Much Ado About Saving

By George P. Brockway, originally published July 13, 1987

1987-7-13 Much Ado About Saving Title

ON THE STRENGTH of two simple simultaneous equations, John Maynard Keynes held that saving equals investment. The argument goes like this: (1) Income (or production) equals consumption plus investment; (2) saving equals income minus consumption (or, income equals consumption plus saving); therefore (3) saving equals investment.

Interestingly, Keynes presented his argument in a mixed form-half definition and half equation. As it now appears in the textbooks, it looks like this: (l) Y = C+ I; (2) Y = C+ S; therefore (3) S= I. But Keynes used only the operational symbols (=, +, -), relying on English for the rest of what he had to say.

Was the mixed language meant to warn against use of the argument as an ordinary equation? Since Keynes didn’t make the point explicitly (and he wasn’t usually bashful), I may be reading too much into his text. Nevertheless, he did not use it as an ordinary equation himself; he noted that “Saving, in fact, is a mere residual”; and he ended the chapter by declaring, “the conception of the propensity to consume will, in what follows, take the place of the propensity or disposition to save.”

So-called Keynesians disregard the implicit warning and proceed to manipulate S = I as they would any equation. These people, whom Joan Robinson called “bastard Keynesians,” make up the majority of American and British economists today. When President Nixon said, “We are all Keynesians,” he should have said, “We are all bastard Keynesians.”

Indeed, if S = I is a statement about residuals, you can’t increase the value of Y, in equation (2) above, by increasing the value of S. Income or production is necessary to saving, but not the other way around. An ordinary equation, though, knows nothing of residuals. If Y = C + S is treated as such, you can increase Y (production) by increasing S (saving); and this has been a steady objective of national policy from President Kennedy on down to President Reagan.

For 30 years now, we have been bombarded with appeals to save, with inducements to save, with threats of disaster if we don’t save. To help us save, every Administration, Democratic and Republican, has cut taxes one way or another. Industry has been offered inducements to invest (S = I); business’ share of Federal taxes has been reduced from 28.6 per cent under Presidents Roosevelt and Truman to less than 6 per cent at present; the top personal income tax has been slashed from 85 per cent to next year’s 28 per cent; and starting with California’s Proposition 13, many states and municipalities have followed in the train. Yet our savings rate has steadily fallen and is currently at an all-time low.

Now, what has been done (and is still being done) is perfectly congruent with traditional (that is, pre-Keynes) economic thought. Traditionally, one observes that every new company is in business for weeks or months or even years before it has anything to sell, let alone any profit. All the while it is paying wages, otherwise the workers would starve. The entrepreneur has to have saved money to pay the wages; and farmers have to have stored (saved) food for the workers to buy. Either that, or everyone else’s rations have to be cut. Furthermore, the new company has to build a factory, and the materials going into it can’t also be used by someone else to build houses. So again the entrepreneur has to have saved money, and again primary suppliers have to have stockpiled (saved) materials, or have to deny them to other users.

The traditional story makes perfect sense – provided you forget that the modern economy runs on credit and is dynamic, not static. An entrepreneur may have saved a little money, but he borrows most of what he needs from banks, which have assembled the relatively small savings of a lot of people. Without those savings, according to the traditional story, the banks would have nothing to lend to entrepreneurs.

That, too, seems reasonable – until you remember how fractional-reserve banking works. Banks don’t lend merely the sum of the deposited savings but perhaps 10 times as much. That is, they retain a reserve equal to 10 per cent of their loans. Whatever the reserve, it is not an immutable figure; it is set either by the banks’ directors or by some governmental authority; it can be changed down or up, anywhere from zero to 100 per cent, or even more. It is a question of credit, belief, trust, faith, determination.

Let’s take the extreme case of zero reserve. An entrepreneur, who has no money, goes to a banker, who has no money. The banker says, “I like the cut of your jib, and I believe you have a good project. I’ll credit your account with x dollars, which you’ll eventually repay plus y per cent interest.” The entrepreneur draws checks on this account, and these are accepted by employees and suppliers, because they believe the bank exercises good judgment in making loans. The suppliers and workers deposit their checks and draw on them to pay their creditors, and the process continues ad infinitum. Maybe somewhere along the line a few people will want greenbacks or coins, and these can be purchased with a check. The whole edifice is built on faith. Even the greenbacks and coins are articles of faith. How else is a hundred-dollar bill worth more than a one dollar bill?

