Economics in One Lesson Part 7

4.

Yet the ardor for inflation never dies. It would almost seem as if no country is capable of profiting from the experience of another and no generation of learning from the sufferings of its forebears. Each generation and country follows the same mirage. Each grasps for the same Dead Sea fruit that turns to dust and ashes in its mouth. For it is the nature of inflation to give birth to a thousand illusions.

In our own day the most persistent argument put forward for inflation is that it will "get the wheels of industry turning," that it will save us from the irretrievable losses of stagnation and idleness and bring "full employment." This argument in its cruder form rests on the immemorial confusion between money and real wealth. It a.s.sumes that new "purchasing power" is being brought into existence, and that the effects of this new purchasing power multiply themselves in ever-widening circles, like the ripples caused by a stone thrown into a pond. The real purchasing power for goods, however, as we have seen, consists of other goods. It cannot be wondrously increased merely by printing more pieces of paper called dollars. Fundamentally what happens in an exchange economy is that the things that A produces are exchanged for the things that B produces. things that A produces are exchanged for the things that B produces.3 What inflation really does is to change the relationships of prices and costs. The most important change it is designed to bring about is to raise commodity prices in relation to wage rates, and so to restore business profits, and encourage a resumption of output at the points where idle resources exist, by restoring a workable relationship between prices and costs of production.

It should be immediately clear that this could be brought about more directly and honestly by a reduction in unworkable wage rates. But the more sophisticated proponents of inflation believe that this is now politically impossible. Sometimes they go further, and charge that all proposals under any circ.u.mstances to reduce particular wage rates directly in order to reduce unemployment are "antilabor." But what they are themselves proposing, stated in bald terms, is to deceive deceive labor by reducing labor by reducing real real wage rates (that is, wage rates in terms of purchasing power) through an increase in prices. wage rates (that is, wage rates in terms of purchasing power) through an increase in prices.

What they forget is that labor has itself become sophisticated; that the big unions employ labor economists who know about index numbers, and that labor is not deceived. The policy, therefore, under present conditions, seems unlikely to accomplish either its economic or its political aims. For it is precisely the most powerful unions, whose wage rates are most likely to be in need of correction, that will insist that their wage rates be raised at least in proportion to any increase in the cost-of-living index. The unworkable relationships between prices and key wage rates, if the insistence of the powerful unions prevails, will remain. The wage rate structure, in fact, may become even more distorted; for the great ma.s.s of unorganized workers, whose wage rates even before the inflation were not out of line (and may even have been unduly depressed through union exclusionism), will be penalized further during the transition by the rise in prices. whose wage rates even before the inflation were not out of line (and may even have been unduly depressed through union exclusionism), will be penalized further during the transition by the rise in prices.

5.

The more sophisticated advocates of inflation, in brief, are disingenuous. They do not state their case with complete candor; and they end by deceiving even themselves. They begin to talk of paper money, like the more naive inflationists, as if it were itself a form of wealth that could be created at will on the printing press. They even solemnly discuss a "multiplier," by which every dollar printed and spent by the government becomes magically the equivalent of several dollars added to the wealth of the country.

In brief, they divert both the public attention and their own from the real causes of any existing depression. For the real causes, most of the time, are maladjustments within the wage-cost-price structure: maladjustments between wages and prices, between prices of raw materials and prices of finished goods, or between one price and another or one wage and another. At some point these maladjustments have removed the incentive to produce, or have made it actually impossible for production to continue; and through the organic interdependence of our exchange economy, depression spreads. Not until these maladjustments are corrected can full production and employment be resumed.

True, inflation may sometimes correct them; but it is a heady and dangerous method. It makes its corrections not openly and honestly, but by the use of illusion. Inflation, indeed, throws a veil of illusion over every economic process. It confuses and deceives almost everyone, including even those who suffer by it. We are all accustomed to measuring our income and wealth in terms of money. The mental habit is so strong that even professional economists and statisticians cannot consistently break it. It is not easy to see relationships always in terms of real goods and real welfare. Who among us does not feel richer and prouder when he is told that our national income has doubled (in terms of dollars, of course) compared with some preinflationary period? Even the clerk who used to get $75 a week and now gets $120 thinks that he must be in some way better off, though it costs him twice as much to live as it did when he was getting $75. He is of course not blind to the rise in the cost of living. But neither is he as fully aware of his real position as he would have been if his cost of living had not changed and if his money salary had been reduced to give him the same reduced purchasing power that he now has, in spite of his salary increase, because of higher prices. Inflation is the autosuggestion, the hypnotism, the anesthetic, that has dulled the pain of the operation for him. Inflation is the opium of the people. goods and real welfare. Who among us does not feel richer and prouder when he is told that our national income has doubled (in terms of dollars, of course) compared with some preinflationary period? Even the clerk who used to get $75 a week and now gets $120 thinks that he must be in some way better off, though it costs him twice as much to live as it did when he was getting $75. He is of course not blind to the rise in the cost of living. But neither is he as fully aware of his real position as he would have been if his cost of living had not changed and if his money salary had been reduced to give him the same reduced purchasing power that he now has, in spite of his salary increase, because of higher prices. Inflation is the autosuggestion, the hypnotism, the anesthetic, that has dulled the pain of the operation for him. Inflation is the opium of the people.

