The Paradox of Thrift: Is Saving Money Bad for the Economy?

NBP Gold.  Photo by covilha.Two years ago (in those economic halcyon days before the so-called “Great Recession”), I wrote a short article entitled Is Not Spending Money Bad for the Economy? In it, I largely concluded (by my own logic) that not spending money – in other words, saving it – isn’t necessarily bad for the economy at at all.

Of course, this article was written against the backdrop of the economic conditions of the time. We were at the peak of six years of economic growth, with only the faintest hints of the economic onslaught about to occur. We, as Americans, also had a negative savings rate at the time – we were actually spending more than we earned as a whole (which meant that there were a whole lot of individuals spending far more than they earned).

Today, we live in a different world. Saving has certainly rebounded – many estimates show that the savings rate is now somewhere around 5%. The economy has certainly slowed as well, and countless trillions have been lost in a 50% dip in the stock market.

So, now’s the time to revisit that question: is saving money instead of actively spending it bad for the economy? Again, I come to the same conclusion – no – but this time, there’s a bit more food for thought on the vine.

The Paradox of Thrift
The whole idea that saving money is bad for the economy comes from the economist John Maynard Keynes, who referred to it as the “paradox of thrift.” (“Paradox of thrift” and John Maynard Keynes is one of those things you can bust out at a party to seem quite smart.) He believed that if everyone saved more money during times of recession, then demand for goods will fall. If demand for goods falls, then economic growth will stall, causing all sorts of additional economic problems (lost jobs, failed businesses, etc.).

It makes some sense on the surface. If everyone stopped spending money tomorrow, the economy would indeed fall apart. There are two big factors that keep this from happening.

First, when demand falls, prices fall, and when prices fall, people are more likely to spend money. That’s why sales always work – and thus businesses regularly have sales. If demand falls across the board, then businesses will lower their prices to get more customers.

Savings Accounts Contribute to the Economy
The second factor – and this is the big one – that makes the “paradox of thrift” fail is that putting money in savings accounts does not remove it from the economy. When you put money in a savings account, it becomes money that the bank can then lend out to businesses. Thus, when more people save, the banks have more resources to pump out to businesses, and when the businesses have more resources, they employ more people, innovate new products, and find new ways to sell.

This is a simple example of why the economy cycles back and forth between economic growth and recession. Right now, we’re in a recession and we’re putting our money away in various savings accounts and investments. That money is then being loaned out to businesses of all kinds who are taking advantage of the very low interest rates available. This means that businesses will soon begin hiring people – reducing unemployment and getting more money out there in the hands of consumers. With more people involved in steady work, more money will be spent and the economy begins to grow. Eventually, people stop saving as much – times are good. The banks then slowly close the taps since they don’t have as many resources for lending. Businesses feel the pinch and begin laying off workers – and we’re back to a recession again.

By saving, you’re actually doing your economic duty, just as you would be if you were buying things. A healthy economy needs plenty of both.

Hoarding Doesn’t Help the Economy
This, obviously, doesn’t include the guy with hundreds of dollars in his mattress or in his safe, or the guy who buys gold coins and buries them in his back yard. That type of saving (I view it as hoarding) does not help the economy at all, as it locks up money in a place where it’s not constantly being cycled back and forth between workers and employers, between businesses and customers.

If you’re concerned about whether or not saving money will help the economy, be aware that it will, but only if you actually invest it in a business (by buying stocks), in a community (by buying bonds), or in a bank where it can be distributed through business and personal loans. That way, you can not only build a safety net for yourself, but you can also do your part in making sure the economy functions like a well-oiled machine.

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62 thoughts on “The Paradox of Thrift: Is Saving Money Bad for the Economy?

  1. Yeah, that’s what it’s always seemed like to me: Putting money in a savings account simply allows the bank to loan it out to somebody else.

    Similarly, investing money in the stock market–assuming the transaction isn’t an IPO–frees up another investor’s cash, which will either be spent or deposited into a savings account and turned into a loan.

  2. John says:

    Read Austrian economics, specifically F.A. Hayek and Ludwig von Mises. Saving is what allows for economic growth. Read “Meltdown” by Tom Woods.

    We’re in the mess we are in now because we didn’t save–we printed money without producing anything leading to a massive inflationary bubble that has now crashed–and we’re doing everything we can to re-inflate the bubble.

    http://www.mises.org

  3. d_2 says:

    i think that you are making the assumption that the banks are operating exactly as they were during the expansionary period.

    if the banks, too, are struggling with cash flow problems, then your savings in the bank account actually may just be sitting there, stagnant, propping up a banks failing balance sheet.

    for example, suppose a bank created a mortgage by lending some money, and then the home owner defaulted. now, they no longer have that income stream coming in, so they may use the money you deposited to fill their reserves instead of loaning it out.

