal value binds everybody in the society to do this. This is still voluntary but societal pressures will exist to support your old parents. Once people became more mobile and the neighbours didn't know each other much, this system broke down. Then the govt. came to support the cause of the older people. The govt took away a portion of every working person's salary and used it to give a pension (or social security) payment to the older people. This is very similar to the original approach of kids supporting their parents except now the govt had to come in between the kids and the old parents to enforce this support through the use of a tax (though it is not called a tax but a social security funding). The third approach is to start saving on your own every month towards retirement and hope to cash those in the retirement years. It is like putting an extra fish a day in a deep freezer. There is cost to maintain the deep freezer and the deep freezer may fail at some point and all your saved fish could turn rotten. It is much better to loan out the extra fish to somebody out there who can use it to invest in a value producing project. There is risk on this too as the loan may turn sour. Loaning out your saved fish is similar to putting money away in a 401k account that is invested in different companies around the world. These different companies are able to tap into the money to use in value adding project. We now again come back to the concept of using savings to fund value adding projects in the economy. In this scenario, we are under-consuming to consume at a much later point in life. In effect, sometimes we under-consume to consume in a shorter future period or a longer future period, depending on the reason behind our under consumption. But the under-consumption and the resulting savings must be used to fund value adding projects in the economy for us to be able to tap into it for future consumption.

Savings - part 3

On the savings front, I think there are two fundamental types of savings. One type of savings is to use savings to fund new projects that could provide better value to society. The other type of savings is related to saving for retirement - underconsume now to be able to consume in old age when we won't have the ability to work. Let's take Peter Schiff's fish example to develop this thought further. Say there are 10 working people catching fish and another 10 working people making clothes. Everybody needs one fish to survive daily. The fish catchers can catch two fish daily and so they eat one fish and trade the other fish to buy clothes. Everybody would like to put on a new cloth everyday and the clothes making people can make 2 clothes each day and so they use one cloth and trade the other cloth to buy fish. In this simple economy, all the 20 working people eat one fish and put on a new cloth every day. All the people have to walk now to get to the next village and it would be nice if they had a faster mode of transportation. All the 20 people are working now and so don't have any time to devote to other stuff. The fish catchers could decide to underconsume on the cloth and decide to wear them for two days instead of one. Two things happen by this decision - the fish catchers will have an extra 5 fish per day in total due to reduction in trade. This underconsumption will also drop the trade demand for the cloth to 5 per day from 10 per day initially. Five clothes makers can satisfy this demand by working full time - 1 cloth for them and 1 cloth for fishmakers. The other five cloth makers only need to work half-time - just 1 cloth for them. They have the other half a day free and they need to do something to feed themselves. Here is where the fish makers use their fish savings - they would provide 1 fish to each of the 5 half-time clothes makers to work on producing a bicycle. It is a risky project - it could fail without producing a bicycle but if it did succeed, it would free a lot of time for everybody to shuttle between the neighbouring villages and they could trade more with those neighbours who would become more accessible. But the fish makers are using their savings to try to build something better for the society and add value to the societal standard of living. By under-consuming on an existing item, they are able to use their savings to channel resources (the five clothes makers) to work on a new value adding project. This is one of the fundamental use of Savings to drive value. If the 5 clothes makers didn't do much for the loaned fish, the Savings would have gone waste. I will talk about the retirement aspect of savings in my next part of the blog.

Savings - part deux

I was talking to a friend of mine over the weekend after writing the first part on the Savings topic. He was suggesting that we as consumers need to make some sacrifices - meaning consume a little less and save more. I can understand cutting down office drive time, live more closer to the office - by doing that, we are cutting down on oil consumption and doing something good for the environment. Most oil is imported and so would not have a big direct impact on US jobs. maybe live in smaller sq ft homes - again benefits the environment by cutting down usage of natural gas, electricity etc. but how far do you go down this sacrifice path - do you cut down all non-essential consumer things. If so, that will have a direct impact on jobs. If we save more, there should be some capitalist who will be able to borrow that money and produce something that is valuable to society. If all the savings is just going into financing wasteful govt spending, those savings won't have much value to the society as a whole. We have to be careful on the reasons behind asking everybody to save more and under consume. If those savings can't be put to greater use within the society, there won't be any value to those savings. yes, there is a need for people to save some amount of money for an emergency so that they have some time to reach in logical way to some sudden changes in life like job loss, additions to family, sickness, accident etc. But beyond that, there needs to be a real reason for savings. If everybody has to save because they won't get another job for the next 10 years if they lose their current job, then the economy as a whole has failed and no amount of savings is good enough for such scenarios.

