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Lies We’re Being Told: Interest is Consumption, Saving is “a Negative Act”

by John Rubino on February 2, 2010 · 15 comments

The latest piece of deep thought from iTulip’s Eric Janszen explains why, if the recession is over, so many people remain in such bad shape. More specifically, how can U.S. GDP be up by a robust 5% when oil imports and rail traffic are down and unemployment is still rising? The answer, in a nutshell, is that once again we’re being conned. Get this: Washington defines interest on credit card debt as “consumer spending” and adds it to GDP. So as debt soars, the gap between what we spend and what we actually receive grows, but the economy appears to improve. Eliminate that accounting trick and the numbers look like most people feel, very bad and getting worse.

Here’s a small but crucial part of Jansen’s argument. A couple of acronyms that might require explaining are FIRE, which stands for “finance, insurance, and real estate”, the industries that come to dominate an economy during the late stages of a credit bubble, and PCE, which stands for “personal consumption expenditures”.

Retail Sales measures sales of goods by retailers to consumers. Goods PCE measures the purchase of goods by consumers, plus the imputed interest payments on the debt taken on by consumers when they use credit to purchase these goods.

What you are looking at above is a Productive versus FIRE Economy comparison, the impact of the rise in the use of credit by consumers to purchase goods, and also home price inflation, since 1959. Note that the inflection occurs, as other charts we have shown you over the years, around the time of the end of the international gold standard and birth of the FIRE Economy in the early 1970s.

Notice also the impact of compound interest on the shape to the Goods PCE curve compared to the linear growth shape of the Retail Sales curve. The chart shows a layer of FIRE Economy sitting on top of the Productive economy, approximately $1.5 trillion in PCE on top of $2 trillion of Retail Sales in Dec. 2009 on an annualized basis. It is, as far as we know, the first chart that depicts the additive impact FIRE Economy to the Productive Economy.

While the FIRE Economy has largely recovered, the “real economy” remains sick.

How did we devolve from an economy based on making real things to one in which “imputed interest” is officially counted as wealth? According to the Future of Freedom Foundation’s Gregory Bresiger, Keynes did it:

If this latest stimulus package fails, candid Obama supporters — like realistic Roosevelt supporters reviewing his sorry economic record decades after the fact — will claim that it failed, not because of the philosophy behind it, but because it wasn’t big enough. But what is the growth philosophy that the United States now depends on instead of the once-traditional pro-saving approach? Supporters of more of the same Keynesianism — although it is depicted as “change” — constantly cite some form of the “paradox of thrift.”

Attacks on saving
This paradox is a very old concept. It was famously advocated by Keynes in the 1920s and 1930s. However, he actually filched the idea from inflationists such as the 18th-century philosopher Bernard Mandeville and the Edwardian journalist J.A. Hobson.

Still, this “spend-now, anti-savings” idea seemed very new when Keynes revived it in the 1930s. He approvingly quoted Hobson’s Physiology of Industry in his own famous book, The General Theory of Employment, Interest and Money. According to Keynes,

[Saving,] while it increases the existing aggregate of capital, simultaneously reduces the quantity of utilities and conveniences consumed; any undue exercise of this habit must, therefore, cause an accumulation of capital in excess of that which is required for use, and this excess will exist in the form of general over-production.

Keynes contended that saving prolongs a recession while spending reverses it and produces a boom. The boom can go on as long as the government keeps spending and inflating. Keynes made these arguments in The General Theory, which was published in 1936.

Oversaving caused and prolonged the Great Depression, according to Keynes and his followers, because it hurt mass buying power. Economic inequality was also a problem in the 1920s, he believed. This is one reason that Keynesian Obama in 2009 seems as determined to redistribute wealth as he is to restore prosperity. He embraces the Keynesian argument that economic inequality, aggravated by too much savings, causes depressions or recessions. Ergo, today’s deep recession can be corrected only by government action.