  4. Jon says:

    Immediately after reading the quote regarding the “Paradox of Thrift” I knew it was bogus. I mean, it’s undeniably true in theory, but realistically speaking, you will NEVER have a time when every single person stops spending.

    Take the worst economic time period in US History, the Great Depression. I understand that FDR’s “New Deal” assisted with the general welfare of nearly everyone during this time, and obviously not many folks would choose to re-live those days, but just imagine the deals you could get with practically any money at all.

    I’m not suggesting that you take advantage of people, but this is also reflected present day. Why did I just buy a new car? Because car dealers are in a bind, they NEED people to buy, even if they aren’t making the profit they were before. I didn’t buy because I ‘felt bad for them’, I bought because I felt like I was able to get a fair deal.

    And Trent, you’re right, the economy goes through cycles. It’s going to recover. Some recessions are worse than others, but there is light at the end of the tunnel.

  5. Clayton says:

    There was a pretty great econtalk podcast on this very issue. I know an hour of Keynesian economics isn’t everyone’s cup of tea, but this will explain it to you pretty well:

    http://www.econtalk.org/archives/2009/01/fazzari_on_keyn.html

  6. Steve says:

    I don’t get how buying stocks helps the economy, but the point about putting your money into banks vs. in the mattress makes sense (as long as it’s fully insured).

    Once the stock is issued, the business doesn’t get any more equity invested in it by you buying stock. There is somewhat of a side benefit (e.g. options can be worth more per share, so they don’t have to give out as much), but it’s not in the same sense as giving money to a bank.

  7. Joanna says:

    Trent,

    Have you seen the documentary I.O.U.S.A.? It’s interesting & talks about this same thing. The recent negative savings rates are presented as a contributor to current economic conditions. Watching it, it makes sense. After all, it’s only logical that spending money you don’t have is unsustainable. If only our government officials understood logic. ;-)

  8. KC says:

    I’m with Jon. We saved the last 8 years or so because prices seemed so high relative to what we were getting in return. Well when the recession hit we found we had quite a bit of money saved, weren’t in risk of losing our jobs and prices started coming down. So we bought the things we needed – bought a bigger house, bought some furniture and got some repairs done that we’d been putting off. My parents are in the same boat – never spent money they didn’t need to and now are taking advantage of some house repairs/improvements and furniture. Its really a good time to buy some things if you really need it. So not everyone is hoarding and the economy isn’t going to stop altogether.

  9. Sadly our economy has transformed into consumer based economy where saving is considered counterproductive. Even the government pushes the country to spend. I remember when one of the stimulus checks was sent out the white house was encouraging people to spend it.

  10. It seems that one of the biggest concerns in a down economy is the possibility of a run on banks, which is what happened at the start of the Great Depression. That was a genuine concern at the end of 2008. I’m just glad Americans held on and didn’t freak out sompletely!

  11. Nate says:

    A great post on an interesting topic Trent.

    One issue you don’t address is the lack of incentive businesses have to borrow money, even at low interest rates, when demand for goods and services drops due to increased savings. When consumers as a group save more and spend less, demand for goods and services drops. When demand for goods and services drops, business are less likely to borrow from banks, making it more likely that deposited money will sit in deposit accounts rather then being lent out as suggested by d_2 in the comment above.

    Also, falling prices are a double edged sword. You mention that as prices fall, consumers are more likely to spend money. This is true theoretically, though in difficult economic times, prices may fall significantly without any increase in consumption for a long period of time. Consumers may be so paralyzed by fear that the falling prices do not create enough incentive for them to return to previous consumption levels (e.g. Great Depression). In those severe cases when prices fall and increased consumption does not follow close behind, businesses take a major hit as they are now selling less goods and services at lower prices. This, in turn, will lower rates of borrowing by businesses, making it more likely that the increasing amounts of money saved by consumers will sit in their deposit accounts unused by the bank and businesses. This also will cause increased unemployment as hurting businesses layoff employees, further lowering consumption rates.

    The whole idea behind the Paradox of Thrift is that in times of sever economic downturn, when consumers decrease spending and increase savings, the government can aid recovery where free markets have stagnated by temporarily running a deficit and injecting money into the economy via government spending measures.

  12. Interesting point of view. Unfortunately here in Italy the premier says go spend to help the economy recover…

  13. Kate says:

    Excellent post and very easy to understand. Maybe it’s because I recently finished the book The Power of Small, but I am really noticing that it’s the little things that matter. Anything done to extremes, whether it’s Big spending or hoarding your cash, ultimately hurts everyone in the end.

  14. noko says:

    The central problem of economic crisis is that banks *stop lending money* out. It was the chief reason that Japan’s deflationary period lasted for such a long time – no matter how much cheap credit was made available to banks, in uncertain times they chose not to lend it out, which results in a liquidity crisis. That’s why so much of the UK’s response to the downturn has being trying to work out how to make banks lend more, rather than just making funds for lending available to them. An increase in savings made available to banks doesn’t do any good if they keep it all because their liquidity preference is sky high, or buy a bunch of government bonds because confidence is so low.