There is this argument that people in the US are not saving enough for retirement and so they should start saving more for retirement. but all those savings could be lost in the stock market if the fundamental economy is not strong enough. If it can be shown that some parts of the economy is getting starved of capital because of the current over-consumption trends in a certain other part of the economy (that over-consumption is driving more money and human resources into a wasteful activity), then it is needful to ask people to underconsume in those sectors to allow some more value-adding sector to get more capital allocation and grow.

Savings - to be or not to be

Peter Schiff keeps talking about the importance of savings in an economy. I wiil go thru a few sentences from his book - 'the lender can benefit only if the borrower benefits' - I agree with this concept. 'but like any other resource, savings must be accumulated before it can be lent out', 'it is essential that Able, Baker, and Charlie continue to underconsume and save for a rainy day'. He goes on to say 'It's production that adds the value','Savings creates the capital that allows for the expansion of production. As a result, a dollar saved makes more of a positive economic impact than a dollar spent'. I have a hard time appreciating this view. How can everybody in an economy save? He has already said that there are borrowers and savers in the economy and that the lender (or saver) benefits only if the borrower benefits. There are only certain things we can save for a rainy day - like some stockpile of essential food items to temporarily respond to a natural calamity or a stockpile of oil to have some time to respond to an Arab oil embargo. These are one time stock building for an emergency. Most of economic activity is around exchange of goods and services between human beings. You are not going to underconsume a haircut to save for a rainy day. The savings is not a well understood concept - everybody keeps harping about savings without understanding it clearly.

Robert Reich's NPR commentary 051910

Today Mr. Reich commented about how the hedge fund mgrs make out-sized earnings and somehow that is supposed to be bad. Top hedge fund mgrs probably made $1 billion last year but they took some risky market positions to earn that. and the US govt is not out to bail them if their risky bets turn out sore. The point was about closing a loophole to tax these earnings as ordinary income rather than get the 15% capitals gain treatment - I agree with that point. but then he went to say how that $1 bil could have been used to pay the salary of 25,000 teachers in the US instead of one hedge fund mgr. This $1 bil wouldn't be there unless the hedge fund mgr took the positions he took in the mkt. It is not like the hedge fund mgr hoodwinked school districts or the state govt or the federal govt and made this money by taking it away from them. The hedge fund mgr saw some arbritrage opportunities in the mkt and took positions to profit from it and by doing that made the market more efficient. and the hedge fund mgr will probably either invest the earnings in the market or spend the money buying goods and services in the economy. and the money gets back into the economic cycle again.

Peter Schiff's new book 'how an economy grows and why it crashes'

I just finished reading Peter Schiff's book. Not a lot of economic insights to be gained from that book. gives a very simplfied picture of an economy using fishes and then gripes about the lack of savings in the US. This is a common gripe from many mainstream economists. but they fail to appreciate that there is a glut of savings in the world that we are able to borrow upon. Savings don't have much value if there are no borrowers to borrow it to make some productive economic exchange of goods and services. If Able had a glut of fish to sustain him for say 10 years, he could retire from fishing for 10 years but he won't have any other luxury provided other than his meal of fish food. If he wants to get some service provided by others in the island, he has to lend his extra savings to other borrowers so that they can create other services in the island. There needs to be borrowers for Able to benefit from his fish savings - without that, he will be just a bum on the beach able to survive eating his fish.

In my next blogs, I will try to go thru chapter by chapter of his book and try to construct an alternate economic model using his same fish example. I agree with Peter Schiff on some of his scorn for the Keynesian economists. Keynesian govt spending is necessary when the overall economic market goes thru a crisis and liquidity dries up due to build up high distrust in the market. The govt can try to cushion those crisis by deficit spending but they can only do so a for a limited time. If the economy itself has fundamental problems, govt over-spending can't sustain economic activity beyond a short period of time. A limited time could mean about one to two years.