So a company has been created out of nothing, and sooner or later the banker gets back the money that he didn’t have in the first place, plus interest. It may seem outrageous – not to say incredible – that the banking system could do all this without any savings whatever. Yet a zero reserve is scarcely less credible than a 10 per cent reserve, or than a 90 per cent reserve. As far as an entrepreneur’s need for money is concerned, no one has to have saved anything at all. It is, to repeat, entirely a question of the expansion of credit and credibility.

Nor, in a modern economy, need any special measures be taken to ensure that the workers have food and that the factory builder has materials. One way or another, everyone in a civilized society will have food to eat whether there are jobs or not; no farmer plants an extra row of beans just because someone gets a job. Likewise, steel makers and brick manufacturers organize their output in as steady a flow as they can manage.

Primary suppliers and their bankers have faith that the economy will advance at a certain rate, and the rate includes the actions and the needs of entrepreneurs.

In sum, no one has to save money, and no one has to save things. Saving is a mere residual.  Consequently, all the palaver we’ve listened to about saving for the past quarter century is beside the point. Worse than that: It has caused grave distortions of the economy.

First, there is the question of what happened to all the tax reductions that were made to encourage saving. The saving wasn’t needed; so it didn’t occur. Yet the tax reductions did occur, as the deficit is our witness. Where did the money go? A good bit of it went into consumption; that’s what fueled the so called recovery. The lion’s share, however, has gone into speculation. The stock market boom has been paid for partly with tax dollars, partly with the borrowings of speculators (for banks lend the same sort of money to speculators as they do to producers), and partly with the trade deficit, whereby others (mainly Japanese, Germans and Taiwanese) have traded their goods for shares in our industries and infrastructure.

Second, there is the question of how the tax reductions were distributed. Like traditional economies, bastard Keynesianism reasons that in order to expand production, you have to expand saving, and therefore you must get more money into the hands of savers. Who are the savers? Those who don’t need the money, of course. Those who need money obviously will spend it; they can’t afford to save. So the tax breaks, in a steady stream, have gone to the rich. The poor, especially, the way it happens, the working poor, have got the short end of the stick. Even those properly dropped from the 1987 tax rolls are merely the people who had been improperly added to the rolls back in 1981.

AS NOTED, the so-called recovery (Y) has been fueled by consumption (C). Neither Y nor C is a residual, for production and consumption are implicit in the simplest economy – in life itself. If consumption were greater, the recovery would be greater. Consumption would be greater if tax benefits went to the poor, who would spend them, rather than to the rich, who pour them into speculation. Reaganomics has not only rewarded the rich for being rich and punished the poor for being poor; its transmogrification of greed from a deadly sin to a virtue has so skewed the rewards and opportunities of our economy that one fifth of our people and one-fifth of our industrial capacity are either underutilized or not utilized at all.

Well, Reaganomics is not to blame for all our troubles; it has merely aggravated them geometrically. The time is out of joint and will not easily be set right. As I have said several times in this space, some sort of employee ownership will be necessary. I say “some sort”  because many proposals have been made. The sad truth is that they are scarcely noticed either by those who claim to be experts or by the general public. Characteristically, the standard book review media don’t pay attention to proposals that are made in book form. I don’t find this aloofness a point in their favor.

While you may have heard of Schumacher’s Small is Beautiful (though not likely from your favorite reviewer), I’ll wager you’ve never heard of Democracy and Economic Power by Louis O. Kelso and Patricia  Hetter Kelso, published last fall, or of their earlier book, Two-Factor Theory: The Economics of Reality. But TwoFactor Theory is one of the few books that have made a difference in the world. It launched the ESOP movement in 1967. What is an ESOP? It is an Employee Stock Ownership Plan. Former Democratic Senator Russell Long of Louisiana successfully sponsored the scheme in Congress in 1974, and now there are more than 7,000 plans in effect, covering some 10 million employees.

I have a reservation about the ESOP law as it is currently drawn and several more about extensions proposed in the Kelsos’ new book, but they’re relatively unimportant. The Kelsos’ is the only game in town that is actually being played. What they have done and what they propose are of the utmost importance to the general welfare. Theirs are books that every good citizen should read and ponder.

The New Leader

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