Too much saving can also block recovery, Keynes warned in The General Theory. “The more virtuous we are, the more determinedly thrifty, the more obstinately orthodox in our national and personal finance, the more our incomes will have to fall.”

No one should be surprised that Keynes questioned thrift on economic grounds. His definition of it, in a work of his a decade before The General Theory, claimed it was “negative.”

“Saving,” he wrote in his Treatise on Money, “is the act of the individual consumer and consists in the negative act of refraining from spending the whole of his current income on consumption.”

“Negative act”?

The savings issue for Keynes was also cultural. Before he wrote The General Theory and before the Great Depression, he was arguing that oversaving hurt society in countless big and small ways.

For example, in The Economic Consequences of the Peace, a scathing critique of the Treaty of Versailles after World War I, Keynes compared the building of the railroads in the 19th century to the building of the pyramids in Egypt by slave labor.

The passion to accumulate savings, to make one’s property bigger — and, using Keynes’s analogy, to bake a bigger cake without ever eating it — became a fetish in the 19th century. It hurt the standard of living in myriad ways, he argued.

“The duty of saving became nine-tenths of virtue and the growth of the cake the object of true religion,” he wrote. “There grew round the non-consumption of the cake all those instincts of Puritanism which in other ages had withdrawn itself from the world and neglected the arts of production as well as enjoyment.”

{ 15 comments… read them below or add one }

John Havey February 2, 2010 at 2:18 pm

Maybe we need a statistic called “GDI”–gross domestic illth. Someone coined “illth” as the opposite of wealth. It could include interest payments, auto collision claims, disaster insurance claims, and medical expenses. Even better might be to measure wealth instead of production. That would get at the residue of “production” that was worth something. GDP counts the rebuilding of New Orleans without noticing the destruction that preceeded it. Wealth would count both the loss and the rebuilding.

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Bruce C. February 2, 2010 at 3:07 pm

A girl friend of mine once said, “The next time I’m introduced to some one who’s considered a genius I’m running the other way.” I’ve never understood why so many philosophers, politicians, and economists who are not only wrong, but perversely so, are considered “brilliant”. Marx, Kant, Mussolini, Hitler, Woodrow Wilson (oh yes), Lenin, Castro, et al. Incredibly energetic proponents of bad/destructive/wrong ideas. Outside of academia, people who “get it wrong” regardless of their intentions or effort or how much they repeat themselves are never called that. Warning: Obama is now being called “brilliant” (since his State of the Union address was so bad.)

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JB February 2, 2010 at 3:48 pm

They, those you mentioned, are only considered “brillian” by the next wave/generation of the same ilk. They all go to the same schools and all study the same text books. Best to avoid them and try and look after oneself and one’s family. Listen to Mozart, drink red wine, read a lot and work and save as best one can whenever one can. Plus hope for the best.

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Hamsterfist February 2, 2010 at 6:07 pm

I thought a key part to Keynesian philosophy, and noticeably absent from this article, is tying the U.S. currency to gold. Then you tie all other currency to the dollar, thus helping fight off inflation. But if I recall correctly a little guy name Nixon took the U.S. off the gold standard. Coincidentally enough all the troubles now facing the U.S. seemed to begin around the same time. Without mentioning this fact about Keynesian economics that author is blindly misleading you. It is about so much more then borrow and spend. But whatever.

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kojacq February 2, 2010 at 7:14 pm

This linear thinking, for which Keynesians & Friedmanites excel at, will be the dearth of human kind.

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Daniel de Paris February 3, 2010 at 5:56 am

Of course, the current economies of US and continental Europe are completely different animal than their counter part of say 1880 to 1940.

What Keynesian economists have willingly ignored that the western citizen is now more of a consumer than a citizen. Bombarded by marketing since inception, one can not refrain from consuming. It is now embedded into the very nature of our societies.

Only those a bit older and with a critical view on this massive change in base behaviour can tackle what is happening now.

The countries that provides capitalism to our world, UK and the US, have just hollowed out their “capital” base via consumption.

