The Truth About Savings and Consumption

We regularly hear how important consumer spending is for the economy. The story goes like this: the more consumers spend, the more money circulates in the economy, which stimulates healthy job growth and profits. If people could be encouraged to go out and spend a little more of their paycheck, we'd all be better off.

Keynes went as far as to say that individuals saving their money may actually be hurting the economy, as saving reduces "aggregate demand" and therefore company revenue. Sounds troubling, doesn't it?

Fear not. You aren't actually hurting anyone by filling up your piggy bank. In fact, savings help the economy, as they make lending to productive entrepreneurs possible. The consumption that we enjoy is only made possible by prior production. And that production is only made possible by savings.

Original source: feeseminars YouTube channel.

Translated by Savo Gajić

(see video below transcript)

Transcript:

We've all heard that consumption and spending grow the economy. Turns out that's wrong. In fact, the exact opposite is true. It is savings and production which make the economy grow, not consumption and spending. Here's a fact: society wouldn't become wealthier if everyone just ran out and bought boats and houses, and cars. If that were true, the larger everyone made their credit card debt, the wealthier we'd be. Something seems fishy.

Think about it this way: a healthy economy is made up of goods and services people want. If we want to understand why some economies have a lot of goods and other few, we have to ask just how does the amount of goods in an economy grow? In one word: production.

Let's look at a family farm. How much food they produce depends on how much they work. When they work, the total amount of food increases. When they eat, the total amount of food shrinks. This consumption isn't a bad thing. It's really the whole point of working in the first place. But if they want to sustain themselves, their production must outpace their consumption.

If they decide to build a plow to help increase their productivity with the plow they could produce twice as much in half the time. Well, plows don't just pop out of thin air. It takes time to make them. And while it is being constructed, those workers won't be producing any food. They'll just be consuming it. That means they'll need to save enough food beforehand to eat while they work. Without those savings, there's no way for them to take time to build the plow. They'd run out of food. Once it's finished, they can produce more efficiently, and the total amount of goods will grow. On top of that, because they no longer have to worry about starving, time is freed up. They can now choose to produce other goods or services, or just relax and enjoy their free time. And this is what happens in a large scale economy.

Factories and bulldozers don't just pop out of thin air either. They have to be constructed with a pool of savings as well. Here's how it works: in a free market, when people save their money and don't spend it, capital piles up in banks. In turn, this money is lent to entrepreneurs who use it to purchase or create equipment which expands their business and increases their level of production. And get this: the more goods that are being produced, the more savings that become available. As this pile of savings grows, even larger loans become available to even more entrepreneurs. This makes an economy grow exponentially. All of this is made possible only by savings. Without it, there wouldn't be any capital available to borrow, and economic expansion would come to a halt. An economy based on consumption and not production can only last until there are no more goods to consume.

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