I’ve been meaning to make this post for a few days now, but work prevented me from finding the time to do it. It also feels particularly funny to write a post like this on a day when the banks in Malaysia have announced cutting interest rates and penalties for credit card holders to reduce their debt. (For the record, reducing these charges only encourages accumulating more debt, but then again, the government is probably thinking that increasing consumption, even if it has to be fueled by increasing debt, is a good thing in a depressed economy.)

My subject today is savings. Now, traditionally, people think of savings as an unalloyed good. That’s the whole point of the parable of the ant and the grasshopper after all. However, one thing that people don’t usually think about is that ultimately savings equal capital, as in the capital of capitalism. This is because unlike the ant storing its food for winter, nowadays, we don’t save money by stuffing cash under the pillow. At the very least, we put it the bank and expect the bank to pay us interest for the privilege of safeguarding our money for us. For those who aren’t risk adverse, there’s no end to the array of possible investments your friendly financial planner is willing to sell to you.

Part of why we do this, apart from the obvious difficulties of safeguarding large amounts of physical cash, is because everyone now recognizes the inevitability of inflation. If we were to keep our savings purely as cash, it would steadily deteriorate in value the longer we keep it unspent. Earning some sort of return on our savings is an absolute necessity to preserve the real purchasing power of our savings for when we actually want to spend it. As financial markets have deepened and become more sophisticated however, investing savings is longer just a matter of running just to keep pace with inflation. Most people, me included, aim for a return that outstrips inflation significantly, such that, far from merely preserving value, it becomes a source of income in of itself.

One observation that I have here is that since leftists tend to dislike the idea that capital should be rewarded, believing that the added value from any endeavour comes predominately or solely from the labour component, it seems fairly difficult for them to square that with the idea that capital is really just the value of previous labour preserved as savings. It seems to me that if leftists were to insist that labour should earn a greater proportion of the rewards of an enterprise than what the free market generally allocates, they should also insist that the rewards of labour should be spent immediately rather than saved to become future capital. Obviously, as a libertarian I have no patience with this line of argument.

A more interesting objection is that relying on investment for income doesn’t look like it could be sustainable. De Minimis touched on this partially in a post that I found particularly memorable and started me thinking about this but it was a series of posts by Jonathan Blow (yes, the creator of the hit indie game of 2008, Braid) on QT3 that nailed the point for me:

Let me put it this way: the amount of real wealth being created in the world is a function of how many people there are to do work, how much time they have to do the work, how smartly they choose the work to do and how efficiently they do it, and how badly they fuck up the environment in the process of doing this stuff. And a complex mix of other things, but you get the idea.

If you have a small number of people earning 6% per year from “investments” then the system appears to work; they can withdraw their money from the bank and go eat at a restaurant or something.

But it’s just common sense that this does not work on a large scale. You can’t have everyone in the world earning interest at 6% per year, unless the amount of time they have to do work, how smartly they choose the work, etc etc, is also increasing at 6% per year.

Now, you can *tell yourself* that you are earning 6% per year, and watch the number on your bank account going up. If you’re lucky, you can withdraw the money and use it to eat at a restaurant. But if everyone in the world wants to actually use their purported money, it becomes quickly evident that the money isn’t really there. We can’t all eat at the restaurant because most of the money is fake.

So then it just becomes a function of who eats at the restaurant at a serendipitous time, before the dinner rush happens.

Now, there are a number of things wrong with this. For example, it seems plausible that capital investment could enable innovations that increase productivity, creating more wealth without necessarily requiring more working hours, and thus be suitably compensated in return. One point that did leave my head scratching was what would happen in a scenario whereby most of the people in the economy had saved a great deal of their previous income and had then exited the labour market with the expectation that the return on their invested savings would sustain them indefinitely even while they were not earning an income through their labour.

Since Blow is undeniably correct that the real wealth in an economy is continuously created from labour working now, having all these retirees exit the labour market should mean a lot of worthless paper money chasing very little labour. Another poster on the QT3, Sidd Budd, pretty much sums this up, saying:

So you took that initial $100k of real wealth, & indirectly used it to create additional wealth. You invested it in debt instruments, like banks or bonds, which means you loaned your money to finance new businesses. Or you invested directly in equities through individual stocks or mutual funds, which used the additional shareholder equity to increase profitability.

When you take out $200k, your extra $100k is your share of the interest, dividends, and/or additional value of the equities that you helped enable with your initial investment.

The one point I do agree with is that if 50 million people do this for 30 years, inflation will work so that your share of final wealth will be directly proportional to how much you invested or saved, relative to the other 49.999 million folks. I think many folks underestimate the extent to which one’s standard of living in retirement is dependent on how much you are saving relative to other people.

Now, it seems painfully obvious in retrospect, but I’d never realized this last point before. This means that unlike the ant from the parable who can predict how long its store of food will last from how much food it’s saved, I can’t predict how far my own savings will stretch when I retire because it depends not only on how much I’d saved relative to my own living expenses but also on how much other people will have saved by then. This raises the prospect that, yes, there can be such a thing as too much saving and not enough spending, especially when a wide section of society does in the expectation that by doing so, they’d be able to retire early.

I’m not necessarily arguing here that Malaysians are saving too much, and in fact, anecdotally, my suspicion is that most people are saving too little. What I am saying is that I find the very idea that a society could save too much to be pretty interesting and novel, and ties in well to some new lines of thought about the financial crisis happening now. That’s going to have to be the subject of another post though.