Financial Times Letter Confuses Credit and Savings
The Feb 5 Financial Times published a letter stating:
Sir, The widespread consensus that the aggressive interest rate cut policy adopted by the then Federal Reserve chairman Alan Greenspan after the tech bubble's burst caused the recent market turmoil is totally misleading. The Fed by making money cheaper has determined a large-scale tendency to borrow money for making investments. This has sustained economic growth.
The error here is that credit does not fund economic growth, only actual savings. Firms can borrow, but they can only use borrowed funds for productive activities by purchasing or renting land, labor, and capital. These factors at all times scarce and their supply is not increased by creating more credit.
What the Fed can do is to create (or enable banks to create) credit that is not funded by voluntary savings. This will increase demand for productive factors, raising their prices. This can result in some additional involuntary saving (also called "forced savings") as the recipients of the excess credit are able to bid away goods from buyers who would have used them for consumption, or used them closer to the consumption end of the structure of production.
The process described in the previous paragraph - increases in the prices of some productive factors combined with forced savings, is the Mises-Hayek theory of the business cycle. The theory shows that these shifts in production are unsustainable because they are not consistent with consumer demand, and therefore not true economic growth.
The free market rate of interest is that rate where credit is equal to voluntary savings. Low market interest rates that come about through a high savings rate do increase economic growth. But for the central bank to set interest rates below the market rate does not because this artificial rate does not represent a shift on the part of the public from consumption to savings.
-Robert
Comments (29)
Nelson
The error here is that credit does not fund economic growth, only actual savings.
This seems false on the surface. For instance in a 2 person economy, A can ask B to help him build his house (for nothing now) and in return promises to help B build his house in the future. B accepts this proposition as he would prefer A's help in the future to whatever else he could be doing with his time now. I.e., a loan of labor. This is clearly helping economic growth as both participants are better off than they were before (assuming A keeps his promise to repay the debt, of course).
Published: February 7, 2008 10:52 AM
Mr. Karla
Right, you mean, that a loan given OUT OF voluntary savings is helping economic growth. Sure, but that doesn't change the point, that this is not the situation when consumers are forced to save for somebody to give somebody else a loan.
Published: February 7, 2008 12:00 PM
fundamentalist
Nelson: "A can ask B to help him build his house (for nothing now) and in return promises to help B build his house in the future."
Go one step further in your example: what do A & B live on while building the house? In order to make the analogy appropriate to the economy, A & B would have to work on the house full time, in which case they would spend savings to sustain them until the house was finished. Savings enables the growth of the economy through the building of the house.
On the other hand, if you assume that both A & B use leisure time to build the house, then the analogy doesn't really apply to the economy because few businesses are able to use the leisure time of workers without paying them for it.
Published: February 7, 2008 12:42 PM
Nelson
Go one step further in your example: what do A & B live on while building the house? In order to make the analogy appropriate to the economy, A & B would have to work on the house full time, in which case they would spend savings to sustain them until the house was finished. Savings enables the growth of the economy through the building of the house.
This is irrelevant. Spending savings on sustenance is neither necessary nor sufficient to produce the house. Building houses (with labor either paid for or borrowed) produces houses.
Besides, nothing says you can't build a house AND gather food.
Published: February 7, 2008 4:06 PM
Nelson
Right, you mean, that a loan given OUT OF voluntary savings is helping economic growth.
Yes I get the point that one man's savings is another man's loan. I was just disagreeing with the fragment "credit does not fund economic growth."
Published: February 7, 2008 4:09 PM
Kilmore
Credit might fund growth in sense of some overall number. However such number is almost meaningless, even better word is misleading. You should look at individual man seeking his aims. Some of them are robbed of their money, while others enjoy gift from heaven (banking system). Obviously enough this is not prosperity. If it was we all certainly should cease working and start stealing. According to those who believe devoutly in credit out-of-thin-air, theft enhances our wealth best.
You may tell me where you live, Nelson. I am going to take your money first to give you taste of this prosperity :)
Published: February 8, 2008 4:13 AM
Nelson
According to those who believe devoutly in credit out-of-thin-air, theft enhances our wealth best.
