'Tis Your Duty to be Stupid!?

[miked10270 0]

http://news.bbc.co.uk/1/hi/business/7745858.stm

THE PARADOX OF THRIFT

--or--

Should we save or should we spend?

"It's gloomy out there. The economy is shrinking, property values are falling and stock markets are in the doldrums.

Many people borrowed heavily during the boom, and now are tempted to pay off debt or save more for a rainy day - something which until now has not characterised the behaviour of UK consumers.

But if this happens, will the government's plan to boost the economy through greater spending work?

Paradox of thrift

Because thrift may be a virtue for the individual, but could damage the economy as a whole, according to the economist John Maynard Keynes, writing in the midst of the Great Depression in the 1930s.

He called it the paradox of thrift. The more people saved, the more they reduced effective demand, thus further slowing the economy.

This was one reason, he pointed out, that a recession can become self-reinforcing.

Keynes also argued that, faced with slowing demand, businesses would not necessarily use the extra savings available in the economy to invest.

In the Keynesian theory, as the slump in demand cascaded through the economy, the resulting slowdown would mean that everyone had less income - ultimately reducing the absolute amount of savings, even if people increase the proportion of their income they put aside.

As unemployment grew, investment would fall, whatever the level of savings.

Government help needed
Sales signs on the High Street
The government has slashed interest rates in a bid to boost spending

But how can we persuade the reluctant consumer to spend, and the reluctant businessman to invest?

Keynes' answer was that it was only the government that could overcome the collective paradox: what was good for the individual would weaken the economy.

This is now the theory being embraced by the chancellor, who has abandoned his fiscal rules for the time being in order to pour money back into the economy.

And cuts in interest rates by the Bank of England are also designed to encourage businesses to continue to invest.

But this is not very effective, because credit markets are in deep freeze. As a result, it is even more important to inject cash into the economy - at least according to Mervyn King, the governor of the Bank of England.

Spectre of deflation

There is another reason why the government wants to give a jolt to the economy now.

It is the fear that prices will actually start to fall as the slowdown gets going.

And deflation - falling prices - would certainly reinforce the paradox of thrift.

If consumers expect prices to drop further in the future, then they have an even stronger incentive to delay their purchases until later, when they can benefit from lower prices.

Deflation, especially in asset prices like houses, can be very long-lasting and hugely damaging to the economy, as recent experience in Japan suggests.

So one reason the government may want to temporarily cut VAT now is to convince people that prices are going to go up later, thus encouraging them to spend.

Rational expectations

Will these measures work?

One reason Keynesian explanations of the economy fell out of favour in the last few decades was the rise of a new economic theory - rational expectations.

This argued that people were aware that any government borrowing would have to be paid back later. As a result they adjust their expectations accordingly, and do not spend as much as predicted.

Since this time, the government will be signalling its intentions to claw back the money it spends in future budgets, perhaps we will all save more to cover our future loss of income.

This theory may well apply to the financial markets, which are making the price of UK debt more expensive on the grounds it is likely to expand dramatically.

But the psychology of individuals may be different.

In the first place, some people may not be able save much whatever their expectations. Money that goes to pensioners surviving on the state pension, for example, may go straight into spending.

And some psychological research suggests that people do not "discount" very effectively in the long term.

So we may be under-estimating the attractiveness of spending even in the midst of a recession.

This, at least, has to be the government's hope as it embarks on its most audacious economic U-turn since Labour came to office in 1997. "


I do remember that during the mid 1970's when Britain was in economic difficulties, one of the main Economic Indicators used was called "Sterling:M3". This wasn't a measure of how much money was in the economy, but how fast it was passing from hand-to-hand. In effect, it's the movement of money that creates wealth rather than its mere existence.

Thoughts?

Mike.

Taking the piss out of the FrenchAmericans since before it was fashionable.

Prenait la pisse hors du FrançaisCanadiens méridionaux puisqu'avant lui à la mode.

[SpeedRacer 1]

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In effect, it's the movement of money that creates wealth rather than its mere existence.

Yes, that is true. Wealth is not just some paper bills sitting in your wallet or gold sitting in a vault. Wealth creation is the exchange of goods and services. Which don't get exchanged unless money is changing hands. The more rapidly money is circulating, the more wealth-generation is going on.

Speed Racer
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[kallend 2,148]

Quote

Quote

In effect, it's the movement of money that creates wealth rather than its mere existence.

Yes, that is true. Wealth is not just some paper bills sitting in your wallet or gold sitting in a vault. Wealth creation is the exchange of goods and services. Which don't get exchanged unless money is changing hands. The more rapidly money is circulating, the more wealth-generation is going on.

