The Way the World Works

[Lone Wolf]

Lone Wolf, I think you are imagining a world very different from our own. Your imaginary world is a world without banks and a world where in the absence of banks people with stuff they needed to sell wouldn't offer credit.

Offering credit is just another form of loaned savings.  The only difference is who issues it (my pal stone or the store.)

Imagine that stone buys the widget-maker for me, then sells it to me with "on credit".  This is the same transaction that I described earlier.  Savings is still required.

I acknowledge that in the real world we have fractional reserve (and you do not hunt emus with your bare hands.)  The principle of savings preceding capital investment, though, remains the same.

[Gumby]

The principle of savings preceding capital investment, though, remains the same.

And where does that initial savings come from, Lone Wolf?

The answer is that it all comes from government spending, as base money. Private bank loans are backed by that base money.

[moda0306]

LW,

http://www.levyforecast.com/assets/Profits.pdf

This might help spark a discussion on truly what the meaning of savings vs investment truly is, and why we might be arguing past each other here.

[MachineGhost]

Not all savings come from political base money.  There's plenty of private forms of money that have no connection to the Federal Reserve System.

I don't like your implication that savings is a creature of the state.  Savings initially comes from excess labor/productivity, not government spending.  Money is merely an alchemy of that excess labor/productivity into a medium of exchange (to be more useful than barter). 

Someone tell me why we have economically-illterate politicians issuing copious amounts of money to monetize our excess labor/productivity?  Is this seriously the best we can do?

MG

The principle of savings preceding capital investment, though, remains the same.

And where does that initial savings come from, Lone Wolf?

The answer is that it all comes from government spending, as base money. Private bank loans are backed by that base money.

[MachineGhost]

I used to correspond with Wannaski before his death.

He did not believe the Federal Reserve should be abolished.  Instead, it should continue to act as a lender of last resort and also target U.S. dollar stability by buying and selling gold reserves, i.e. a gold peg.  That makes much more sense to me than a return to the so-called "gold standard".

The Laffer Curve is an interesting theoretical construct, but it may not apply to the world world.  Despite the differences in marginal income tax rates, the government always collects approximately 20% of GDP as tax revenues.  The free market has decidied that is what is optimal.

Perhaps Wanniski's best contribution was in highlighting how destructive the world's reserve currency was to the ex-imperial nations of Africa dealing with NGO/IMF-mandated socialism.  Along with the flunctuating exchange value of the U.S. dollar, the marginal income tax brackets were punitive and confiscatory, such as a 40% marginal rates hitting on just $1000 USD (think of the purchasing power disparities).  It can be argued that this is a large reason why Africa is such a basketcase, but this still gets very little attention even today (for obvious reasons, the spoiled NGO/IMF types from the West would rather be stuffing their faces in an expensive restaurant and hobknobbing with the ruling elite than actually dealing with the poverty just outside their window).

MG

[quote="edsanville"]
Has anyone else here read the book "The Way the World Works" by Jude Wanniski?  I read it earlier this year, and I found it to be pretty fascinating.  Especially when he talks about a broader definition of what "capital" is.  That part really struck a chord with me.

[/quote

[MediumTex]

Someone tell me why we have economically-illterate politicians issuing copious amounts of money to monetize our excess labor/productivity?  Is this seriously the best we can do?

I think that it probably is.

Throughout history, wise politicians seem to be more the exception than the rule.

I really don't think that the average person realizes what a damaged type of personality that politics attracts.  The average politician is an insecure, ambitious, narcissistic, manipulative, driven, semi-delusional egomaniac.  What kind of policy insights would one expect from such a person? 

[moda0306]

In my opinion, it's the deficit hawk politicians today that have absolutely no idea what they're talking about, as well-meaning as they may (or may not) be.  They constantly use the idea of China lending to us at their own discretion as a reason to be scared of running deficits, and it's a complete fallacy to look at things that way.

"Savings" could be considered any store of value that you've obtained for future use.  Outside of currency, we could be talking about shelter, canned corn, or a lantern, but the typical definition in our society is excess common medium of exchange, or US dollars, since most people aren't in a position to efficiently bartar.

If you remove gov't money, "savings," or store of value, could be anything from a promise to fix a drain, to nonperishable food, to the home you bought.  Investment would be the decision to create and build sustainable value, aka, savings. 