6.

And this is precisely its political function. It is because inflation confuses everything that it is so consistently resorted to by our modern "planned economy" governments. We saw in chapter four, to take but one example, that the belief that public works necessarily create new jobs is false. If the money was raised by taxation, we saw, then for every dollar that the government spent on public works one less dollar was spent by the taxpayers to meet their own wants, and for every public job created one private job was destroyed.

But suppose the public works are not paid for from the proceeds of taxation? Suppose they are paid for by deficit financing-that is, from the proceeds of government borrowing or from resort to the printing press? Then the result just described does not seem to take place. The public works seem to be created out of "new" purchasing power. You cannot say that the purchasing power has been taken away from the taxpayers. For the moment the nation seems to have got something for nothing.

But now, in accordance with our lesson, let us look at the longer consequences. The borrowing must some day be repaid. The government cannot keep piling up debt indefinitely; for if it tries, it will some day become bankrupt. As Adam Smith observed in 1776: When national debts have once been acc.u.mulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid. The liberation of the public revenue, if it has even been brought about at all, has always been brought about by a bankruptcy; sometimes by an avowed one, but always by a real one, though frequently by a pretended payment.

Yet when the government comes to repay the debt it has acc.u.mulated for public works, it must necessarily tax more heavily than it spends. In this later period, therefore, it must necessarily destroy more jobs than it creates. The extra-heavy taxation then required does not merely take away purchasing power; it also lowers or destroys incentives to production, and so reduces the total wealth and income of the country.

The only escape from this conclusion is to a.s.sume (as of course the apostles of spending always do) that the politicians in power will spend money only in what would otherwise have been depressed or "deflationary" periods, and will promptly pay the debt off in what would otherwise have been boom or "inflationary" periods. This is a beguiling fiction, but unfortunately the politicians in power have never acted that way. Economic forecasting, moreover, is so precarious, and the political pressures at work are of such a nature, that governments are unlikely ever to act that way. Deficit spending, once embarked upon, creates powerful vested interests which demand its continuance under all conditions.

If no honest attempt is made to pay off the acc.u.mulated debt, and resort is had to outright inflation instead, then the results follow that we have already described. For the country as a whole cannot get anything without paying for it. Inflation itself is a form of taxation. It is perhaps the worst possible form, which usually bears hardest on those least able to pay. On the a.s.sumption that inflation affected everyone and everything evenly (which, we have seen, is never true), it would be tantamount to a flat sales tax of the same percentage on all commodities, with the rate as high on bread and milk as on diamonds and furs. Or it might be thought of as equivalent to a flat tax of the same percentage, without exemptions, on everyone's income. It is a tax not only on every individual's expenditures, but on his savings account and life insurance. It is, in fact, a flat capital levy, without exemptions, in which the poor man pays as high a percentage as the rich man. follow that we have already described. For the country as a whole cannot get anything without paying for it. Inflation itself is a form of taxation. It is perhaps the worst possible form, which usually bears hardest on those least able to pay. On the a.s.sumption that inflation affected everyone and everything evenly (which, we have seen, is never true), it would be tantamount to a flat sales tax of the same percentage on all commodities, with the rate as high on bread and milk as on diamonds and furs. Or it might be thought of as equivalent to a flat tax of the same percentage, without exemptions, on everyone's income. It is a tax not only on every individual's expenditures, but on his savings account and life insurance. It is, in fact, a flat capital levy, without exemptions, in which the poor man pays as high a percentage as the rich man.

But the situation is even worse than this, because, as we have seen, inflation does not and cannot affect everyone evenly. Some suffer more than others. The poor are usually more heavily taxed by inflation, in percentage terms, than the rich, for they do not have the same means of protecting themselves by speculative purchases of real equities. Inflation is a kind of tax that is out of control of the tax authorities. It strikes wantonly in all directions. The rate of tax imposed by inflation is not a fixed one: it cannot be determined in advance. We know what it is today; we do not know what it will be tomorrow; and tomorrow we shall not know what it will be on the day after.

Like every other tax, inflation acts to determine the individual and business policies we are all forced to follow. It discourages all prudence and thrift. It encourages squandering, gambling, reckless waste of all kinds. It often makes it more profitable to speculate than to produce. It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies. It plants the seeds of fascism and communism. It leads men to demand totalitarian controls. It ends invariably in bitter disillusion and collapse.

1Stripped down to its essentials, this is the theory of the Keynesians. In The Failure of the "New Economics" The Failure of the "New Economics" (New Roch.e.l.le, N.Y.: Arlington House, 1959) I a.n.a.lyze this theory in detail. (New Roch.e.l.le, N.Y.: Arlington House, 1959) I a.n.a.lyze this theory in detail.