I can be convinced that "out of thin air" doesn't produce growth, but that's not what I'm arguing against. I just want the authors of these articles to be more careful with what they say, especially when they make it their central theme: "The error here is that credit does not fund economic growth, only actual savings."
Credit *can* fund economic growth (for the sake of argument lets say it comes from voluntary savings). The theme statement clearly said "credit does not fund growth." You can't make a good argument when you start off with a faulty theme statement.
Savings may or may not fund growth. Savings buried in the back yard will not produce growth, but savings loaned out (credit!) *might* produce growth (it also might produce a loss).
Semantic errors in the body of an argument may be looked over, but is it too much to ask for an accurate and precise theme statement?
Published: February 8, 2008 6:16 AM
fundamentalist
Nelson: "This is irrelevant. Spending savings on sustenance is neither necessary nor sufficient to produce the house. Building houses (with labor either paid for or borrowed) produces houses.
Besides, nothing says you can't build a house AND gather food."
So where does the home builder get the materials to build the house? Didn’t he have to give up some consumption (save) in order to purchase them? And spending savings on sustenance is necessary if you’re doing it full time, and doing it full time is the only way your analogy would apply to the economy. Resources, including capital and time, are scarce. You can’t build a house and gather food at the same time.
Nelson: "...is it too much to ask for an accurate and precise theme statement?"
Most readers will understand the article very well if they know anything about Austrian econ. Credit expansion is understood to be artificial. Savings is understood to be invested because sticking money in a hole in the ground is known as hoarding, not saving. These terms are familiar to Austrians. Including a dictionary of terminology for non-Austrians would make every article very long and tedious.
Published: February 8, 2008 12:18 PM
Kilmore
I am sorry for those harsh words. Just few moments before I wrote them I had read about our wise central bankers (Czech National Bank). They have allowed prices to grow 7% last mont and yet they are not willing to slow down printing press (they are talking about US crisis and neccessity to keep interest low). I was too angry do discuss delicacies of semantics. Again I am sorry.
But you yourself must be as precise as you ask others to be. Those savings buried in your backyard **do*** produce growth. You must render some services to earn them. Then you may spend all the money immediately or you may withhold that sum from circulation for some time (backyard). Increased amount of services and lower total sum of money means lower market prices for your fellow citizens. Interest paid on this form of saving is not high, it is (approximately) as much as anual HDP growth (if only we neglect central thieves). To get more you have to use banks as mediators (risk is considerably higher and therefore reward must be also more interesting).
Published: February 8, 2008 1:37 PM
Nelson
So where does the home builder get the materials to build the house? It doesn't matter.
Didn’t he have to give up some consumption (save) in order to purchase them?There are always opportunity costs to everything, but if you mean opportunity costs, then don't use the word "savings". He can gather them himself or promise to pay at some future date.
And spending savings on sustenance is necessary if you’re doing it full time, and doing it full time is the only way your analogy would apply to the economy. How is it impossible to build a house part time as opposed to full time and how would that invalidate my analogy?
Resources, including capital and time, are scarce. I never claimed otherwise.
You can’t build a house and gather food at the same time. Obviously, but it is also not necessary to do both at the same time. There are more than enough hours in a day to do both sequentially.
Published: February 8, 2008 3:23 PM
Nelson
Those savings buried in your backyard **do*** produce growth. You must render some services to earn them.
I claim that it is the act of rendering a service that produces the growth and not the act of saving.
I will grant that savings may (but don't necessarily) produce growth at some future date.
Published: February 8, 2008 3:32 PM
Nelson
Thank you for being so gracious. At least we can debate openly in a relatively respectful way. Besides, that was nothing compared to the threats I got on one of the conservative blogs when I posted that I supported (more or less) open immigration. Those guys literally wanted to kill me.
Published: February 8, 2008 3:40 PM
Jaq Phule
Nelson,
I think the fundamental problem here in the communication is one of definition.
"Credit" in Austrian parlance does *not* refer to a loan of someone's savings. It refers to pure debt, with nothing in the asset column to back it up except for a vague promise for future repayment via taxation.
If by "credit" you mean a loan from actual funds, then no one here has a problem with that.