Our currency has value because our gov't, rightly or wrongly, leverages its military/court power to collect taxes in greenbacks.  If $800 billion in QE or $1.1 trillion in deficit spending has zero real value, then neither does any dollar-denominated debt or fiat currency currently in issuance.... none of it is tradable for gold or anything else without legislative fiat.  Why do we just talk about inflation having no real value... NONE of it is valuable if it's all enforced by a gov't promise to punish...

Where it derives its value is its function as a medium of exchange... and a more efficient one than any other, at that.  Much like our freeways, our medium of exchange is not valuable without a productive economy (traffic) to use it... but once we reach a certain point of economic activity, we tend to like efficiency as opposed to 100% government non-involvement.

[MediumTex]

In my opinion, it's the deficit hawk politicians today that have absolutely no idea what they're talking about, as well-meaning as they may (or may not) be.

It was exactly the same in the late 1930s in economic conditions that weren't too different from those we are facing today.

[MachineGhost]

Deficit hawks tend to be Republican who tend to be "against big government" athough we all know in reality they are the biggest hypocrites in the world.  So I don't think those types are going to be understanding how the post-gold political monetary system works.  They're rooted in the "gold standard" scarcity mentality where inflationary deficits would eventually come to a head and force painful devaluations.  It would make more sense to have been a deficit hawk in the PIIGS where they don't have a national currency and don't have a "printing press".

But, theres something to be said for the lack of moral corruption that unproductive government spending seems to bring with it.  Look how far society has decayed in terms of basic skills, values and etiquette since the Great Society started federal funding of education.  That's not to deny many progressive victories, but such did not require having a political money system, did it?

MG

Where it derives its value is its function as a medium of exchange... and a more efficient one than any other, at that.  Much like our freeways, our medium of exchange is not valuable without a productive economy (traffic) to use it... but once we reach a certain point of economic activity, we tend to like efficiency as opposed to 100% government non-involvement.

[stone]

IMO there is an error here that goes WAY deeper than issues about state money or private money. Lone Wolf seems to be entirely denying the whole credit creation of money concept. You also seem to be denying that anyone has any excess potential labour that could be directed to making machines once all desired consumption goods have been made. Please explain how on Earth you explain the MASSIVE excess of M1 over M0 in your explanation of how loans work. It is totally wrong IMO to imagine that credit amounts to loaned savings unless you are ONLY talking about savings in terms of the work done to produce the widget making machine. You seem to say that "fractional reserve" banking is a mere detail. The wider picture of providing goods etc on credit is the whole basis of the real world and entirely invalidates the basis of what you are saying. You are imagining a world with no credit where everyone is working 24/7 producing consumption goods/services. It is so divorced from the real world that thinking about your imaginary world gives an entirely topsy turvey view point.
Money is just an administrative device. It is an administrative device that can either be controlled by the government or not controlled by the government. Lone Wolf's claim about saved money being needed to make machines is wrong IMO irrespective of whether or not there is ANY government.
Lets say I'm a coconut harvester. Each day I finish harvesting coconuts at midday. I can then spend the afternoon making  baskets to put  coconuts in. Using that basket I can finish coconut harvesting at 10am. Investment occurred with no prior saving unless you count  loss of my afternoon leisure time as "saving". That is exactly how real capital investment comes about in our economy too. If we want to add money into the equation, then we can have the same occurring with evenly distributed base money being exchanged to pay for the transactions or have  credit or someone owning everything and directing who does what.
The massive problem we have is that in our economy we can't see the stupid distant consequences of what we do with our money. What we do or don't do with our money inadvertently directs legions of people to stand idle or spend all day touting for work that no one wants done. The only way to cure that is to have much wider wealth distribution IMO.

Lone Wolf, I think you are imagining a world very different from our own. Your imaginary world is a world without banks and a world where in the absence of banks people with stuff they needed to sell wouldn't offer credit.

Offering credit is just another form of loaned savings.  The only difference is who issues it (my pal stone or the store.)
Imagine that stone buys the widget-maker for me, then sells it to me with "on credit".  This is the same transaction that I described earlier.  Savings is still required.
I acknowledge that in the real world we have fractional reserve (and you do not hunt emus with your bare hands.)  The principle of savings preceding capital investment, though, remains the same.

[Lone Wolf]

Lone Wolf seems to be entirely denying the whole credit creation of money concept.
...
Lone Wolf's claim about saved money being needed to make machines is wrong IMO irrespective of whether or not there is ANY government.