2The reader interested in an a.n.a.lysis of them should consult B. M. Anderson, The Value of Money The Value of Money (1917; new edition, 1936); Ludwig von Mises, (1917; new edition, 1936); Ludwig von Mises, The Theory of Money and Credit The Theory of Money and Credit (American editions, 1935, 1953); or the present writer's (American editions, 1935, 1953); or the present writer's Inflation Crisis, and How to Resolve It Inflation Crisis, and How to Resolve It (New Roch.e.l.le, N.Y.: Arlington House, 1978). (New Roch.e.l.le, N.Y.: Arlington House, 1978).

3Cf. John Stuart Mill, Principles of Political Economy Principles of Political Economy (Book 3, Chap. 14, par. 2); Alfred Marshall, (Book 3, Chap. 14, par. 2); Alfred Marshall, Principles of Economics Principles of Economics (Book VI, Chap. XIII, sec. 10); Benjamin M. Anderson, "A Refutation of Keynes' Attack on the Doctrine that Aggregate Supply Creates Aggregate Demand," (Book VI, Chap. XIII, sec. 10); Benjamin M. Anderson, "A Refutation of Keynes' Attack on the Doctrine that Aggregate Supply Creates Aggregate Demand," in Financing American Prosperity in Financing American Prosperity by a symposium of economists. Cf. also the symposium edited by the present author: by a symposium of economists. Cf. also the symposium edited by the present author: The Critics of Keynesian Economics The Critics of Keynesian Economics (New Roch.e.l.le, N.Y.: Arlington House, 1960). (New Roch.e.l.le, N.Y.: Arlington House, 1960).

Chapter XXIV.

THE A a.s.sAULT ON S SAVING.

FROM TIME IMMEMORIAL proverbial wisdom has taught the virtues of saving, and warned against the consequences of prodigality and waste. This proverbial wisdom has reflected the common ethical as well as the merely prudential judgments of mankind. But there have always been squanderers, and there have apparently always been theorists to rationalize their squandering. proverbial wisdom has taught the virtues of saving, and warned against the consequences of prodigality and waste. This proverbial wisdom has reflected the common ethical as well as the merely prudential judgments of mankind. But there have always been squanderers, and there have apparently always been theorists to rationalize their squandering.

The cla.s.sical economists, refuting the fallacies of their own day, showed that the saving policy that was in the best interests of the individual was also in the best interests of the nation. They showed that the rational saver, in making provision for his future, was not hurting, but helping, the whole community. But today the ancient virtue of thrift, as well as its defense by the cla.s.sical economists, is once more under attack, for allegedly new reasons, while the opposite doctrine of spending is in fashion.

In order to make the fundamental issue as clear as possible, we cannot do better, I think, than to start with the cla.s.sic example used by Bastiat. Let us imagine two brothers, then, one a spendthrift and the other a prudent man, each of whom has inherited a sum to yield him an income of $50,000 a year. We shall disregard the income tax, and the question whether both brothers really ought to work for a living or give most of their income to charity, because such questions are irrelevant to our present purpose. their income to charity, because such questions are irrelevant to our present purpose.

Alvin, then, the first brother, is a lavish spender. He spends not only by temperament, but on principle. He is a disciple (to go no further back) of Rodbertus, who declared in the middle of the nineteenth century that capitalists "must expend their income to the last penny in comforts and luxuries," for if they "determine to save ... goods acc.u.mulate, and part of the workmen will have no work."1 Alvin is always seen at the night clubs; he tips handsomely; he maintains a pretentious establishment, with plenty of servants; he has a couple of chauffeurs, and doesn't stint himself in the number of cars he owns; he keeps a racing stable; he runs a yacht; he travels; he loads his wife down with diamond bracelets and fur coats; he gives expensive and useless presents to his friends. Alvin is always seen at the night clubs; he tips handsomely; he maintains a pretentious establishment, with plenty of servants; he has a couple of chauffeurs, and doesn't stint himself in the number of cars he owns; he keeps a racing stable; he runs a yacht; he travels; he loads his wife down with diamond bracelets and fur coats; he gives expensive and useless presents to his friends.

To do all this he has to dig into his capital. But what of it? If saving is a sin, dissaving must be a virtue; and in any case he is simply making up for the harm being done by the saving of his pinchpenny brother Benjamin.

It need hardly be said that Alvin is a great favorite with the hat check girls, the waiters, the restaurateurs, the furriers, the jewelers, the luxury establishments of all kinds. They regard him as a public benefactor. Certainly it is obvious to everyone that he is giving employment and spreading his money around.

Compared with him brother Benjamin is much less popular. He is seldom seen at the jewelers, the furriers or the night clubs, and he does not call the head waiters by their first names. Whereas Alvin spends not only the full $50,000 income each year but is digging into capital besides, Benjamin lives much more modestly and spends only about $25,000. Obviously, think the people who see only what hits them in the eye, he is providing less than half as much employment as Alvin, and the other $25,000 is as useless as if it did not exist.