The Keynes argument could certainly be applied to China. Not to our countries. Of course Krugmanites will not like it. But the truth is that ECONOMICALLY SPEAKING to-days US bears more resemblance with the 1867 Austro-Hungarian Empire than with the very same US during the thirties.

Your parochial gallic “Jacques Rueff” reader

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Edward Ulysses Cate February 3, 2010 at 8:21 am

Lies we’re being told, as your title states, is simply so that those in position to plunder can continue doing so. One’s common sense says that if they didn’t lie and steal so much from each of us, there would be more trading of labor, which would create and sustain more jobs. The drones have simply stolen too much too quickly. The rest of us are on to them now. Labor + Raw Materials = Wealth.
Trading paper instruments only re-distributes that wealth from workers to drones. Workers don’t see it simply because they were lied-to-by-omission in government, education and religion. Example:
When plunder becomes a way of life for a group of men living together in society, they create for themselves in the course of time a legal system that authorizes it and a moral code that glorifies it.” … Frederic Bastiat (1801 – 1850)
I’m 62. I only discovered this quote, Bastiat and his text “The Law” a few days ago. It should have been taught to all citizens before one graduates from high school. I’m aware many others know of this. I’m just disappointed that only now I’ve come across it. Sort of sums up our economy, no?!

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derryl February 3, 2010 at 2:05 pm

Actually when you look at a national economy from a cash flow perspective Keynes is entirely correct. Classical economics describes a barter economy where it is assumed that the production of goods creates its own exchange medium by which to trade or sell the goods (Keynes actually noted this in his General Theory; I am not a Keynesian, but I will give credit where it is due). But in a monetary economy there is no direct relationship between the quantity or value of goods produced and the amount of money in the system. In a money economy goods values and the exchange medium (the money) are 2 entirely separate systems.

Businesses “invest” by paying money to their workers and suppliers. Those payments are the business’s “costs” but they are the worker’s and the supplier’s “incomes”. So Costs = Incomes. Governments will tax some of those incomes and redistribute them to other people, so tax-and-spend government changes the distribution structure of incomes but not the gross amount of income. It remains true that business’s costs = national income.

When those workers and suppliers buy the goods that the business produced, those sales become the business’s income. So from the business’s perspective, Spending = Income.

If a nation’s business’s spend a trillion dollars producing goods, then they have collectively spent a trillion dollars of spendable incomes into the economy as their “costs”. But if they expect to earn a 10% profit then businesses will put $1 trillion + 10% of “prices” into the economy. Where does the money come from to collect as profits?

Besides business spending, consumer debt spending puts incomes into the economy. A homebuyer borrows $300k and spends it on a house, where the money becomes incomes to all the builders and suppliers of the house construction and sale. So there are 2 sources of incomes in an economy (3 if you want to double-count and add government redistribution): business investment spending and consumer debt spending. QE adds a 3rd source of spending-incomes, when central banks create money to buy bonds and governments spend the money.

Either way, Spending = Incomes. When people remove money from the spending-income stream as “savings”, and if people are saving at a time when money supply is not growing by people taking out and spending more debt-money, then you get Keynes’ “paradox of thrift”. Reduced spending causes reduced incomes which leads to more reduced spending, etc., down the deflationary spiral. To see the mechanics of a money economy (i.e. not a barter economy), you have to look at it from a cash flow perspective. Once you do that the arithmetic is simple.

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Jason C. February 3, 2010 at 6:08 pm

The paradox of thrift. I remember an economics teacher (Keynesian) who actually believed in the paradox of thrift. It seems logical in the short term to believe that if everyone saves at the same time, economic activity will diminish and a recession will ensue. Being that Keynesianism is the false religion of economics (a short-sited one at that), it fails to look beyond its own nose into the future to see that increased savings is one of the ways in which economic growth is sustained. So unless everyone saves by stuffing their mattress with $100 bills, that savings will exist in a bank to be lent to those with production in mind. Won’t that create jobs? It’s production that creates wealth, not consumption. And yes, Keynesian enjoys government sponsorship because it gives governments the excuse to deficit spend without feeling guilty about the long-term damage it does to living standards.

