A lot of my progressive friends are besides themselves over the fact that lots conservatives and centrists don’t get the Paradox of Thrift. This is an interesting result in itself because I think it helps support the notion that there are deep biological difference between schools of thought. However, that’s a point for another day.
Today I want to at least outline why conservative and centrist intuition is wrong on this issue. As usual I think the misunderstanding is grounded in basic near meta-physical assumptions and so I will speak in that language.
The fundamental question comes down to this, how does one transport goods and services through time. This is what a “prudent” person wants to do. You want to accumulate goods and services when times are good, when you are young, and strong and then consume those goods and services when times are bad or you are old.
This is the message underlying the Fable of Ant and the Grasshopper. In this fable the Ant stores actual grain that he collects during the summer, while the grasshopper plays. When the winter comes the Ant has plenty of food and in the more strict versions of the tale the Grasshopper dies of starvation.
Now, fast forward to a modern economy. Is this tale still a useful guide for us.
In most cases the answer is yes. However, not in all. The reason is that the Ant is actually experiencing negative real rates of return. This is because grain in the winter is the same as grain in the summer. The grain has not delivered a return.
However, the grain does have a “carrying cost” that is it is not free to store grain. So, collecting grain in the summer in order to eat in the winter means that you face negative real rates of return.
The rates of return are actually worse than that from the Ant’s perspective because he has a very high marginal value of leisure in the summer and very low in the winter. So he is effectively collecting grain when it is expensive, holding it at a positive carrying cost and then eating it when it is cheap.
However, we don’t really need to go deep into that. We just have to recognize that there is a negative real rate of return here.
Now, in a monetary economy this can become problematic. The reason is that the rate of return on cash money is always minus the inflation rate. If the inflation rate is lower than the carrying cost of real goods and services then it will never be profitable to stockpile them the way the Ant did.
Its always be a better idea to attempt to hold lots of cash, which you can then use later to buy things. Indeed, you see both banks and tech companies doing this.
This problem is made worse by the fact that in our modern economy lots of things have a really really high spoilage rate and so the carrying costs are enormous and sometimes infinite.
For example, how do you stockpile medical services. To some extent you can get a lot of tests done today, but if you don’t actually need a procedure today, then getting it today usually won’t help you out tomorrow. You have to actually wait until tomorrow comes. That makes it hard to stockpile medical services.
The same is true for accounting services, legal services, lawncare services etc. These things are darn near impossible to store. However, they are things you might want in the future and so the only way to save for a rainy day is to accumulate either cash or assets you hope to sell for cash later.
Not to beat a dead horse but I want to point out this is also true for lots of industrial goods as well. Cars depreciate and so does industrial machinery. Indeed, in an environment where technology is moving fast, these things actually depreciate faster, meaning that high tech growth makes it even harder to hoard physical goods because they will become obsolete soon.
This further encourages you to hoard cash. The problem of course is that not everyone can hoard cash at the same time. Moreover, the attempt to do this causes a perverse effect. The way you get cash is by selling things.
However, the way you horde cash is by not buying things. So when people are trying to hoard cash you get into a peculiar situation where everyone wants to sell but few people want to buy. This drives the entire economy down.
Now, you may still feel uncomfortable with this. There should be some way to make productive investments in the future. Indeed, there is a way that is almost always open to us.
That is, to build more buildings. The reason this usually works is that well built buildings depreciate really slowly and the cost to carry them is usually pretty low because the sit on the ground and are by definitions protected from the elements. You could just build the building and let it sit empty until it was ready to be used.
You can also usually feel pretty confident that people will want to use buildings because the population has been for most of the industrial age, growing. Thus there will always be some person in the future to live and work in this structure and so it’s a good idea to build it.
This is why property bubbles are particularly painful. They cause a run-up in the price of land. If you look its really the land not the structures that are most rapidly increasing in value. Indeed, the structures only increase in value in weird circumstances where there are legal impediments to modifying or tearing down old structures to build new ones.
It’s the land that becomes expensive in a bubble. Then the bubble pops and the value of land falls. Now, if you have a sudden increase in the desire to push consumption into the future you are going to have a big problem.
The type of negative real rates of return the Ant is willing to endure cannot be realized because people can just start hoarding money. Our go to outlet for pushing resources into the future – building structures – is closed because structures are by definition attached to land. The price of land is falling, which means that the value of the “structure-land” unit will be falling and so its not profitable to buy land in order to build a structure on it.
Thus we are stuck in a trap that where we can’t do what we as a market society want to do – transfer more resources from today, into the future. Its not that savings has somehow become “bad” its that savings in the quantity that people want to do is impossible.
That’s because the essence of savings is not refraining from consumption today. Its refraining from consumption today, so as to push real resources into the future. Since, the second part can’t be done at the rate people wish to do it, saving is impossible.
Just to make the point very clear, the market would be able to solve this if it the interest rate could go negative. All the time we run into the problem of people wanting to do things which are impossible for them simultaneously do. This problem is solved by a shift in prices that discourages people from doing it.
If lots of people want to save at once then the return to savings should fall to arbitrarily low levels until markets balance. However, since this cannot happen we wind up with a perverse affect from savings.
This is the source of our problems today.