Credit expansion is what happens when the FED creates money. There is no actual basis for the creation of these dollars. If the dollars are created electronically, you can as easily create five billion dollars as five dollars, in exchange for a promise that the government will raise enough taxes at some nebulous point in the distant future to pay the debt off.
With the increase in dollars in circulation, the value of each dollar declines. This is why your grandparents remember bread for a nickel. So-called price inflation is *not* a necessary condition of the world. During most of the nineteenth century in the United States, prices actually declined slightly. Why? Because while credit expansion did take place, it was on a much smaller scale, and was not institutionalized by the government. Dollars were defined in terms of shiny metallic specie, and served as a simple correction mechanism when credit expansion *did* get out of hand.
In order to correct both the current out-of-control situation, and the simpler boom-bust cycle of the nineteenth century, the Austrian solution is to use some kind of 100% reserve currency. What this means is that the "dollar" or whatever is defined in terms of a measurement of something that is difficult to produce. If you have a dollar on paper, there should actually be a physical dollar somewhere in the world that corresponds to that paper dollar. Banks would not be allowed to lend out the same dollar multiple times, as they have done for centuries.
Under this scenario, if you borrowed money from someone -- a bank, or a friend, or whatever -- then you have a claim on the physical money, and a liability equal to the amount of the money plus interest according to whatever scale agreed upon with the lender. "Credit" does not *expand* in this scenario.
If you are productive with the money you borrow, which is to say you make a profit of some sort, either directly monetary, or indirectly through an increase in your standard of living, what this does is to actually increase the value of the money. Technology, which is ideas as applied to resources, compounds this effect. Technology also allows more room for price cutting in a competition-driven industry. As a result, prices fall.
All this is why Austrians always keep harping on gold. You can mine more gold, but it's an expensive process. Inflationary pressure is exceedingly low. Technology will always outpace gold production, so prices will fall, benefitting consumers.
Back to your initial analogy. It's a good analogy, by the way. You're missing a couple of points, though.
First, B's ability to labor an asset owned by B. "A" can assess this and make the deal.
The US government has never, not since 1830 or so, fulfilled its obligations to raise enough to pay off its credit debt. After 175 years of falling behind on payments, wouldn't you call this guy a bad risk?
Secondly, A has not made a deal with B about B's distant descendants. This would be in my mind quite immoral -- what right does B have to bargain away the rights of others, who might not even exist yet?
Unfortunately, this is exactly the effect of the inflationary policies of credit expansion. It is true, sometimes credit expansion provides a short-term profit. But at what expense long term? Our children's, and our grandchildren's ability to use the dollars at their disposal will dwindle. As credit expands in such a way that overseas creditors are buying up the debt, at what point do our so-called leadership have to admit surrender of our rights and freedoms in order to prevent the Chinese from calling the loans due?
I think this is a large part of the reason why the current foreign policy is "bomb the earth". It's because the only way to stay fat, dumb, and in debt, is to threaten our creditors with mushroom clouds. The cycle goes like this -- in order to protect whatever politically charged racket is going on -- including but not limited to oil -- President Nincompoop declares war. In order to pay for this war, billions upon billions of dollars are borrowed, mainly from abroad. Credit expands, the consumer's ability to spend contracts, and, lest we forget, freedoms are curtailed to increase presidential authority to wage the war. Well, with consumers not spending, other politically charged rackets are threatened -- call it "financial services". The final step in the cycle will be nuclear war, probably with China, paid for by fiat, using slave labor, to attack our creditors, in order for our insane leadership to hold onto power and try to protect their turf. The more credit expands, the more the dollar contracts, and the closer we get to that exceedingly ugly scenario.
So this is why Austrians are so angry, curmudgeounish, and hate the very idea of credit expansion. And government altogether generally, and the Republicans and Democrats specifically. (Except for Ron Paul. He's one of *ours*.)
Do, be skeptical of our ideas. Look around this site, listen to some Murray Rothbard. I was a doubter too, originally. But the logic is pretty overwhelming if you consider it.
Published: February 8, 2008 6:53 PM
fundamentalist
Nelson: "So where does the home builder get the materials to build the house? It doesn't matter."
It certainly does! You're claiming that people can build a house without saving for it.