But let us see what Benjamin actually does with this other $25,000. He does not let it pile up in his pocketbook, his bureau drawers, or in his safe. He either deposits it in a bank or he invests it. If he puts it either into a commercial or a savings bank, the bank either lends it to going businesses on short term for working capital, or uses it to buy securities. In other words, Benjamin invests his money either directly or indirectly. But when money is invested it is used to buy or build capital goods-houses or office buildings or factories or ships or trucks or machines. Any one of these projects puts as much money into circulation and gives as much employment as the same amount of money spent directly on consumption. invests it. If he puts it either into a commercial or a savings bank, the bank either lends it to going businesses on short term for working capital, or uses it to buy securities. In other words, Benjamin invests his money either directly or indirectly. But when money is invested it is used to buy or build capital goods-houses or office buildings or factories or ships or trucks or machines. Any one of these projects puts as much money into circulation and gives as much employment as the same amount of money spent directly on consumption.

"Saving" in short, in the modern world, is only another form of spending. The usual difference is that the money is turned over to someone else to spend on means to increase production. So far as giving employment is concerned, Benjamin's "saving" and spending combined give as much as Alvin's spending alone, and put as much money in circulation. The chief difference is that the employment provided by Alvin's spending can be seen by anyone with one eye; but it is necessary to look a little more carefully, and to think a moment, to recognize that every dollar of Benjamin's saving gives as much employment as every dollar that Al vin throws around.

A dozen years roll by. Alvin is broke. He is no longer seen in the night clubs and at the fashionable shops; and those whom he formerly patronized, when they speak of him, refer to him as something of a fool. He writes begging letters to Benjamin. And Benjamin, who continues about the same ratio of spending to saving, not only provides more jobs than ever, because his income, through investment, has grown, but through his investment he has helped to provide better-paying and more productive jobs. His capital wealth and income are greater. He has, in brief, added to the nation's productive capacity; Alvin has not.

2.

So many fallacies have grown up about saving in recent years that they cannot all be answered by our example of the two brothers. It is necessary to devote some further s.p.a.ce to them. Many stem from confusions so elementary as to seem incredible, particularly when found in the works of economic writers of wide repute. The word Many stem from confusions so elementary as to seem incredible, particularly when found in the works of economic writers of wide repute. The word saving saving, for example, is used sometimes to mean mere h.o.a.rding mere h.o.a.rding of money, and sometimes to mean of money, and sometimes to mean investment investment, with no clear distinction, consistently maintained, between the two uses.

Mere h.o.a.rding of hand-to-hand money, if it takes place irrationally, causelessly, and on a large scale, is in most economic situations harmful. But this sort of h.o.a.rding is extremely rare. Something that looks like this, but should be carefully distinguished from it, often occurs after a after a downturn in business has got under way. Consumptive spending and investment are then downturn in business has got under way. Consumptive spending and investment are then both both contracted. Consumers reduce their buying. They do this partly, indeed, because they fear they may lose their jobs, and they wish to conserve their resources: they have contracted their buying not because they wish to consume less but because they wish to make sure that their power to consume will be extended over a longer period if they do lose their jobs. contracted. Consumers reduce their buying. They do this partly, indeed, because they fear they may lose their jobs, and they wish to conserve their resources: they have contracted their buying not because they wish to consume less but because they wish to make sure that their power to consume will be extended over a longer period if they do lose their jobs.

But consumers reduce their buying for another reason. Prices of goods have probably fallen, and they fear a further fall. If they defer spending, they believe they will get more for their money. They do not wish to have their resources in goods that are falling in value, but in money which they expect (relatively) to rise in value.

The same expectation prevents them from investing. They have lost their confidence in the profitability of business; or at least they believe that if they wait a few months they can buy stocks or bonds cheaper. We may think of them either as refusing to hold goods that may fall in value on their hands, or as holding money itself for a rise.

It is a misnomer to call this temporary refusal to buy "saving." It does not spring from the same motives as normal saving. And it is a still more serious error to say that this sort of "saving" is the cause cause of depressions. It is, on the contrary, the of depressions. It is, on the contrary, the consequence consequence of depressions. of depressions.

It is true that this refusal to buy may intensify and prolong a depression. At times when there is capricious government intervention in business, and when business does not know what the government is going to do next, uncertainty is created. Profits are not reinvested. Firms and individuals allow cash balances to acc.u.mulate in their banks. They keep larger reserves against contingencies. This h.o.a.rding of cash may seem like a cause of a subsequent slowdown in business activity. The real cause, however, is the uncertainty brought about by the government policies. The larger cash balances of firms and individuals are merely one link in the chain of consequences from that uncertainty. To blame "excessive saving" for the business decline would be like blaming a fall in the price of apples not on a b.u.mper crop but on the people who refuse to pay more for apples. intervention in business, and when business does not know what the government is going to do next, uncertainty is created. Profits are not reinvested. Firms and individuals allow cash balances to acc.u.mulate in their banks. They keep larger reserves against contingencies. This h.o.a.rding of cash may seem like a cause of a subsequent slowdown in business activity. The real cause, however, is the uncertainty brought about by the government policies. The larger cash balances of firms and individuals are merely one link in the chain of consequences from that uncertainty. To blame "excessive saving" for the business decline would be like blaming a fall in the price of apples not on a b.u.mper crop but on the people who refuse to pay more for apples.