    Furthermore, you overlook the fact that if businesses must drop prices to sell the same amount of goods, then economic output (i.e. the product of price of goods sold and quantity of goods sold) falls.

    Furthermore, even if you accept that banks will lend out savings (which history suggests they won’t), why will businesses take advantage of cheap credit to expand if everyone is saving instead of spending? Are you suggesting that businesses will invest more money to sell goods at a lower price? Because that’s against one of the most fundamental principles of economics (an upward sloping Supply curve). If businesses are to expand, that requires an increase in consumption, which yes, does require people to spend rather than save.

    I’m not suggesting that people have any moral duty to spend money on consumer goods rather than to save it – I’m simply pointing out that some of the ideas in your article do not make logical sense. I enjoy your personal finance and cookery posts, but I don’t think this post was up to your usual standard.

  15. This is a fun topic Trent, thanks for bringing it up.

    I laugh when I hear wonks suggesting that we need to spend money to spur the economy… go buy a new car and we’ll protect you if you lose your job or even worse was the government’s attempt to make interest on car loans tax deductible… glad that didn’t make it into the spending bill or we’d have more folks to bail out.

    The idea that one person or many people acting in a particular way can influence the US or global economy is kinda silly. But what isn’t silly is everyone having an impact on THEIR economy. I’ve called this an ‘economy of one’ in some of my posts.

    The idea is that if I do right by my economy then I’ll be a responsible member of the overall economy. If EVERYONE did this, then the overall economy would boom!

    Good discussion, thanks for getting it going!
    Dave

  16. Kevin says:

    Buying stocks is not the same as investing in a business. The business only gets the money if it is the business that is selling the stock (like in an IPO or secondary offering).

    Likewise, buying bonds is not investing in a community (or business) unless it is bought directly (i.e. not traded on an exchange or in a bond fund) from the entity.

    Putting it in the bank only helps if the bank is originating new loans. While many smaller banks may still be making loans, loan origination from the big banks is down steeply.

    And ObliviousInvestor’s claim that “investing money in the stock market….frees up another investor’s cash, which will either be spent or deposited into a savings account and turned into a loan…” is probably not accurate either. Most sellers don’t withdraw the cash from a sale, they keep it in the brokerage to fund further purchases.

  17. Christopher says:

    I don’t think people should be too concerned about the effects of their spending (or not spending) on the economy, other than as an academic speculation. Your primary duty is to do what’s best for yourself and your family, with “the economy” running a distant third (if at all).

  18. Kevin: Right, the seller probably purchases some other security with the cash. But what about the seller of that second security? At some point, the money comes out of the market.

  19. quick addition:

    Or, at least, some of the money must come back out of the market.

    I’m sure you’re correct that a portion of the amount you invest in the market stays in the market in the form of higher security prices. But clearly if a person invests $10,000 in the stock market, it doesn’t drive up prices by a total of $10,000. A good portion of that money comes back out.

  20. Joey says:

    The idea that the economy will collapse if the proletariat don’t return their meager wages to corporations, post haste, is one of the bigger lies of capitalism, though it pales besides the ultimate lie of the “free market”.

  21. Adam says:

    You seem to be misunderstanding basic economics. When demand for goods falls, the quantity of goods purchased falls at every price point. So even if prices are lower, fewer total goods are being consumed, which means unemployment rises, people’s income falls, etc.

    Additionally, putting money in a bank is not nearly as good for the economy. Part of the money just sits there (to satisfy banks’ reserve requirements), and part is lent out to businesses, unlike consumption, where the spending multiplier kicks in. Also, as someone pointed out, if demand for goods and services falls, businesses won’t be expanding even if the money is available. Indeed, there certainly isn’t a shortage of credit out there right now – the Fed is literally pouring money into the economy.

    Finally, as someone else pointed out, buying stocks isn’t investing in a company at all if it’s done on an exchange – you’re just buying it from someone else who happens to have it.

    I started coming to this site from Lifehacker, but this is the last time I will visit it. The writing is continually shoddy and inaccurate (an earlier post this week told someone they would pay capital gains taxes on dividend. well, no, you pay income taxes on dividends and captial gains taxes on…capital gains). I’m beginning to think that this is one of the problems with our economy – people getting financial advice from people whose bona fides are that they didn’t realize for SEVERAL YEARS that you can’t spend more than you earn.

  22. Kevin M says:

    I think comments #2 and #7 are more on-point – I’m not sure the problem/paradox is with actual humans saving more money, but with the banks holding that money either a) being more restrictive in their loans or b) just not being able to loan it out at all because of small businesses being fearful in a down economy.