All this talk of fractional reserve, M0, M1, saved "money" etc. etc. means that we have gotten a bit disconnected.  When I speak of "savings", I mean real savings, for which money (as you correctly point out) is merely a stand-in.  So let's reset the conversation from that perspective.

Did you notice MediumTex's rhetorical question about whether $50 printed by some bureaucrat represented "savings"?  It's very key that that's not savings.  That's just money that somebody printed up.  The point is that it's not about the "money" per se -- it's about the real resources (aka the "real pool of savings") that this money (ostensibly) represents.  To help make this clear, I'll talk about "coconuts" as our currency since the word "dollars" comes with a huge amount of baggage.  ("Dollars" was a poor choice on my part.)

Lets say I'm a coconut harvester. Each day I finish harvesting coconuts at midday. I can then spend the afternoon making  baskets to put  coconuts in. Using that basket I can finish coconut harvesting at 10am. Investment occurred with no prior saving unless you count  loss of my afternoon leisure time as "saving".

Sure.  Your basket is a simple project and you've easily accumulated enough coconuts in the morning (your savings) to eat in order to get you through the afternoon.

Now imagine that your basket is going to take an entire day to finish.  If you wish to finish the basket, you'll need to have enough coconuts "saved up" to eat tomorrow while you do the work required.

Now let's say that your basket is a huge project, requiring 3 months to finish.  If you have saved up 3 months of coconuts to sustain you through this period, you will finish the project just in time, your savings having enabled your capital investment.  If you do not have sufficient savings, no problem -- I will lend them to you with the understanding that over time you'll be able to pay me back.

In the end, savings enables your capital investment... and in turn, the capital investment (if it is efficient), will leave you with a greater level of savings.  Once, you've paid back "Loan Wolf" of course.  (Which ought to be your very top priority, honestly.)

With me paid back and you growing wealthier all the time, our collective pool of savings gets bigger.  This greater pool of savings will allow you and I to embark on more and more ambitious projects over time, marshaling a greater level of resources.  One day, this will yield such gains in productivity that we'll have an abundance of food, lots of leisure time, and technologies so advanced that they allow us to type away on keyboards to people on other islands about "investment portfolios".  Way to go!

[Gumby]

Did you notice MediumTex's rhetorical question about whether $50 printed by some bureaucrat represented "savings"?  It's very key that that's not savings.  That's just money that somebody printed up.  The point is that it's not about the "money" per se -- it's about the real resources (aka the "real pool of savings") that this money (ostensibly) represents.  To help make this clear, I'll talk about "coconuts" as our currency since the word "dollars" comes with a huge amount of baggage.  ("Dollars" was a poor choice on my part.)

Even coconuts are technically printed. The currency literally grows on trees. That's where the savings come from.

The coconuts that drop from trees are M0.

[moda0306]

LW,

I totally understand your will to start in a world without fiat money and imagine "savings" and "investment" in those terms.  I'd argue, though, that this highlights that it's the real wealth our economy creates, not the financial assets/liabilities used to lubricate the machine, that truly matters.  Financial assets wouldn't even exist if it wasn't for peoples' will to engage in economic activity when they don't currently have enough to offer.

This is perfectly natural, and healthy debt is a sign of a healthy economy.  It means people can put their skills to use without having to be wealthy enough already to start a functioning business.

The problem is, once you enter the fiat currency it can be difficult to imagine how it fits inot the picture... if the $50 isn't real savings then how is any of it?  How is any of our confetti real savings if it's all given value via legislative fiat?

You can't say the $50 is meaningless while holding on to your $50,000 for dear life.  So there's something here that we have to acknowledge, and that is we think the confetti is going to buy us the coconut anyway, so why actually hold coconuts.  Adding $50 to the system will only be "meaningless" if the tree-whompers have knocked all the coconuts of the tree, and there's no more to knock off.  Nobody's going to be able to buy anymore coconuts than before the $50 was printed... because the trees only have so much productive capacity.

But what if people are so used to conducting business in these dollars, but don't have enough to buy coconuts with their savings given the prices that have to be charged to make a profit for the coconut herder... you could have a situation where there are both plenty of coconuts to harvest, plenty of people hungry for coconuts, but neither getting what they want/need because they've engineered their life/business around using $$'s as savings, not coconuts, directly.  Then, adding $50 to the economy will simply create enough savings for someone to buy coconuts that only have to be knocked off the tree.