But when once people have decided to deride a practice or an inst.i.tution, any argument against it, no matter how illogical, is considered good enough. It is said that the various consumers' goods industries are built on the expectation of a certain demand, and that if people take to saving they will disappoint this expectation and start a depression. This a.s.sertion rests primarily on the error we have already examined-that of forgetting that what is saved on consumers' goods is spent on capital goods, and that "saving" does not necessarily mean even a dollar's contraction in total total spending. The only element of truth in the contention is that spending. The only element of truth in the contention is that any any change that is change that is sudden sudden may be unsettling. It would be just as unsettling if consumers suddenly switched their demand from one consumers' good to another. It would be even more unsettling if former savers suddenly switched their demand from capital goods to consumers' goods. may be unsettling. It would be just as unsettling if consumers suddenly switched their demand from one consumers' good to another. It would be even more unsettling if former savers suddenly switched their demand from capital goods to consumers' goods.

Still another objection is made against saving. It is said to be just downright silly. The nineteenth century is derided for its supposed inculcation of the doctrine that mankind through saving should go on baking itself a larger and larger cake without ever eating the cake. This picture of the process is itself naive and childish. It can best be disposed of, perhaps, by putting before ourselves a somewhat more realistic picture of what actually takes place.

Let us picture to ourselves, then, a nation that collectively saves every year about 20 percent of all it produces in that year. This figure greatly overstates the amount of net saving that has occurred historically in the United States, This figure greatly overstates the amount of net saving that has occurred historically in the United States,2 but it is a round figure that is easily handled, and it gives the benefit of every doubt to those who believe that we have been "oversaving." but it is a round figure that is easily handled, and it gives the benefit of every doubt to those who believe that we have been "oversaving."

Now as a result of this annual saving and investment, the total annual production of the country will increase each year. (To isolate the problem we are ignoring for the moment booms, slumps, or other fluctuations.) Let us say that this annual increase in production is 2.5 percentage points. (Percentage points are taken instead of a compounded percentage merely to simplify the arithmetic.) The picture that we get for an eleven-year period, say, would then run something like this in terms of index numbers: [image]

The first thing to be noticed about this table is that total production increases each year because of the saving because of the saving, and would not have increased without it. (It is possible no doubt to imagine that improvements and new inventions merely in replaced replaced machinery and other capital goods of a value no greater than the old would increase the national productivity; but this increase would amount to very little and the argument in any case a.s.sumes enough machinery and other capital goods of a value no greater than the old would increase the national productivity; but this increase would amount to very little and the argument in any case a.s.sumes enough prior prior investment to have made the existing machinery possible.) The saving has been used year after year to increase the quant.i.ty or improve the quality of existing machinery, and so to increase the nation's output of goods. There is, it is true (if that for some strange reason is considered an objection), a larger and larger "cake" each year. Each year, it is true, investment to have made the existing machinery possible.) The saving has been used year after year to increase the quant.i.ty or improve the quality of existing machinery, and so to increase the nation's output of goods. There is, it is true (if that for some strange reason is considered an objection), a larger and larger "cake" each year. Each year, it is true, not all not all of the currently produced cake is consumed. But there is no irrational or c.u.mulative restraint. For each year a larger and larger cake is in fact consumed; until, at the end of eleven years (in our ill.u.s.tration), the annual consumers' cake alone is equal to the combined consumers' and producers' cakes of the first year. Moreover, the capital equipment, the ability to produce goods, is itself 2 5 percent greater than in the first year. of the currently produced cake is consumed. But there is no irrational or c.u.mulative restraint. For each year a larger and larger cake is in fact consumed; until, at the end of eleven years (in our ill.u.s.tration), the annual consumers' cake alone is equal to the combined consumers' and producers' cakes of the first year. Moreover, the capital equipment, the ability to produce goods, is itself 2 5 percent greater than in the first year.

Let us observe a few other points. The fact that 20 percent of the national income goes each year for saving does not upset the consumers' goods industries in the least. If they sold only the 80 units they produced in the first year (and there were no rise in prices caused by unsatisfied demand) they would certainly not be foolish enough to build their production plans on the a.s.sumption that they were going to sell 100 units in the second year. The consumers' goods industries, in other words, are already geared to already geared to the a.s.sumption that the past situation in regard to the rate of savings will continue. Only an unexpected the a.s.sumption that the past situation in regard to the rate of savings will continue. Only an unexpected sudden and substantial increase sudden and substantial increase in savings would unsettle them and leave them with unsold goods. in savings would unsettle them and leave them with unsold goods.