    Also, re: lower prices – it becomes more attractive to buy, but unless businesses are dependent on sheer volume (or have high fixed costs), they are likely to cut back production in a down cycle.

  23. Adam says:

    It should also be pointed out that it’s easy to defeat an argument when you mischaracterize it. Keynes didn’t say that ‘saving was bad,’ just that if the marginal propensity to save suddenly increases during a recession, the recession will be exacerbated.

    Paraphrasing and reposting wikipedia articles must be a fun way to make a living.

  24. harm says:

    Yeah……..right, Joey :D

  25. Curt says:

    In the long run, saving money is always better for the economy.

  26. Eric says:

    This is definitely an interesting topic. I find it infuriating that people claim it is our fiduciary duty to spend money to “spur the economy.”

    One of the biggest reasons we are in this recession is people as a whole had TOO MUCH debt and spent more than they earned for too long. So why do people think the solution is to make credit more available and try and increase spending? That only exacerbates the problem, it doesn’t solve it.

    A recession is by definition, is negative GDP growth for two consecutive quarters. GDP is measured by Consumer Spending + Gross Investment (Inventories, Fixed Assets) + Government Spending + Trade Surplus (Deficit).

    So if you consider GDP to be the measure of our “economy” – then yes, Consumer Spending is one of the biggest factors. Saving does not contribute to GDP, except perhaps as claimed above that it increases loans to build factories and cars and houses and other business investments.

    I’m trying not to make this too complicated, but our recession is a result of two very significant changes. First, consumer spending changed dramatically. When consumers as a whole went from a savings rate of NEGATIVE 2% to POSITIVE 5%, that net change in such a short amount of time is what has caused so many problems. Second, two of the largest inventories in United States (Houses and Cars) have fallen in demand/price – and no amount of credit or loans is going to bolster those up. There are too many new cars and there were too many overpriced homes.

    These are the two fundamental reasons for negative GDP growth. And GDP is what economists are referring to when they claim that spending stimulates the economy. This is because spending has a direct result on GDP and saving does not.

    Economics and GDP aside, I believe that saving is incredibly important and that is one of the reasons why this recession is so necessary. Consumers HAVE to have a healthy savings rate in order for the economy to grow in such a way that deep recession is not necessary.

    So I guess my point is – when you crunch the numbers – spending is what matters for the economy. But if you spend more than you make, you are only putting off the inevitable. I hope that people learn from this recession and that saving becomes as important to our generation as it was in the generation that lived through the Great Depression.

  27. Katie says:

    Kevin – Good points. It does help ease investors’ worries when they know their purchases are liquid, so perhaps we can consider the bond markets (the actual exchanges) and bond funds as ways of supporting municipalities and other government agencies and bond issuers, but indirectly.

    Just some food for thought!

  28. JonFrance says:

    @Kevin, buying stocks *is* the same as investing in a business–it’s the very definition of investing in a business. You’re putting your money in for a stake in the company.

    The money always goes to the company in the sense that by definition the person you’re buying the stock from is a part-owner of the company, but it also benefits the company is an institutional sense, for at least two reasons I can think of immediately:

    1) The price of the stock is determined by the demand among buyers. The stock price determines the company’s market capitalisation, which is one of the major factors that give the company weight to take out loans, issuing corporate bonds.

    2) Secondary offerings, as you mention, raise money for the company directly, and they are not an infrequent phenomenon. They can be a critical way for companies to raise capital, one which they can only do if the demand is there to keep the stock price from deflating.

    In other words if I put $1000 into shares of company X, no it doesn’t mean company X has $1000 more dollars (one of it’s (ex-)owners does), but all the ways in which company x *does* raise money on its own are strengthened by my investment.

    All that is just how the *company* benefits, though: as a shareholder, the benefits are potentially much greater, since I earn dividends and, if the company does well and more people want to be part-owners, then the share price will increase, giving me more money when I sell my stake.

  29. Eido Cohen says:

    There is so much misinformation out there that I feel I have to address the points made, one by one. First, Trent, thank you for attempting to address the fallacy of Keynesian economics, as well as the erroneous notions of the “paradox of thrift”. However, the macroeconomic decisions of the U.S. govt., through its quasi-private/public intermediary – the Federal Reserve – make moot much of the points you have made about “hoarding” being bad for the “economy”.

    Banks in the U.S. (and in all industrialized nations and most of the rest of the world) DO NOT use the money deposited in savings accounts on a 1 to 1 basis. They engage in fractional reserve banking (see: http://en.wikipedia.org/wiki/Fractional-reserve_banking#Criticism), wherein banks keep less than 10% reserves and *can* lend out (although many banks choose not to use their feel leverage at the moment) 10 dollars for every 1 dollar in their reserves.

    The Federal Reserve has pumped unprecedented amounts of money into the financial system in an attempt to stave off deflation, or that fear of “stagflation”. This money is literally “created out of thin air”.