Nelson: "Didn’t he have to give up some consumption (save) in order to purchase them?There are always opportunity costs to everything, but if you mean opportunity costs, then don't use the word "savings".
No I don't mean opportunity costs. I mean how did the builder get the money to buy the materials? In the real world, he would have saved his money to buy them or borrowed the savings of someone else, but someone had to save at some point in time in order for the builder to buy the materials.
Nelson: "How is it impossible to build a house part time as opposed to full time and how would that invalidate my analogy?"
Because in the real economy, people don't work for other people for nothing in their spare time. They might do it for a friend or relative, or for their own sake, but you would be describing the exceptions, not the real world. You're building your theory of economics on the rare exceptions, not the general rules of human behavior.
Published: February 8, 2008 8:15 PM
Nelson
"Credit" in Austrian parlance does *not* refer to a loan of someone's savings. It refers to pure debt, with nothing in the asset column to back it up except for a vague promise for future repayment via taxation.
So in Austrian terms my "I help you now, you help me later" can't be called credit? It seems like the very definition of credit. I'm certainly giving you something now and all I get is a claim on your labor at some point in the future. Btw, if labor counts as savings, you guys need to start using a different vocabulary or you'll never get your point across to normal people.
Thanks for the explanations though.
Off topic:My criticism with gold is I don't really "want" gold and the market for it can fluctuate based on emotions and or manipulation... in other words fiat is just as good as gold for my purposes and simpler to transport as well. My main criticism of Rothbard is he sometimes "defines away" problems... which I guess is okay in some kind of circular logic imaginary world, but doesn't work so well in real life, which is anything but perfect.
Published: February 8, 2008 8:20 PM
Nelson
He could gather/make them himself. Or someone else could do it for a *promise* of repayment. Either way, it's a combination of raw materials (these weren't "saved" they were given by nature) and effort (also not saved).
Published: February 8, 2008 8:27 PM
Nelson
Because in the real economy, people don't work for other people for nothing in their spare time.
But he's *not* working for nothing. He's working for a *promise* of repayment.
Published: February 8, 2008 8:29 PM
Jaq Phule
So in Austrian terms my "I help you now, you help me later" can't be called credit?
Sure it can.
The error in the Financial Times is not this scenario, however. Your friend's ability to help is a real-world good. Has your friend's ability to help you build a house increased the net amount of wealth in the world? Yes, it has.
The FED produces dollars. Dollars are not a real-world good. Increase the number of dollars in the world, and have you increased the amount of wealth in the world? No. All it has done is to devalue the dollars relative to everything else.
This is the core of Robert Blumen's argument.
The effect of devaluation however is not instantaneous. It takes time for the dollar to sink. Thus, whomever gets the newly created dollars *first* gets their value at the old rate. This is the evil downside to "trickle-down economics". Whoever gets it last, gets it at its least valuable.
Who gets it first, of course, is the government, and the way things have been the past few years, it's been the military-industrial complex specifically.
The more complex the structure of production, the longer it takes for this effect to take place. We are *not* talking about an efficient market for currency, here.
if labor counts as savings, you guys need to start using a different vocabulary
It's a little bit of a stretch, but not too much. From wikipedia,
In terms of personal finance, saving refers to preserving money for future use
Replace the word "money" with "something of value", and we're a bit closer to the reality. What you are saving isn't really your labor, but rather the promise of delivering on that labor in the future, which is definitely a valuable thing.
On your gold comment, well, dollars have the same problem. Dollars fluctuate, actually, pretty much with an inverse relationship to how much gold fluctuates. Over time, that is. Gold is a bit quicker to react than dollars.
Two thousand years ago, you could buy a pretty nice suit (or toga, or whatever) for about an ounce of gold. Back in about 2001, when prices were relatively stable, you could also buy a fairly nice suit for about the price of a gold ounce. I read somewhere that there are several such relations that have held true for centuries like that.
Of course, gold is now towering at about $1000 per ounce and I think it will go substantially higher. The dollar will eventually inversely follow suit, as far as how little it will purchase.