The big factor with whether the $50 is meaningless or not is whether there are excess coconuts that aren't being purchased.  Currently, we have a lot of productive capacity not being used because people can't/won't barter... $50 in that world will actually mean something.  It would be wrong to think of it as an asset in a vacuum, but it wil allow the hungry man and the coconut herder to meet and engage in commerce.

[stone]

Lone Wolf, the very big problem though is that saving money does not translate into creating capital goods or providing sustenance to people whilst they create capital goods. To go back to the coconuts, imagine I had accumulated far more coconuts than I needed in the hope of selling them to buy a basket. Saving money is like the basket maker deciding to eat fewer coconuts and go hungry so that I'm left with rotting coconuts and unable to buy the basket. You have to start off with actively instigating the investment and shouldering the consequent "saving". Starting off with the saving and hoping that the investment will spring from that just leads to waste.

[moda0306]

Did you notice MediumTex's rhetorical question about whether $50 printed by some bureaucrat represented "savings"?  It's very key that that's not savings.  That's just money that somebody printed up.  The point is that it's not about the "money" per se -- it's about the real resources (aka the "real pool of savings") that this money (ostensibly) represents.  To help make this clear, I'll talk about "coconuts" as our currency since the word "dollars" comes with a huge amount of baggage.  ("Dollars" was a poor choice on my part.)

Even coconuts are technically printed. The currency literally grows on trees. That's where the savings come from.

The coconuts that drop from trees are M0.

Gumby,

We disagree here... Coconuts will have value without a government taxing us... they have an intrinsic value that doesn't have to be dreamt up by the state.  They are real wealth without maintaining a military and IRS and court system.  Like gold, they may serve as a decent medium of exchange.

I think what LW is getting at is that the gov't can not create wealth, so that means, by definition, that the positive value we give to money is theft from the government in some other form.  

I tend to think of common currency like a freeway... no intrinsic value in and of itself, but is only functional as a medium of exchange or transportation, respectively.  Our gov't leverages the power of the court/military system to collect taxes and enforce rules of the road, making these things incredibly efficient compared to the private-sector alternative.

This makes it much easier for people to realize their productive potential.  That's the TRUE asset... our increased productive potential as a result of common, growing medium of exchange and a common transportation system.

[stone]

Accumulating coconuts is investment not saving. Coconut are inventory produced as a way to get money. Saving money is deciding not to buy those already picked coconuts.

[moda0306]

stone,

Savings = investment.  That inventory is savings to the company that knocks down coconuts.

Did anybody read this???  It's very good stuff!!

http://www.levyforecast.com/assets/Profits.pdf

[stone]

moda, I agree that savings=investment. I'm just saying that the TYPE of investment you get when people save money because they have more than they can attend to, is rotting coconuts rather than coconut harvesting baskets. You have to actively go about making baskets to get baskets. Also if there are plenty of coconuts, nothing whatsoever is gained by not eating them before they rot.

That pdf is the one you linked a while back isn't it?

[moda0306]

moda, I agree that savings=investment. I'm just saying that the TYPE of investment you get when people save money because they have more than they can attend to, is rotting coconuts rather than coconut harvesting baskets. You have to actively go about making baskets to get baskets. Also if there are plenty of coconuts, nothing whatsoever is gained by not eating them before they rot.

That pdf is the one you linked a while back isn't it?

Yes it is.

[edsanville]

I have to say this thread has been pretty educational for me.  Everybody in here has made good points and comes to the table with some new ideas.

I think Lone Wolf had a lot of good points.  He's looking at the issue from the point of view that actual goods and services are what matters.  Savings (investment) in the "wild" natural come about by sacrificing current consumption with the hope of using those saved resources (time, materials, labor, etc.) to develop some kind of system (business, invention, etc.) that could provide a better yield of goods and services in the future.

When  the government steps in and prints new money to inject into the economy, of course the net balance of "savings" has increased as measured in terms of the currency.  But no new real wealth was created by the printing press.  I think that, in reality, the only thing that has changed is that the ownership of a small piece of the economy was redistributed from the savers to the bankers. 

In other words, the total real savings has not changed, but its ownership has changed slightly.  In that sense, money printing is like a kind of redistributive socialism that is directed by the bankers who make loans, rather than the government.

[edsanville]

When I say that wealth is redistributed from the savers to the bankers, what I mean is:

Specifically, I'm talking about the savers whose wealth is in the form of the fiat currency (savings accounts, cash, CDs, etc.), not the savers whose wealth is in the form of stocks or commodities.  In this sense, I think money printing hurts the poor more than it hurts the rich, unfortunately.  The poor who have savings, usually have their meager savings in the form of the fiat currency.