But the same unsettlement, as we have already observed, would be caused in the capital capital goods industries by a sudden and substantial goods industries by a sudden and substantial decrease decrease in savings. If money that would previously have been used for savings were thrown into the purchase of consumers' goods, it would not increase employment but merely lead to an increase in the price of consumption goods in savings. If money that would previously have been used for savings were thrown into the purchase of consumers' goods, it would not increase employment but merely lead to an increase in the price of consumption goods and to a decrease in the price of capital goods. Its first effect on net balance would be to force shifts in employment and temporarily to and to a decrease in the price of capital goods. Its first effect on net balance would be to force shifts in employment and temporarily to decrease decrease employment by its effect on the capital goods industries. And its long-run effect would be to reduce production below the level that would otherwise have been achieved. employment by its effect on the capital goods industries. And its long-run effect would be to reduce production below the level that would otherwise have been achieved.

3.

The enemies of saving are not through. They begin by drawing a distinction, which is proper enough, between "savings" and "investment." But then they start to talk as if the two were independent variables and as if it were merely an accident that they should ever equal each other. These writers paint a portentous picture. On the one side are savers automatically, pointlessly, stupidly continuing to save; on the other side are limited "investment opportunities" that cannot absorb this saving. The result, alas, is stagnation. The only solution, they declare, is for the government to expropriate these stupid and harmful savings and to invent its own projects, even if these are only useless ditches or pyramids, to use up the money and provide employment.

There is so much that is false in this picture and "solution" that we can here point only to some of the main fallacies. Savings can exceed investment only by the amounts that are actually h.o.a.rded in cash. h.o.a.rded in cash.3 Few people nowadays, in a modern industrial community, h.o.a.rd coins and bills in stockings or under mattresses. To the small extent that this may occur, it has already been reflected in the production plans of business and in the price level. It is not ordinarily even c.u.mulative: Few people nowadays, in a modern industrial community, h.o.a.rd coins and bills in stockings or under mattresses. To the small extent that this may occur, it has already been reflected in the production plans of business and in the price level. It is not ordinarily even c.u.mulative: dish.o.a.rding, as eccentric recluses die and their h.o.a.rds are discovered and dissipated, probably offsets new h.o.a.rding. In fact, the whole amount involved is probably insignificant in its effect on business activity. dish.o.a.rding, as eccentric recluses die and their h.o.a.rds are discovered and dissipated, probably offsets new h.o.a.rding. In fact, the whole amount involved is probably insignificant in its effect on business activity.

If money is kept either in savings banks or commercial banks, as we have already seen, the banks are eager to lend and invest it. They cannot afford to have idle funds. The only thing that will cause people generally to try to increase their holdings of cash, or that will cause banks to hold funds idle and lose the interest on them, is, as we have seen, either fear that prices of goods are going to fall or the fear of banks that they will be taking too great a risk with their princ.i.p.al. But this means that signs of a depression have already appeared, and have caused the h.o.a.rding, rather than that the h.o.a.rding has started the depression.

Apart from this negligible h.o.a.rding of cash, then (and even this exception might be thought of as a direct "investment" in money itself) savings and investment are brought into equilibrium with each other in the same way that the supply of and demand for any commodity are brought into equilibrium. For we may define savings and investment as const.i.tuting respectively the supply of and demand for new capital. And just as the supply of and demand for any other commodity are equalized by price, so the supply of and demand for capital are equalized by interest rates. The interest rate is merely the special name for the price of loaned capital. It is a price like any other.

This whole subject has been so appallingly confused in recent years by complicated sophistries and disastrous governmental policies based upon them that one almost despairs of getting back to common sense and sanity about it. There is a psychopathic fear of "excessive" interest rates. It is argued that if interest rates are too high it will not be profitable for industry to borrow and invest in new plants and machines. This argument has been so effective that governments everywhere in recent decades have pursued artificial "cheap-money" policies. But the argument, in its concern with increasing the demand for capital, overlooks the effect of these policies on the supply of capital. It is one more example of the fallacy of looking at the effects of a policy only on one group and forgetting the effects on another. for capital, overlooks the effect of these policies on the supply of capital. It is one more example of the fallacy of looking at the effects of a policy only on one group and forgetting the effects on another.

If interest rates are artificially kept too low in relation to risks, there will be a reduction in both saving and lending. The cheap-money proponents believe that saving goes on automatically, regardless of the interest rate, because the sated rich have nothing else that they can do with their money. They do not stop to tell us at precisely what personal income level a man saves a fixed minimum amount regardless of the rate of interest or the risk at which he can lend it.

The fact is that, though the volume of saving of the very rich is doubtless affected much less proportionately than that of the moderately well-off by changes in the interest rate, practically everyone's saving is affected in some degree. To argue, on the basis of an extreme example, that the volume of real savings would not be reduced by a substantial reduction in the interest rate, is like arguing that the total production of sugar would not be reduced by a substantial fall of its price because the efficient, low-cost producers would still raise as much as before. The argument overlooks the marginal saver, and even, indeed, the great majority of savers.

