Increased savings is Good for the economy.
The most likely forms your increased savings will take won’t hurt the economy and will probably help it. You probably don’t have to worry that your savings will spike the broader economy.
What is Savings?
In a boiled-down, simplistic definition – savings is spending less than the amount coming in via cash-flow. That’s not to say that folks won’t and can’t argue on that definition – often, savings definitions also include the paydown of principal. In that case, savings would be any increase in assets or decrease in liabilities.
Now, often savings is thought of as ‘cash’ savings – whether buried in your backyard, hoarded in your piggy bank, or deposited in a “savings account” (or checking account) at a bank. Oft-ignored is that “investing” in things is really savings as well – although it’s usually funding a business (or real estate, or infinity other things), not cash creating lumps under your mattress… and has increased risk of losing money.
Confusingly, too, ‘savings’ often takes the form of ‘investment’, or at least ‘spending’.
When you deposit money in a bank, the bank doesn’t just put it under its well-guarded mattress… they generally (see the recent exception) lend it out for various things – personal loans, credit cards, mortgages, car loans and the like. That goes for companies too – they ‘invest’ and ‘spend’ on humans – employees – along with capital assets, research and development, and all sorts of other things. They also, of course, invest themselves – in financial assets, and even, yes, cash and cash equivalents(!).
Even governments play a role – consider that a lot of people save in government assets… a lot of government debt is actually held by the public (pdf). The government, in turn, spends that on various things – sure, they service the interest on existing debt, but they spend by proxy through transfer payments, as well as spending on various things – such as the military. And, yes, governments do sometimes invest in the “traditional” way.
Why Would Anyone Consider Increased Savings Bad For the Economy?
It all boils down to a zero-sum theorem known as the “Paradox of Thrift“.
In essence, this paradox makes intuitive sense – your spending is someone else’s income. If you spend $500 a month on eating out, and suddenly stop it – well, that means there are $500 less of your dollars in the local restaurants next month. Multiply that by enough people and the economy falls apart, right? Q.E.D., spend more money, it’s the Patriotic way!
“These [savings] pitfalls are not surprising, given the libertarian-flecked ideology of personal finance. Through its bleary lens, money is sui generis — something that exists apart from human society and actions. The scold focus is solely on accumulating a big enough money pile for oneself, never on the broader economic ecosystem that supports that wealth.”
Obviously, using “libertarian” as a scare-word is a pretty big red flag (“Those liberal hippies! Those conservative warmongers!“) in itself – but the article falls apart on further review.
Mr. Money Mustache needs no defense from our site, but personal finance ‘scolds’ in general see savings as a means to an end… not the actual end itself. And that’s the important part – the point isn’t to die with the most money under your mattress or in a “big enough pile”… that’s ridiculous and probably a deliberate misreading of savings advice. The point of saving starting now is to accumulate enough resources that you’ll be in the driver’s seat as you get older. (And time waters down the options that would otherwise be available to you!)
If you don’t believe me, tell me how a 48 year old couple with 3 kids and no savings can work as long or as hard as a 22 year old recent college grad with no savings… I’ll wait. If you agree with me, I’ll point this out: if the 48 year olds started saving at 22, they’d have a lot more options at 48.
Cooper quotes sources which pretty much directly contradict all of his points. From Steve Randy Waldman, of the blog Interfluidity, Cooper links an article about the “Evils” of savings. But Waldman, too, separates savings into different buckets (!) – calling out banks and governments as poor stewards of your money in light of the Great Recession: “But if you keep your wealth in bank CDs or government bonds, you are a deadbeat.” while simultaneously recognizing that companies with their possibility to fail is how an ‘investment’ is ‘supposed’ to work: “Savers were supposed to be investors who monitored how the wealth they put aside was used to generate future wealth.”. So, shareholders in companies that can fail. Hard to disagree about that.
Waldman’s got a point on the banks & government thing – along with the savers who saved using banks and government debt. Banks screwed up their lending practices, (the royal) we messed up by believing they would be good stewards of our money (in deposits over $100,000 and money market accounts) and the government screwed up by bailing us and the banks out with increased FDIC limits… meaning deposits were (and no longer are) no-risk – well, only as risky as the US itself failing. That’s not how investing is supposed to work – that just encourages further risky behavior, since we’ve got insurance in the form of Uncle Sam bailing us out.