My criticism with gold is I don't really "want" gold
I'll have to be honest with you. That's not a criticism, that's a personal preference. I don't want broccoli, but I eat it. I don't really "want" gold either, but throughout history it has always been a good hedge against inflation against the collapse of a fiat currency, so I buy it. It's insurance. Who really wants to pay for insurance?
Gold is hard to manipulate on its own, unless your name is "Rothschild" and own a hefty stake in every central bank on earth. It's hard to manipulate, precisely because it's much harder to make than paper or electronic dollars.
Rothbard ... sometimes "defines away" problems
Huh? I don't think we're talking about the same guy, if that's what you think.
Please post an example. It's getting too late for me to respond much more, but I'm sure someone else will pounce. Be nice, folks!
Published: February 8, 2008 8:54 PM
TLWP Sam
I wonder what how many gold coins I would have needed to buy a HD Plasma TV in Ancient Rome?
Published: February 8, 2008 9:09 PM
Jaq Phule
Let me clarify one point. When we talk about "credit", we're mainly just using that as shorthand for "credit created by the crappy creators of conterfeit", ie FED-created psuedo wealth.
You're right about your definition of credit, but since that concept in and of itself isn't so interesting to us when bemoaning public policy, we just use the special case.
It confused me at first too. I'm not an economist, but I sensed vaguely they were using the term in a way I didn't fully understand. We should be more accomodating and define our terms more precisely, I suppose.
Published: February 8, 2008 9:11 PM
Nelson
It confused me at first too. I'm not an economist, but I sensed vaguely they were using the term in a way I didn't fully understand. We should be more accomodating and define our terms more precisely, I suppose.
Ok, that makes sense. It seems like a simple adjective would suffice. For instance one may say "fiat credit" when referring to Fed actions. Four letters and a space doesn't seem like a bad compromise when balancing brevity with precision... especially on a website which (I presume) is trying to educate the public.
Published: February 8, 2008 9:34 PM
Nelson
Sure thing.
In Power & Market - Government and The Economy Rothbard states on page 2
This is certainly convenient. If we could guarantee (a) and (b) we wouldn't need a defense service to begin with.
On page 7
The whole point of Anarchy is individual rights trump "socially-agreed-upon" regulations and now he wants to use "socially-agreed-upon" regulations. The system we have now is run by "socially-agreed-upon" regulations.
On page 9
Now he assumes that all States are equal. In actuality some states are "more free" than others (even granting that none are "perfectly" free). We *would* lose something if we, say, gave up a United States type government for this experiment and ended up with a Stalinist Russia type government as a result.
Published: February 8, 2008 10:16 PM
Inquisitor
Rothbard is rather clear on all this, and I don't see him defining problems away. On the first quote, it does not follow from what he said that he is establishing conditions under which it would be needless for a defence service - he is saying it can be provided as a good on the market.
The point of anarchism is that individual rights trump collective 'rights', not that social regulations (at least ones voluntarily abided by) cannot exist. Competition itself 'regulates', so to speak.
Whatever he is doing there, this is not an instance of defining problems away. Rothbard was pedantic when it came to definitions, but for good reason - most economists make a mess of them.
Published: February 9, 2008 4:19 AM
Nelson
On the first quote, it does not follow from what he said that he is establishing conditions under which it would be needless for a defence service - he is saying it can be provided as a good on the market.
"(a) gained their revenue voluntarily rather than by coercion and
(b) did not—as the State does—arrogate to themselves a compulsory monopoly of police or judicial protection."
If we could guarantee these conditions on the security service, which presumably would have weapons and people trained in fighting, then we could guarantee these conditions on anyone. If we could guarantee these conditions on anyone, then no one would use coercion and we wouldn't need security forces.
But we can't guarantee these conditions privately any more than we can guarantee these conditions publicly therefore we've gained nothing.
And you're right. Rothbard admits the defense forces may become corrupted... "Of course, some of the private defense agencies will become criminal, just as some people become criminal now. But the point is that in a stateless society there would be no regular, legalized channel for crime and aggression, no government apparatus the control of which provides a secure monopoly for invasion of person and property."
Excuse me for preferring regular legalized predictable "theft by taxation" to chaotic unpredictable aggression and theft.
