Modern Money Theory: Deadly Innocent Fraud #6: ​We need savings to provide the funds for investment. – Warren Mosler. 

Fact: Investment adds to savings.

This innocent fraud undermines our entire economy, as it diverts real resources away from the real sectors to the financial sector, with results in real investment being directed in a manner totally divorced from public purpose. It might be draining over 20% annually from useful output and employment – a staggering statistic, unmatched in human history. And it directly leads the type of financial crisis we’ve been going through.

“The paradox of thrift”

(The paradox of thrift (or paradox of saving) is a paradox of economics. The paradox states that an increase in autonomous saving leads to a decrease in aggregate demand and thus a decrease in gross output which will in turn lower total saving. The paradox is, narrowly speaking, that total saving may fall because of individuals’ attempts to increase their saving, and, broadly speaking, that increase in saving may be harmful to an economy.

Both the narrow and broad claims are paradoxical within the assumption underlying the fallacy of composition, namely that what is true of the parts must be true of the whole. The narrow claim transparently contradicts this assumption, and the broad one does so by implication, because while individual thrift is generally averred to be good for the economy, the paradox of thrift holds that collective thrift may be bad for the economy. Wikipedia)

– In our economy, spending must equal all income, including profits, for the output of the economy to get sold.

– If anyone attempts to save by spending less than his income, at least one other person must make up for that by spending more than his own income, or else the output of the economy won’t get sold.

– Unsold output means excess inventories, and the low sales means production and employment cuts, and thus less total income. And that shortfall of income is equal to the amount not spent by the person trying to save.

Think of it as the person who’s trying to save (by not spending his income) losing his job, and then not getting any income, because his employer can’t sell all the output.

So the paradox is, “decisions to save by not spending income result in less income and no new net savings.” Likewise, decisions to spend more than one’s income by going into debt cause incomes to rise and can drive real investment and savings.

“Savings is the accounting record of investment.” Professor Basil Moore

Unfortunately, Congress, the media and mainstream economists get this all wrong, and somehow conclude that we need more savings so that there will be funding for investment. What seems to make perfect sense at the micro level is again totally wrong at the macro level. Just as loans create deposits in the banking system, it is investment that creates savings.

So what do our leaders do in their infinite wisdom when investment falls, usually, because of low spending? They invariably decide “we need more savings so there will be more money for investment.”(And I’ve never heard a single objection from any mainstream economist.) To accomplish this Congress uses the tax structure to create tax-advantaged savings incentives, such as pension funds, IRA’s and all sorts of tax-advantaged institutions that accumulate reserves on a tax deferred basis. Predictably, all that these incentives do is remove aggregate demand (spending power). They function to keep us from spending our money to buy our output, which slows the economy and introduces the need for private sector credit expansion and public sector deficit spending just to get us back to even.

In fact it’s the Congressionally-engineered tax incentives to reduce our spending (called “demand leakages”) that cut deeply into our spending power, meaning that the government needs to run higher deficits to keep us at full employment. Ironically, it’s the same Congressmen pushing the taxadvantaged savings programs, thinking we need more savings to have money for investment, that are categorically opposed to federal deficit spending.

And, of course, it gets even worse! The massive pools of funds (created by this deadly innocent fraud #6, that savings are needed for investment) also need to be managed for the further purpose of compounding the monetary savings for the beneficiaries of the future. The problem is that, in addition to requiring higher federal deficits, the trillions of dollars compounding in these funds are the support base of the dreaded financial sector. They employ thousands of pension fund managers whipping around vast sums of dollars, which are largely subject to government regulation. For the most part, that means investing in publicly-traded stocks, rated bonds and some diversification to other strategies such as hedge funds and passive commodity strategies. And, feeding on these “bloated whales,” are the inevitable sharks – the thousands of financial professionals in the brokerage, banking and financial management industries who owe their existence to this 6th deadly innocent fraud.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s