On the other hand, money printing probably helps the poor who are greatly in debt.  This is actually kind of disturbing to me, because it seems that the government is sending this message to the poor:

"If you go heavily into debt, we'll be there to help you out.  But, if you're looking out for your future by saving your money in the bank, we're going to have to steal from you to subsidize the heavily indebted."

[edsanville]

I don't think that saving fiat bills is akin to letting your coconuts rot.  Nothing is actually being allowed to rot or disintegrate in the case of a large savings account.

It's like Warren Buffett said...  dollars are just claim checks that can be exchanged for the future products of everyone else's labor.  By saving your dollars, you're telling the economy:

"I don't need anything right now, but I'll get back to you when I have some ideas about what would make a good investment, or what kind of consumption would make me happy."

In that sense, I think savings in the form of currency is actually a way to prevent society's "coconuts" from rotting.  That is, if you consider the consumption of goods and services that aren't really wanted or needed to be a form of "coconut rot."

For example, how many people out there have bought some gym equipment that sits in their house accumulating dust instead of being used?  They thought they would have the willpower to start a good excercise program, but it turns out they didn't have the time, etc.  That would be a form of modern "coconut rot."  Savings fiat currency until you're certain of needing or wanting something is a way to prevent the "rot" of real goods and services, while hedging against the uncertainty of the future, IMO.

[stone]

Edsanville, what you're saying in many ways fits in with what I also said on another thread:-
http://gyroscopicinvesting.com/forum/in ... ic=1972.45
« Reply #54 on: January 10, 2012, 11:11:37 AM »
"moda, I think you are asking about exactly the same phenomenon that makes me dislike the MMT prescription for budget deficits. The government budget deficits put money in at one end. Wealth rises through the system like fat globules in a stew and builds asset prices. It has less effect on wage inflation. Net financial assets build up and there is more paper wealth and so there is more ability out there to buy any labour offered. Another way of saying the same thing is to say that labour has been devalued. Deficits devalue labour.
Paper wealth is just a way to portion up the real world. All that increasing paper wealth can do is redistribute power over other people's time and possessions. It can only create (or destroy) real wealth insofar as it alters how much real wealth people waste or create."

Where I don't follow your reasoning is where you seem to say that net saving across the whole economy doesn't lead to things going to waste. I suppose the distinction may be between net saving and the situation where one person is saving whilst another is drawing down savings. We both agree that such balanced saving and dissaving is all fine and dandy. If everyone saves at once then you do IMO get the situation where the basket maker chooses to go hungry rather than buy the stock of coconuts that the coconut harvester had collected in order to sell to buy a basket. That does lead to waste IMO.
Net saving across the economy is happening on a massive scale at the moment because so much of the asset stock is held by so few people. They can't possible consume the earnings those assets throw off. If they spent the earnings on training people or building capital goods etc then they would loose money because no one could afford to buy the extra production that came from that. So they have to save it up and that is just like the basket maker not buying the coconuts and leaving them to rot instead. The millions of unemployed and underemployed people are our equivalent of the rotting coconuts.

[moda0306]

edsanville,

When there's no excess productive capacity in the economy, pumping more "savings" into it will have the affect you describe.

However, the entire purpose of a fiat currency (vs gold) is to have it grow with the productive capacity of the country.  If our collective balance sheets are keeping us from keeping ourselves fully employed, adding "savings" to the economy will have the affect of adding to the real wealth because people engineer widgets instead of sitting collecting unemployment.

[stone]

This link (spotted by Gumby) has a very thorough description of how our finance system works that clearly sets out how saved money is NOT involved in bank loans:
http://pragcap.com/mmt-and-the-operatio ... ary-system
" Every transaction in a real-world economy affects financial statements of those engaged, and if an economic theory or a posited model is not consistent with how real-world financial statements are affected, then the theory is inapplicable.  A typical example used by MMT’ers is the loanable funds market, which posits a demand for loanable funds and a supply of loanable funds available for the macroeconomy.  This model is simply inapplicable to our current monetary system in which bank loans are created “out of thin air”? without the requirement of prior reserve balances or deposits to “fund”? the loan’s creation.  Completely contrary to the loanable funds model, in fact, the vast majority of bank liabilities have been created by banks simply growing their balance sheets through loans and asset purchases."