The point of anarchism is that individual rights trump collective 'rights', not that social regulations (at least ones voluntarily abided by) cannot exist.
So now we get in the situation where there wouldn't be regulations because one can "voluntarily" not abide by them.
Whatever he is doing there, this is not an instance of defining problems away. Rothbard was pedantic when it came to definitions, but for good reason - most economists make a mess of them.
Pedantic or not this does not counter my objection to classifying all States as equally undesirable.
Anyway, this has gone way off topic. My apologies. Perhaps I should register for a forum account.
Published: February 9, 2008 11:21 AM
Inquisitor
Where is your proof that it'd be chaotic? Why does a multitude of states not lead to a world of pure chaos? In fact, why not institute a world government if this (supposedly) eliminates chaos? The conditions he outlined would not eliminate the need for private defence agencies as they would provide arbitration and protection services, freeing up time to do other things.
Markets penalize certain negative activities. For instance, if one systematically cheats their clients, aside from being liable for fraud, they will lose their clients' patronage. No one imposes this regulation from above.
Anyway, if you want to further debate the topic, you might as well bring it up on mises.com I suppose.
Published: February 9, 2008 4:41 PM
fundamentalist
Nelson: "He could gather/make them himself. Or someone else could do it for a *promise* of repayment. Either way, it's a combination of raw materials (these weren't "saved" they were given by nature) and effort (also not saved)."
In the real economy, people work for wages to buy goods. Articles on this site discuss the real world, not imaginary worlds or what people do in their spare time for entertainment or as hobbies. But even in your example, someone somewhere down the line is going to ask for cash because everyone can't live on promises. In the real world, people have to earn incomes to buy food; everyone can't just give everthing away in exchange for promises.
And what if the guys got the wood from nature? Who owns the trees? Where did they get the tools? Or did they get these in exchange for promises too? Do you really think that's the real world? If so, I have a bridge I'd like to sell you.
Published: February 9, 2008 9:18 PM
Robert Blumen
After reading some of the comments, I believe that my post was too short and did not explain the concepts fully.
By credit, I mean a loan. Mises distinguished between two types of credit, which he called "commodity credit" and "circulation credit". The former means the loan by a borrower to a saver. The latter occurs when a bank credits the borrower with a loan but there is no saver. The bank has created the credit out of nothing, not backed by any savings.
By "saving" I mean saving-and-investing. This can be confusing because in normal English, the term saving means "not spending". In economic terms, not-spending-at-all is called increasing your cash balance. Saving-and-investing means not spending on consumption goods, but instead, spending on means of production.
By "funding economic growth", I mean providing the consumption goods that are consumed during the period of production where additional means of production are being created. What I mean by "credit does not fund economic growth" is that it is not the credit as such but the savings which are loaned that enable economic growth. More credit not backed by any savings only rearranges the pattern of investment. Other than forced savings, it does not enable more means of production to be created.
In a non-monetary economy, people can save by accumulating stockpiles of consumption goods, e.g. dried beans or dried fish. They could then use these stockpiled savings to fund either production of more capital, or more leisure. In a monetary economy, while it is possible tos ave by stockpiling, most people save in monetary terms. That is, most people save-and-invest in monetary terms. The transfer of savings to investment can take place through capital markets, starting a business, or direct purchase of capital goods.
By the way, the example discussed above of a house is not the best example because a house is a consumption good. Creating more factories will eventually result in more consumption goods being produced, but not so for more houses.
Published: February 11, 2008 2:29 PM
Harvey Bloom
I agree about the house example, but I do think people do most of their savings in monetary terms, too.
With the economic conditions such as they are now, I can see both kinds of savings along with forced savings. We have adjusted a lot since reading blogs like this one and stickyasset.com. No question that now is the best time to get your own personal house in order.
Harvey
Published: October 20, 2008 12:52 PM
Pravin
Question about why credit cant create real growth:
Please explain the beginnings of Google.The founders literally maxed out their credit cards to borrow money for their startup venture. It paid off big time,didnt it?
This credit was from thin air -ie credit cards.Where's the savings in the form of credit here?
Or are we saying that Google is a malinvestment -that doesnt sound right.
thanks
Pravin
Published: October 25, 2008 1:41 PM