    There are 1000′s of articles on mises.org (the Austrian School of economics) which demonstrate all kinds of fallacies in much of today’s economic thought.

    Jon (comment #3) – I agree with your sentiment in your comment. Please note that FDR *did not* help the economy with his misguided notions and alphabet soup administration; neither did Hoover.
    Rather than belabor these points, see this article from the Wall Street Journal http://online.wsj.com/article/SB122576077569495545.html
    as well as an extensively documented research paper by the Mackinac Center http://www.gmu.edu/departments/economics/wew/articles/09/GreatMythsOfTheGreatDepression.pdf

    Joanna (comment #4) – I was initially positive to and impacted strongly by I.O.U.S.A. Unfortunately, for some reason, David Walker (the former comptroller to the U.S. whose “Fiscal Wake Up Tour” was the progenitor of this movie) and the Peter G. Peterson Foundation http://en.wikipedia.org/wiki/Peter_G._Peterson
    which he heads, praise the use of trillions of dollars of “stimulus money” by the Obama administration, while simultaneously decrying the bankruptcy of the U.S. economy and the massive deficit the U.S. faces today. This split personality is not conducive to a rational debate.

    Linda (comment #6) – Be aware that the FDIC has reserves amounting to less than 1% of bank holdings, and this number will decrease substantially when legislation within the last year that reduces the obligations of the FDIC takes full effect. In short, the FDIC is a sham. There is nothing substantial (other than nationalization of the banks and forced bank closures) to stop a true “run on the banks”.

    Nate (comment #7) – There are *so* many ways to demonstrate the fallacies in the paradox of thrift. If people are so “paralyzed by fear” during falling prices then lets look at two scenarios:
    1) Prices for technology have tended to decrease for decades. Even though we are getting far more for our inflated dollar today than say, in 1980, computers continue to improve year after year and prices get LOWER and LOWER. Yet, are people “paralyzed with fear” when they consider a technology purchase? Far from it. Consumers realize (if they ponder anything at all) that innovation permeates the field, and even though the computer they just bought is likely to be obsolete almost immediately, they can replace it a year or two later for a BETTER model at a LOWER price (whether or not you adjust for inflation). People’s REAL behavior is the OPPOSITE of the stupid notions of Keynesian economics. Where people are “paralyzed with fear” is when govt. intervention stops the free market from establishing truth between consumers and businesses.

    2) If you think deflation is bad, consider what INFLATION does to an economy. Look at the examples of the Weimar Republic in Germany following WWI, Argentina in the 1990′s and Zimbabwe today. When inflation of such scale hits, people will save NOTHING. Businesses fail on a catastrophic level. What brought us to today’s financial nadir is *not* simply the “greed” of investors or financial analysts, etc. It is the *mal-investment* created by the Fed artifically lowering interest rates, which stimulated the real estate boom, and then the Fed pumping rates way up in 2006, which stimulated the subsequent bust. And we are back again in a artifically low interest rate level today. This method was tried over and over and over by Japan, and it has *never* worked.

    Kate (#8), Dave Ramsey (#9), Christopher (#11) and Curt (#17) – Thank you all for your rational discourse.

    Joe (comment #14) – I’m not sure of your stance here. There has always been intervention by the U.S. govt., interfering in there ever being a true “free market”. Are you saying that the free market has never occurred, though it ideally would be a good thing if it could… or are you saying something like “capitalism is evil and the free market is a lie”? Though I sense the socialistic tendencies in your use of the word “proletariat”. If so, even though the current U.S. economy is far from an ideal for the flourishing of capitalism, please demonstrate the success of a single socialistic economy *ever*.

  30. Eido Cohen says:

    Two quick edits: I meant to say “banks do not use their *full* leverage at the moment”, and “intervention stops the free market from establishing *trust* between consumers and businesses.”

  31. Saving money only hurts the economy if people are saving above the spend/save equilibrium point. There must be some point that is the best rate for savings versus spending. Unless people are already saving at a rate above this point, the economy is better off with people increasing their savings rate.

    The “Paradox of Thrift” is a short term view of the economy. It just makes sense that if retirees don’t have enough money to spend when they retire that this would hurt the economy at that time.

  32. Lenore says:

    I’ve become a mattress-stuffer because I fear banks failing and don’t want to be taxed and re-taxed on the same pool of money. I still have a checking account, but I’d rather keep my meager savings locked up at home than trust them in a low-yield savings account.

  33. deRuiter says:

    One reason Americans don’t save much is that interest rates are reltively low AND THE GOVERNMENT TAXES THE INTEREST AS INCOME SO SAVERS ARE ACTUALLKY FALLING BEHIND DUE TO INFLATION AND TAXES IF THEY PUT MONEY IN A SAVINGS ACCOUNT OR CD. You’re better off financially prepaying a mortgage because the government can not tax you on interest which you don’t pay due to prepaymet of principal. You’re also better off paying off high interest debts like credit cards, student loans, persoal loans, IF YOU HAVE THE SELF DISCIPLINE NOT TO RUN UP MORE LOANS.