The effect of keeping interest rates artificially low, in fact, is eventually the same as that of keeping any other price below the natural market. It increases demand and reduces supply. It increases the demand for capital and reduces the supply of real capital. It creates economic distortions. It is true, no doubt, that an artificial reduction in the interest rate encourages increased borrowing. It tends, in fact, to encourage highly speculative ventures that cannot continue except under the artificial conditions that gave them birth. On the supply side, the artificial reduction of interest rates discourages normal thrift, saving, and investment. It reduces the acc.u.mulation of capital. It slows down that increase in productivity, that "economic growth," that "progressives" profess to be so eager to promote.

The money rate can, indeed, be kept artificially low only by continuous new injections of currency or bank credit in place of real savings. This can create the illusion of more capital just as the addition of water can create the illusion of more milk. But it is a policy of continuous inflation. It is obviously a process involving c.u.mulative danger. The money rate will rise and a crisis will develop if the inflation is reversed, or merely brought to a halt, or even continued at a diminished rate. continuous new injections of currency or bank credit in place of real savings. This can create the illusion of more capital just as the addition of water can create the illusion of more milk. But it is a policy of continuous inflation. It is obviously a process involving c.u.mulative danger. The money rate will rise and a crisis will develop if the inflation is reversed, or merely brought to a halt, or even continued at a diminished rate.

It remains to be pointed out that while new injections of currency or bank credit can at first, and temporarily, bring about lower interest rates, persistence in this device must eventually raise raise interest rates. It does so because new injections of money tend to lower the purchasing power of money. Lenders then come to realize that the money they lend today will buy less a year from now, say, when they get it back. Therefore to the normal interest rate they add a premium to compensate them for this expected loss in their money's purchasing power. This premium can be high, depending on the extent of the expected inflation. Thus the annual interest rate on British treasury bills rose to 14 percent in 1976; Italian government bonds yielded 16 percent in 1977; and the discount rate of the central bank of Chile soared to 75 percent in 1974. Cheap-money policies, in short, eventually bring about far more violent oscillations in business than those they are designed to remedy or prevent. interest rates. It does so because new injections of money tend to lower the purchasing power of money. Lenders then come to realize that the money they lend today will buy less a year from now, say, when they get it back. Therefore to the normal interest rate they add a premium to compensate them for this expected loss in their money's purchasing power. This premium can be high, depending on the extent of the expected inflation. Thus the annual interest rate on British treasury bills rose to 14 percent in 1976; Italian government bonds yielded 16 percent in 1977; and the discount rate of the central bank of Chile soared to 75 percent in 1974. Cheap-money policies, in short, eventually bring about far more violent oscillations in business than those they are designed to remedy or prevent.

If no effort is made to tamper with money rates through inflationary governmental policies, increased savings create their own demand by lowering interest rates in a natural manner. The greater supply of savings seeking investment forces savers to accept lower rates. But lower rates also mean that more enterprises can afford to borrow because their prospective profit on the new machines or plants they buy with the proceeds seems likely to exceed what they have to pay for the borrowed funds.

4.

We come now to the last fallacy about saving with which I intend to deal. This is the frequent a.s.sumption that there is a fixed limit to the amount of new capital that can be absorbed, or even that the limit of capital expansion has already been reached. It is incredible that such a view could prevail even among the ignorant, let alone that it could be held by any trained economist. Almost the whole wealth of the modern world, nearly everything that distinguishes it from the pre-industrial world of the seventeenth century, consists of its acc.u.mulated capital. intend to deal. This is the frequent a.s.sumption that there is a fixed limit to the amount of new capital that can be absorbed, or even that the limit of capital expansion has already been reached. It is incredible that such a view could prevail even among the ignorant, let alone that it could be held by any trained economist. Almost the whole wealth of the modern world, nearly everything that distinguishes it from the pre-industrial world of the seventeenth century, consists of its acc.u.mulated capital.

This capital is made up in part of many things that might better be called consumers' durable goods-automobiles, refrigerators, furniture, schools, colleges, churches, libraries, hospitals and above all private homes. Never in the history of the world has there been enough of these. Even if there were enough homes from a purely numerical point of view, qualitative qualitative improvements are possible and desirable without definite limit in all but the very best houses. improvements are possible and desirable without definite limit in all but the very best houses.

The second part of capital is what we may call capital proper. It consists of the tools of production, including everything from the crudest axe, knife or plow to the finest machine tool, the greatest electric generator or cyclotron, or the most wonderfully equipped factory. Here, too, quant.i.tatively and especially qualitatively, there is no limit to the expansion that is possible and desirable. There will not be a "surplus" of capital until the most backward country is as well equipped technologically as the most advanced, until the most inefficient factory in America is brought abreast of the factory with the latest and finest equipment, and until the most modern tools of production have reached a point where human ingenuity is at a dead end, and can improve them no further. As long as any of these conditions remains unfulfilled, there will be indefinite room for more capital.

