Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
US Presidential Election Cycle and Recessions - 18th Mar 24
US Recession Already Happened in 2022! - 18th Mar 24
AI can now remember everything you say - 18th Mar 24
Bitcoin Crypto Mania 2024 - MicroStrategy MSTR Blow off Top! - 14th Mar 24
Bitcoin Gravy Train Trend Forecast 2024 - 11th Mar 24
Gold and the Long-Term Inflation Cycle - 11th Mar 24
Fed’s Next Intertest Rate Move might not align with popular consensus - 11th Mar 24
Two Reasons The Fed Manipulates Interest Rates - 11th Mar 24
US Dollar Trend 2024 - 9th Mar 2024
The Bond Trade and Interest Rates - 9th Mar 2024
Investors Don’t Believe the Gold Rally, Still Prefer General Stocks - 9th Mar 2024
Paper Gold Vs. Real Gold: It's Important to Know the Difference - 9th Mar 2024
Stocks: What This "Record Extreme" Indicator May Be Signaling - 9th Mar 2024
My 3 Favorite Trade Setups - Elliott Wave Course - 9th Mar 2024
Bitcoin Crypto Bubble Mania! - 4th Mar 2024
US Interest Rates - When WIll the Fed Pivot - 1st Mar 2024
S&P Stock Market Real Earnings Yield - 29th Feb 2024
US Unemployment is a Fake Statistic - 29th Feb 2024
U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - 29th Feb 2024
What a Breakdown in Silver Mining Stocks! What an Opportunity! - 29th Feb 2024
Why AI will Soon become SA - Synthetic Intelligence - The Machine Learning Megatrend - 29th Feb 2024
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Cause of Today's Economic Crises: Too Much Thrift

Economics / Economic Theory Feb 28, 2010 - 04:48 AM GMT

By: Mansoor_H_Khan

Economics

In this essay I want to propose that the ultimate of cause of today's economic crises is that we have too much thrift.  This view is very similar to John Maynard Keynes' Paradox of Thrift.  What I want to show is that this is not a paradox at all but confusion about what saving money really means and what consequences it has.  I want to explain this confusion by way of examples and using non-technical economic jargon usually used by Keynesian economists.   But before I can go into why too much savings leads to a disaster in the modern economy I need to clarify what I mean by savings  and what money is by way of an example:


A baker produces ten loaves of bread.  He consumes one loaf of bread.  He barters one loaf of bread with his neighbor, the dairy farmer, for one gallon of milk.  He barters three loaves of bread for one bushel of wheat with his other neighbor,  the wheat farmer for wheat for next batch of loaves he will produce tomorrow.  He gives one loaf of bread to the poor.  He is now left with four loaves of bread.  Now, he wants to be able save these loaves for his old age.  So he goes to the market and sells his excess four loaves of bread for four pieces of gold.  He saves the gold in his mattress.   He does this because he will need loaves of bread in old age when he is physically unable to work.

Note that I am going to define pieces of gold as money for now.  Because it is easier to understand.  We will then expand the discussion to include fiat money.   The baker saved four loaves of bread.  That is his savings.   Note that it is more proper to think of savings as the loaves of bread rather than the pieces of gold under his matteress.   The baker is not really interested in pieces of gold but he is convinced that he can exchange them for loaves of bread when he retires.   Because of this belief the pieces of gold give him psychological comfort and peace of mind that he physically owns the asset which he can exchange for loaves of bread. 

Note that when he gets to his old age and goes back to the market and attempts to exchange the pieces of gold for loaves of bread he will get back loaves of bread based on the market price (in terms of pieces of gold) at the time of exchange.   By acquiring pieces of gold (which is the most liquid asset in the baker's civilization) he has effectively acquired equity shares in the world economy (at least in his gold based money example economy of the baker).   The market price (in terms of pieces of gold) of the loaf of bread at the future time will depend on the balance of equity shares (money) trying to purchase (bid up the price) of loaves of bread and the supply of loaves of bread at that time.   Note that it is not the absolute supply of equity shares (pieces of gold) that matters what matters is the number of equity shares trying to chase (purchase) the supply of loaves of bread at that time.   Another way to make the same point is this:   The price of loaves of bread will not increase even if more equity shares are created and handed out unless receivers of the equity shares actually attempt to spend the newly created equity shares.

Another way our baker could have attempted to save his loaves of bread for the future is by exchanging his four pieces of gold for four shares of Google stock.  This gives our baker a chance to acquire even more loaves of bread if Google makes good profits in the future.  Of course, the baker is taking a risk. Google may not be able to make good profits. 

Now apply this situation to all excess producers participating in the world markets (by excess producers I mean people like our baker who produce more loaves of bread than they need for current consumption but would like to consume their output in the future).    As people become more and more productive there is more and more excess production (if consumption does not increase in tandem with efficiency increases) then this production will be directed (by financial markets) to produce more and more assets which can be exchanged ultimately for consumer goods in the future.  This is how we get a boom.   Bust happens when excess producers realize their assets (like dot com company shares or residential and commercial real estate holdings) will not yield as much return as they expected and may even give a negative return.  Rightly,  excess producers then rush to safety of the most liquid asset  (cash).   

Note that:   if investment does not take place and consumption does not increase production must decrease to match consumption.  Since productivity (output per labor hour) is continually increasing (and has rocketed upwards in the past 100 years) we will have more and more unemployment unless one of following or combination of the following occurs to a sufficient degree to stem the tide of improving productivity:

1.  Increase our consumption.  Increase demand for goods and services.

2.  Decrease our labor hours.  Work less.

3.  Do projects which will "use up" excess production.

All the stuff about too much debt (public and private) , falling asset prices and printing money is just accounting entries.    We should use accounting to manage the reality around us to improve our lives and not to get confused about what is going on with the production process itself.

Mansoor H. Khan http://aquinums-razor.blogspot.com/

About the author: I am an Electrical Engineer by training (Bachelor of Engineering from Stevens Institute of Technology). I also have a Masters of Business Admnistration degree (MBA) from the University of Virginia.

© 2009 Copyright Mansoor H. Khan - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in