  34. lurker carl says:

    Saving money is good for the saver, good for business, good for banks; therefore, good for the economy. The current recessionary cycle is the perfect example of what NOT saving money does for the economy.

    Smart folks conserve their money when times are good because prices are going up and spend when time are bad when prices are down. There should always be a healthy balance between saving and spending, all things in moderation, following the economic cycles.

    Hoarding your cash in a barrel invites time to whittle away at that stash. Compounding interest over many years keeps the hungry jaws of inflation from eating up your savings. Save as much as you can early in life so you’ll have it to spend later on. This follows the cycle of life, you’ll have money to live off of when your ability to work declines as you age.

  35. Paul says:

    Great article! I have a friend who is putting his money into foreign currency – this friend of mine knows someone in another country who he is sending money to deposit in an overseas bank. He is worried that the dollar is going to go down in value. How does this effect our national economy? Is it similar to the hoarding effect? I guess it wouldn’t effect the global economy or does it all tie together and this isn’t a negative thing at all?

  36. tammy says:

    I think saving money helps me be more responsible for myself. I understand banked savings should go to start up businesses,but having been a start up business, those funds are nearly unreachable. Government entities like Small Business Administration will tell you in order to borrow money, you must HAVE money.
    I’ve always been a saver and I’ve always planned ahead so the economy doesn’t affect me as much as others, even though I am a freelance gal.

  37. E.D. says:

    “That money is then being loaned out to businesses of all kinds who are taking advantage of the very low interest rates available.”

    As other posters have said, I don’t think this is true. Most businesses, especially public companies, are extremely wary of taking on new debt right now, preferring to cut expenses and people to the bone instead. Even if businesses were willing to take on debt, banks are hoarding money.

    We have saved quite a bit of money. Some of it is for an emergency fund, and the rest is money we have saved to renovate our bathrooms. Right now, we are sitting on that money until our jobs seem more stable.

  38. Katy says:

    Great post! Even though I know little about economics, I agree with you because of what I’ve seen play out in my husband’s small business.

    The owner of his 7-person civil engineering firm has taken some big losses over the last year, since fewer companies are building new structures during the recession. He had to get a loan just to keep up with payroll for a few months there. But now they have a few more projects coming in, and he’s on track to pay down the loan by the end of the year.

    I look at it this way: My increased savings gave the bank more money to turn around and lend to my husband’s boss so that he could pay my husband’s salary. Sure, there are a LOT of other factors involved, and I may be looked upon as naive, but it just makes sense to me. And as long as businesses pay off the loans when the economy picks up, there’s no harm done!

  39. Katy says:

    And another thing (about small businesses taking loans): Those who say “I don’t think this is true” don’t seem to actually KNOW anyone who owns a small business right now. I’ve seen it all firsthand, so I know that it IS true that small businesses have incentive to take loans right now. They don’t WANT to lose their employees and will do whatever it takes to keep them.

  40. Wondering says:

    If someone chooses to spend their money on physical gold or silver, why is that hoarding more than someone spending a lot of money on storable food and stashing it? Is buying gold jewelry hoarding? Gold dental work? Buying physical metals puts money into the economy too, even if it doesn’t keep it moving…now. If the economy goes very south, God forbid,(and it can happen, even now many banks are on very shaky ground) your stash of food in the basement will be very valuable, as would a stash of physical metal. The dollar is still falling, and certain countries are serious about returning to the gold standard. Much as we value the simple dollar, it’s still just paper.

  41. Tabatha says:

    There is still a minor economic benefit to mattress stuffing. It fights inflation by reducing cash availability. I read an interesting article about this a while back, particularly in relation to criminal activities that cause people to hoard large amounts of unreported cash and the unexpected effects when the Euro became more popular than the Dollar due to the availability of larger denominations.

  42. Mike says:

    Please PLEASE do not listen to this Keynes’ B.S.

    Read the Mises article which shows why thrift is not paradoxical. While there, please read the other articles which tell you the truth about our economy and governments. No, this is not some tinfoil hat paranoia. Read the articles and you’ll see.

    http://mises.org/story/3194

    In case links are stripped out, go to:

    MISES dot ORG slash STORY slash 3194

  43. tightwadfan says:

    I cringe when I hear people say that saving will be bad for the economy. The idea that the people who have been living on credit should be discouraged from paying down their debts or just not taking on any more debt, is frightening.

    The painful truth is that the only way for the economy to regain the losses of the recession any time soon would be through another bubble caused by spending based on debt.