Sorry, I just don't buy that argument, which has in a sense led to the problems we face now. We can't all get wealthy by taking in each other's laundry.

...

The only sure way to survive a canopy collision is not to have one.

[SpeedRacer 1]

um, no, we get wealthy as a whole by doing our respective jobs which provide the goods & services we need.

Speed Racer
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[shropshire 0]

Quote

Quote

Quote

In effect, it's the movement of money that creates wealth rather than its mere existence.

Yes, that is true. Wealth is not just some paper bills sitting in your wallet or gold sitting in a vault. Wealth creation is the exchange of goods and services. Which don't get exchanged unless money is changing hands. The more rapidly money is circulating, the more wealth-generation is going on.

Sorry, I just don't buy that argument, which has in a sense led to the problems we face now. We can't all get wealthy by taking in each other's laundry.

Agh, Chain Letter economics .... everyone is O.K utill the chain breaks.

(.)Y(.)
Chivalry is not dead; it only sleeps for want of work to do. - Jerome K Jerome

[shropshire 0]

So darling Darling cut VAT from 17.5% to 15%... saving us (if the cut is actually passed on to the paying public) tupence ha'penny in the pound ... Gonna buy me a tropical island with mine.

(.)Y(.)
Chivalry is not dead; it only sleeps for want of work to do. - Jerome K Jerome

[billvon 3,116]

>Sorry, I just don't buy that argument, which has in a sense led to the problems
>we face now.

It is indeed how our economy works - AND is one of the things that led to our current problems.

[kallend 2,148]

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um, no, we get wealthy as a whole by doing our respective jobs which provide the goods & services we need.

But increasingly our economy has outsourced the creation of goods and knowledge to other nations, and relied on shuffling money (and other "financial instruments") around, skimming off a little as it passes, to give the illusion of creating wealth. Rather like collecting $200 each time you pass "Go" in Monopoly.

...

The only sure way to survive a canopy collision is not to have one.

[billvon 3,116]

>But increasingly our economy has outsourced the creation of goods and
>knowledge to other nations, and relied on shuffling money (and other
>"financial instruments") around, skimming off a little as it passes . . .

Right - but that has been going on ever since the first guy exchanged a chicken for a gold coin instead of a wineskin. The abstraction of material wealth started with money, then continued with checks, loans, currency markets, mortgages, futures markets, public ownership of companies, mutual funds, credit instruments and now credit default swaps.

There are problems with all the above, and they should be tweaked and/or fixed as needed. But we can't go back to trading chickens for wine, even though that's the only "real" way to value such things.

[kallend 2,148]

Quote

>But increasingly our economy has outsourced the creation of goods and
>knowledge to other nations, and relied on shuffling money (and other
>"financial instruments") around, skimming off a little as it passes . . .

Right - but that has been going on ever since the first guy exchanged a chicken for a gold coin instead of a wineskin. The abstraction of material wealth started with money, then continued with checks, loans, currency markets, mortgages, futures markets, public ownership of companies, mutual funds, credit instruments and now credit default swaps.

There are problems with all the above, and they should be tweaked and/or fixed as needed. But we can't go back to trading chickens for wine, even though that's the only "real" way to value such things.

But the guy who mined the gold and minted the coin created wealth. The guy who harvested the grapes and processed them into wine created wealth. The guy who raised the chicken and butchered it created wealth. The middle man who shuffled bits of of paper (or nowadays bits made up of electrons) didn't create wealth, he just shuffled it around and took his cut.

And increasingly the USA is becoming a nation of wealth shufflers rather than wealth creators.

...

The only sure way to survive a canopy collision is not to have one.

[billvon 3,116]

>But the guy who mined the gold and minted the coin created wealth.

Ah - but not as much as the coin was worth! The characteristic of money nowadays is that it has a valuation above what the physical money is worth. That's one of the reasons it works. So while he did indeed create some wealth directly, he also took advantage of the inherent worth of money.

If individuals do this, it tends to destabilize the economy, because those with the gold (or the dies, or the printing presses) control the currency. Hence government control of mints.

> The guy who harvested the grapes and processed them into wine created
>wealth. The guy who raised the chicken and butchered it created wealth.

Right - those two are the only two who really created new wealth. And if we based our economy on them trading chickens and wineskins, we'd have less money to build (for example) new chicken coops or new wineries.

Yes, it's a shell game. The only reason we put up with it is that it works.

[kelpdiver 2]

We should be saving.

In the immediate term, that prolongs the fun, but in the longer picture, our economy would be more stable if people maintained savings. Behavior would be more consistent.

Right now, with people living by the paycheck, when they hit a roadblock they eliminate all of their spending, and stop paying creditors. In response the credit card companies punish every else with 20% rates and up.