But how can the additional capital be "absorbed"? How can it be "paid for"? If it is set aside and saved, it will absorb itself and pay for itself. For producers invest in new capital goods-that is, they buy new and better and more ingenious tools-because these tools reduce costs of production reduce costs of production. They either bring into existence goods that completely unaided hand labor could not bring into existence at all (and this now includes most of the goods around us-books, typewriters, automobiles, locomotives, suspension bridges); or they increase enormously the quant.i.ties in which these can be produced; or (and this is merely saying these things in a different way) they reduce bring into existence goods that completely unaided hand labor could not bring into existence at all (and this now includes most of the goods around us-books, typewriters, automobiles, locomotives, suspension bridges); or they increase enormously the quant.i.ties in which these can be produced; or (and this is merely saying these things in a different way) they reduce unit unit costs of production. And as there is no a.s.signable limit to the extent to which unit costs of production can be reduced-until everything can be produced at no cost at all-there is no a.s.signable limit to the amount of new capital that can be absorbed. costs of production. And as there is no a.s.signable limit to the extent to which unit costs of production can be reduced-until everything can be produced at no cost at all-there is no a.s.signable limit to the amount of new capital that can be absorbed.

The steady reduction of unit costs of production by the addition of new capital does either one of two things, or both. It reduces the costs of goods to consumers, and it increases the wages of the labor that uses the new equipment because it increases the productive power of that labor. Thus a new machine benefits both the people who work on it directly and the great body of consumers. In the case of consumers we may say either that it supplies them with more and better goods for the same money, or, what is the same thing, that it increases their real incomes. In the case of the workers who use the new machines it increases their real wages in a double way by increasing their money wages as well. A typical ill.u.s.tration is the automobile business. The American automobile industry pays the highest wages in the world, and among the very highest even in America. Yet (until about 1960) American motorcar makers could undersell the rest of the world, because their unit cost was lower. And the secret was that the capital used in making American automobiles was greater per worker and per car than anywhere else in the world.

And yet there are people who think we have reached the end of this process,4 and still others who think that even if we and still others who think that even if we haven't, the world is foolish to go on saving and adding to its stock of capital. haven't, the world is foolish to go on saving and adding to its stock of capital.

It should not be difficult to decide, after our a.n.a.lysis, with whom the real folly lies.

(It is true that the U.S. has been losing its world economic leadership in recent years, but because of our own anticapitalist governmental policies, not because of "economic maturity.") 1Karl Rodbertus, Overproduction and Crises Overproduction and Crises (1850), p. 51. (1850), p. 51.

2Historically 20 percent would represent approximately the gross the gross amount of the gross national product devoted each year to capital formation (excluding consumers' equipment). When allowance is made for capital consumption, however, amount of the gross national product devoted each year to capital formation (excluding consumers' equipment). When allowance is made for capital consumption, however, net net annual savings have been closer to 12 percent. Cf. George Terborgh, annual savings have been closer to 12 percent. Cf. George Terborgh, The Bogey of Economic Maturity The Bogey of Economic Maturity (1945). For 1977 gross private domestic investment was officially estimated at 16 percent of the gross national product. (1945). For 1977 gross private domestic investment was officially estimated at 16 percent of the gross national product.

3Many of the differences between economists in the diverse views now expressed on this subject are merely the result of differences in definition. Savings Savings and and investment investment may be so defined as to be identical, and therefore necessarily equal. Here I am choosing to define may be so defined as to be identical, and therefore necessarily equal. Here I am choosing to define savings savings in terms of money and investment in terms of goods. This corresponds roughly with the common use of the words, which is, however, not consistent. in terms of money and investment in terms of goods. This corresponds roughly with the common use of the words, which is, however, not consistent.

4For a statistical refutation of this fallacy consult George Terborgh, The Bogey of Economic Maturity The Bogey of Economic Maturity (1945). The "stagnationists" whom Dr. Terborgh was refuting have been succeeded by the Galbraithians with a similar doctrine. (1945). The "stagnationists" whom Dr. Terborgh was refuting have been succeeded by the Galbraithians with a similar doctrine.

Chapter XXV.

THE L LESSON R RESTATED.

ECONOMICS, as we have now seen again and again, is a science of recognizing secondary secondary consequences. It is also a science of seeing consequences. It is also a science of seeing general general consequences. It is the science of tracing the effects of some proposed or existing policy not only on some consequences. It is the science of tracing the effects of some proposed or existing policy not only on some special special interest interest in the short run in the short run, but on the general general interest interest in the long run in the long run.

This is the lesson that has been the special concern of this book. We stated it first in skeleton form, and then put flesh and skin on it through more than a score of practical applications.

But in the course of specific ill.u.s.tration we have found hints of other general lessons; and we should do well to state these lessons to ourselves more clearly.