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Brad Thrasher February 4, 2010 at 12:33 pm

I don’t need to know anything about economics to know that Gregory Bresiger is wrong.

My Aunt Fran taught me it is both rude and cowardly to speak ill of the dead. The fact that Mr. Bresiger does so, while claiming some superior moral authority as to the virtue of savings merely suggests, as my Aunt Fran would say, “He butters his toast with our cheap money. And there’s no cheaper money to a banker than the money we put in our savings accounts.”

Aunt Fran was right, up until the Fed started giving the stuff away.

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Chris S February 4, 2010 at 9:22 pm

FDR effectively removed the individual citizens from the gold standard in 1933. After his executive order and subsequent legislation to make it legal, the federal reserve notes were no longer notes in the actual sense. A person could not exchange them for gold at a local bank. Nixon (not that I am defending the man) was forced into a corner by the actions of France under Charles De Gaulle, Spain, and a few other nations who starting in 1960′s, began to exchange their dollars for gold bullion from the national treasury. The United States had been printing more “notes” than they had bullion and the French called us on it. (Time Magazine February 12, 1965) The Fed had followed the same pattern of self destruction that had plagued banks from their inception in the 1600′s. Keynesian economic theory is flawed in a singular and most glaring sense. The death spiral starts as soon as you do what he advised. The instant a government relies on continual debt loads to cover bad behavior, is the instant that those debt loads will continue to grow indefinitely. During a boom those of the bad behavior sort spend the “surplus” in all facets of life, during bust, those in charge spend to end the downturn.
The problem is that we no longer produce. Under the Keynesian theory, the dynamic money stream would have to reflect a dynamic economy. As the economy grows, so does the reserve of cash. As the economy shrinks, so does the reserve. That is what the fed is supposed to be doing with interest rates. However under the Keynesian model so skillfully followed under FDR, and every other administration, Instead of the money supply following the dynamic economy it assumes a dynamic money supply with a static economy.

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Paul February 7, 2010 at 2:59 pm

Derryl,

Where your argument fails spectacularly is in the assumption that Labor/Production/Inventories & Cash are all part of a closed loop (Insular) Financial economic system. What you (And more likely Keynes) have glaringly failed to factor in is income derived from export sales.

Workers are free to save all they want (Or indeed spend without the risk of incuring credit charges) without any ‘Negative’ detriment to their own economy if what they produce is of value to purchasers abroad.

One doesn’t need to do much research to discover that the Chinese population are being actively encouraged by their own government to purchase Gold/Silver (Savings), all while their economy continues to grow, and their standard of living increases. Because they produce.

Western economies that rely solely on local service industries to employ workers and credit cards/housing equity for spending to ensure GDP growth, but in turn don’t produce anything of worth, are by definition, doomed to a debt burdened burn-out. It’s simple 1st grade stuff.

Keynsianism is, by any other name, a pyramid economy, a Ponzi scheme.

And all Ponzi schemes fail in the end.

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Ken February 8, 2010 at 8:56 pm

Paul is right.

“Businesses “invest” by paying money to their workers and suppliers. Those payments are the business’s “costs” but they are the worker’s and the supplier’s “incomes”. So Costs = Incomes. Governments will tax some of those incomes and redistribute them to other people, so tax-and-spend government changes the distribution structure of incomes but not the gross amount of income. It remains true that business’s costs = national income.”

- this doesn’t work if the workers and suppliers are in China. Those costs = incomes are not in the US so all the rest of your argument becomes moot.

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Bill Jones February 13, 2010 at 6:11 pm

John Havey: What’s wrong with GDD- Gross Domestic Destruction?

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larry morris February 19, 2010 at 6:08 pm

the only reason they want you too spend all your money is so that you are always broke, they can not steal your money if you are saving some on it I’m old enough too see that everyone in office has but one notion and that is to lie too you and that is why they are not to be trusted ever.

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