    The only people I would encourage to spend money right now to stimulate the economy would be the fortunate few who have secure jobs, no debt, and savings. It might help if people like that would open their wallets a bit and be less frugal than they normally would.

  44. Kris says:

    Personally, this post lost any credibility with me as soon as you mentioned Keynes. This is the same “economist” that insist that the way out of recession is for the government to spend, spend, spend. He is often credited for “The New Deal” which didn’t work and our government today has bought into these flawed theories.
    Our economy did not hit a downturn because people decided to save a few bucks, we are in this mess because people, businesses and our governments failed to manage debt properly.

  45. Mike says:

    @ tightwadfan #28
    Why should people who saved, have no debts, and secure jobs bail out people who did not? I know you didn’t say “bailout” but that’s essentially what you’re suggesting I think.

    Don’t listen to anything Keynes said. It’s all B.S. Read the articles from MISES dot ORG to enlighten yourself.

    I’m not affiliated with that site in anyway, other than wanting SERIOUS change in our society.

    Consumers don’t cause recessions, corrupt central bankers and corrupt governments do.

  46. Neal Frankle says:

    I don’t know anybody who makes an investment decision based on macro economics. It’s all about “ME”…right?

    Just the same, I do like this post because it sort of explodes some myths.

    Our entire system is built on the idea that people acting in their own self-interest, help everyone. You’ve demonstrated how true that is.

    Well done.

  47. Erik says:

    My opinion is that higher savings rates will ultimately benefit macro-economic health, but the results will not be seen immediately. We are a nation of immediate gratification, and that is why you see politicians trying to make quick fixes to the economy by pumping more money into it. To me, this is no different than using a credit card to balance your budget short fall. It fixes the situation temporarily, but you still need a plan for eliminating the shortfall in your budget.

    If we become a nation of savers again, we will have more disposable income and spend MORE money in the long-term. It could take 5 or 10 years to see the results, but it will have a lasting effect for multiple generations.

  48. Michael says:

    You need to diversify your diet of lousy modern (Renaissance+) economics books, Trent. You are confusing increased profits with greater wealth.

    Really, there’s nothing that will get through until you get yourself a better economics education. Read better books!

    You might point out that books specializing in economics are rare before the Renaissance. That’s correct, and there is a good reason for it. Learning that reason will help you understand this better.

  49. Andy says:

    Nate @#7 was correct.

    When demand falls below the ability of our economy to produce there is little incentive for industry to borrow money to increase production. Businessed can’t produce their way out of slack demand by customers.

    Slack demand caused prices to fall. Falling prices is called deflation. Deflation is devastating for an economy because consumers soon figure out that its better to wait for prices to fall further before making purchases. So, when prices fall, demand actually falls with it, and an economic depression ensues.

    This is why, during this kind of recession, it is critical that the government take advantage of cheap available credit to borrow and spend money to increase demand to prevent an economic depression.

  50. JB says:

    Trent, it’s statements like “Today, we live in a different world” that frustrate me about your blog. I know, it’s your opinion, and you don’t pretend to be a professional or an academic or a specialist on the economy. The problem is that it’s not a well-thought-out critically-analyzed statement about the economy, it’s just a sound-bite that’s hardly accurate. We don’t live in a different world; in fact, what we are experiencing has happened many times before, just as the boom that preceded it has happened many times before. This is part of a cyclical pattern of boom and bust. Ignoring that is short-sighted.

  51. Cory says:

    Most people who save don’t do it so they can have a ton of money. They do it so they can afford to pay for the things they value without going into debt.

    Even avid savers need products and services. They still have to buy that new car when the old one dies. They still need the new washing machine when it gets too expensive to fix the old one.

    When they do spend the money goes to the the vendor without a lot of $ going to a credit card company. A higher percentage of their income go into businesses providing services or products instead of creditors. In fact most savers will end up spending MORE than they earn as job income because they will be getting interest income as well.

    So being a saver may be bad for credit card and consumer loan companies to a point, but how can it be bad for the economy?

  52. Borealis says:

    The argument that savings is bad for the economy is a very short term argument. If your ethics are all about the short term, you might worry about it, but there are lots of other things you should worry about too. This also means that when the economy is booming, you should be saving an extraordinary amount of your income.

    If your ethics are about the long term, then being responsible (saving for a rainy day) and the long term economy are always aligned very well.

  53. Jen says:

    @JB: I interpreted Trent’s statement “Today, we live in a different world” as a reference to the time (two years ago) when his first post on the topic was written. This was not a reference to the world in general, across all times. In this case, he is right. It is a very different world now than it was two years ago!

    Everyone else may have learned their lesson and be tightening their wallet, but my brother and sister-in-law are hell bent on saving the economy all on their own. They most definitely cannot afford it, but they have gone into a frenzied deficit spending mode. It’s nothing new, but it’s actually increased as the economy has worsened. It blows my mind.