[miked10270 0]

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We should be saving.

In the immediate term, that prolongs the fun, but in the longer picture, our economy would be more stable if people maintained savings...

Yes. Saving is the sensible course for individuals.

Yet... Is it possible for anyone to save if no-one spends? Would YOU be able to save if no-one buys what you're selling?

At hte moment, absolutely nothing material has disappeared. What is lacking is the confidence to spend money we have, believing that more money will come our way.

Mike.

Taking the piss out of the FrenchAmericans since before it was fashionable.

Prenait la pisse hors du FrançaisCanadiens méridionaux puisqu'avant lui à la mode.

[kelpdiver 2]

Quote

At hte moment, absolutely nothing material has disappeared. What is lacking is the confidence to spend money we have, believing that more money will come our way.

The paper losses may not be material, but the large financials and the hundreds of thousands of lost jobs related to it or real estate are.

[kallend 2,148]

Quote

>But the guy who mined the gold and minted the coin created wealth.

Ah - but not as much as the coin was worth! The characteristic of money nowadays is that it has a valuation above what the physical money is worth. That's one of the reasons it works. So while he did indeed create some wealth directly, he also took advantage of the inherent worth of money.

If individuals do this, it tends to destabilize the economy, because those with the gold (or the dies, or the printing presses) control the currency. Hence government control of mints.

> The guy who harvested the grapes and processed them into wine created
>wealth. The guy who raised the chicken and butchered it created wealth.

Right - those two are the only two who really created new wealth. And if we based our economy on them trading chickens and wineskins, we'd have less money to build (for example) new chicken coops or new wineries.

Yes, it's a shell game. The only reason we put up with it is that it works.

While a certain amount of manipulation is needed to lubricate the system of wealth creation, we have reached and passed the point where we predominantly shuffle wealth for its own sake and provide the greatest rewards (in general) for the wealth manipulators rather than the wealth creators.

...

The only sure way to survive a canopy collision is not to have one.

[miked10270 0]

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The paper losses may not be material, but the large financials and the hundreds of thousands of lost jobs related to it or real estate are.

Yes, but have these jobs been lost because people aren't saving, or because they aren't spending?

The point of the original article is that unless people spend, the economy will shrink with more job losses.

Mike.

Taking the piss out of the FrenchAmericans since before it was fashionable.

Prenait la pisse hors du FrançaisCanadiens méridionaux puisqu'avant lui à la mode.

[billvon 3,116]

>While a certain amount of manipulation is needed to lubricate the system of wealth creation . . .

Agreed.

>we have reached and passed the point where we predominantly shuffle wealth for its own sake . . .

We reached that point in the 1700's, when banks first started crazy speculation schemes to raise money. In 1711, the South Seas Company started a speculation bubble that peaked at over 1000 pounds per share, involving tens of thousands of shares. The company based its claimed profitability on future tariffs on goods from South America, most of which never materialized. It even had a program to lend people money at low low rates to buy its own stock - and this was centuries before Enron.

Newton was shocked. He said he "could not calculate the madness of people." It, of course, eventually collapsed.

The problem is that our economy is based on this vaporware, on things like the future value of oil, the future assurance that loans will be repaid and that people will, in the future, buy stuff. If we got rid of all that we'd have to subsist on a greatly reduced economy. Which we could of course do, but we would rapidly become a backwater of the world, unable to afford things like food, education, research or defense.

[masterblaster72 0]

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Yes, it's a shell game. The only reason we put up with it is that it works.

A system that works as well as you say shouldn't create such gigantic hiccups so as to necessitate government bailouts. I wish I shared your confidence in this economic system...but I have doubts that it is truly sustainable over the long term.

Be humble, ask questions, listen, learn, follow the golden rule, talk when necessary, and know when to shut the fuck up.

[billvon 3,116]

>A system that works as well as you say shouldn't create such gigantic
>hiccups so as to necessitate government bailouts.

I didn't say it worked well. I just said that it worked well enough that we put up with it. Would you rather have your money grow 8% a year (i.e. stock market average) 4% a year (keeping it in a bank) or 0% a year? (keeping it in your mattress.) Most people choose the 8% a year average, even if some years they lose 20%.

>I wish I shared your confidence in this economic system...but I have doubts
>that it is truly sustainable over the long term.

The long term? It will undoubtedly fail, as has the economic system of every other nation.

[mnealtx 0]

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And increasingly the USA is becoming a nation of wealth shufflers rather than wealth creators.

So why do you keep supporting taxes that drag down the wealth creators?

Mike
I love you, Shannon and Jim.
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