  54. Rimaye says:

    Looks like the Misians are out in full force, and all it took was the mere mention of Keynes – not even in a favorable light, as Kris (#44) would have seen had s/he read the whole post.

    The only Mises fan who goes beyond “OMG! Keynes is a bad man!” is Eido Cohen (#29), and his logic demonstrates that he has no grasp of basic economics. Technological innovation is not the same thing as deflation. His argument about computer prices would only be correct if manufacturing efficiency were constant. Unfortunately, however, the fact that computer prices are constantly falling has to do with huge gains in efficiency, not deflation. For those who may not know the definition of deflation, it’s when prices of the same goods decline over a period of time, all else being equal. The key terms being “the same” and “all else being equal” – same product, same manufacturing process.

  55. Rimaye says:

    Also, I agree with Adam (#21): Trent, someone who writes on such an influential blog should do more research and make sure you understand an issue before you hold forth on it. Whether or not you agree with the “paradox of thrift” argument, I think you have a responsibility to fairly present the idea, rather than caricaturing it. Nate (#11), on the other hand, was spot-on.

  56. Trent says:

    “Trent, someone who writes on such an influential blog should do more research and make sure you understand an issue before you hold forth on it.”

    In what way am I not fairly presenting the idea? Because I’m not addressing Adam, who starts off saying “You seem to be misunderstanding basic economics.” and then immediately says “When demand for goods falls, the quantity of goods purchased falls at every price point” … uh, what? In what universe is that true? Take commodity prices, for one.

    Sorry, I don’t dance with trolls.

  57. We are all consumers, I just let my neighbors do more of the frivolous spending for all of us . . .

  58. Sam says:

    I just want to say that I really enjoyed all the commentary on this post. I guess it shows that “money” is very elusive concept. I realize that this post isn’t really representative of what you usually focus on in your blog, but personally I would like to see more posts of this nature (i.e. “economic philosophy” for lack of a better word at the moment).

  59. Eido Cohen says:

    This is in response to comment #54 by Rimaye. It is ironic that you begin your comment decrying other’s ad hominem attacks on Keynes and then immediately proceed to label me as “[having] no grasp of basic economics”. Let’s keep our comments here as civil, please.

    Rimaye, you have conflated two separate comments of mine to serve your argument. The statement I made about technological innovation and falling prices had nothing to do with deflation. That 1st statement was in regards to people’s *behavior* during falling prices of a particular sub-set of goods in the technology sector. When I said in the 2nd comment “If you think deflation is bad, consider what INFLATION does to an economy”, I was simply saying that I view rampant inflation as a far worse ill than deflation. This was an EXAMPLE against the paradox of thrift, not an observation or transition from the previous comment about technological innovation.

    I did *not* say that the reason for falling prices for computers was from deflation; I said that people respond to falling prices in the computer industry by *continuing to buy*.

    This is why the connotation of deflation with “falling prices” creates such false notions as the “paradox of thrift”. People’s behavior in the Great Depression was influenced far more by the government’s failed attempts to “fix” the economy than by falling prices. See my link in my previous message (#29) for evidence of this as well as http://mises.org/books/deflationandliberty.pdf

    Instead, if you define deflation as a “decrease in the money supply”, then you integrate deflation with people’s behavior *IN REAL LIFE* and see that deflation is a natural and necessary consequence of the un-natural pumping of the money supply that the Fed has engaged in.

    Oh, and Nate (comment #11)… “temporarily running a deficit”? Do you really believe that this is temporary? The current govt. deficit is nearly $12 trillion… the responses of the govt. to the current financial crisis is to obligate over $10 trillion today and for the future… the govt’s obligations to the American people are already over $50 trillion. How is *any* of this insanity in *any* way temporary?

  60. Tim says:

    Your argument completely misunderstands Keynes – it is an argument that is completely fallacious and has been rehashed in various forms for decades – it is basically the same as the “Treasury View” from the 1930′s.

    If you are deciding to save rather than spend, you are still reducing aggregate demand – some of the money you leave in the bank will be lent out, but a significant portion will not.

  61. Thevail says:

    Keynesian economics is a complete crock as is the “free” market. Once political entities (like the federal reserve”, Monetary Fund etc. get involved.

    If consumer demand sold more products, created more jobs…effective wages would have risen in the last few decades to keep up with inflation. They didn’t. If lower tax rates and cheap loans caused businesses to hire more people, we’d be swimming in good paying jobs right now..we’re not.

    There are certain financial realities..like “a business will not hire employees it does not need, no matter how much money the business makes”
    and “automation means less workers are needed”
    and “no company will pay an employee based on the employees needs or overall market conditions, they will only pay exactly what they must, regardless of the economy” (which means hiring people in any country but America)

    That are far more important in the overall economy than economics theory in any form. Most economic theories are like socialism, or communism..they work great…in theory..

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