I mean, how many of you really believe “Too Big to Fail” was a common phrase before 2008-2009? How about Moral Hazard? Cite sources, please.
Federal Reserve Chief Janet Yellen has written about the Paradox of Thrift as well – in the form of the ‘paradox of deleveraging‘ (closely related), where unwinding bad loans caused decreased investments across the economy as even the relatively responsible companies and savers cut back even more. But the Federal Reserve party line remains – savings is inherently good because:
“…in the long run, the accumulated money from individual savers is available for capital investment, a situation where businesses borrow to purchase capital (e.g., machinery and technology). Thus, an increase in the saving rate increases capital investment (e.g., investment in machinery for production).”
Cooper’s article is thoroughly debunked at this point – savings is a good thing because individuals who might not be all that productive with their assets are really investing those assets in people and institutions which have the ability to be more productive – like companies, and (maybe?) governments and banks.
In my one sop to the original argument: if you are only investing in your checking account or burying money and gold in the backyard and can convince a lot of other people to do the same? That’s likely a bad thing for the economy (especially if you think banks are bad stewards of your money).
Cooper doesn’t acknowledge this distinction between unproductive savings and other forms of savings, and even links a story of his own struggle to invest in the stock market – he hasn’t yet invested in any stocks or mutual funds, but apparently keeps a lot of his own assets as cash. He makes some valuable points about some mutual funds being confusing or, perhaps, taking too much money – but, Mr. Cooper, if you’re reading, we’d love to help you take charge with passive investing – set it and forget it. (We’d love to see you taking advantage of your 401(k), especially in a broad index fund with low fees.)
Mr. Money Mustache, on the other hand (and most finance writers, present company included!), is a huge believer in investing – he puts his money where his mouth is and invests in companies, which invest it on his behalf in capital, people, R&D, and spending. (Verdict: not evil.)
Other Problems With the Paradox of Thrift: “The Long Run”
John Maynard Keynes, probably the most important economist to our current-day economic understanding (for better or worse – and if not the most important policy wise, at least in our policy debate), is credited with popularizing the Paradox of Thrift.
However, Keynes also once said this: “In the long run, we’re all dead.” His concerns with the effects of excess savings lead to his ideas on active government support for the economy: basically, when the general population stops spending, government should step in to fill its place (in the Keynesian view, if we all increased our savings rate to 50% overnight in the scenario posed by Cooper in his article, the government would step in and spend money on “various things”, stopping a horrible depression).
All of this nihilism-flecked ideology of personal spending ignore that there is a life-cycle aspect to all of this savings and spending. Cooper may claim Social Security is a success, but the fact remains: it was always meant to be supplemental, and when it is relied on it really only allows spending on the true necessities and not much more. We finance writers are generally read by a younger audience – folks in their 20s, 30s, and 40s who are interested in setting up their future selves with the best possible lifestyle by deferring consumption today.
Here’s the other thing: if death is one of the only certainties of life (taxes being the other), it’s also certain that you can’t take your money with you. It’s going to be spent in the future – on your great grandchildren attempting to live on the trust funds you left them, on you and your spouse when you withdraw it, on a beneficiary of your charity, or even by the government if they can’t figure out an heir (or, again, if they tax it)!
That means all of us “scolds” are saving money today, but we’re really only delaying consumption until some tomorrow. Since we are supplementing our own Social Security (or insert-other-country’s-old-age-payment-program-name-here), we will also have the ability to spend on non-necessities in our retirements! That means people who save now will have the ability to spend that money more lavishly than the spending-scolds when we stop accumulating. Remember: necessities always will be spent on – you can’t eat an iPad, but you do need to eat something, sleep somewhere, have a reasonably temperate room, and wear clothing. Even Mr. Money Mustache agrees – he may have stopped working a day job at 30 to work a web site and other jobs he felt like working (a reasonable retirement for a 30-something), but he himself states his two cars and larger-than-average house are not necessities. And, newsflash: he’s not old enough to take Social Security… he bought these lavish things before Social Security could have even assisted.
That’s right, we’ll now be the first site (that you read today) to use Milton Friedman to rebut Keynes… specifically the Permanent Income Hypothesis (to rebut Keynes’s consumption function). People spread their consumption over a lifetime: student loans beget savings for retirement and to pay off that loan, then wealth drawdowns happen in retirement – a topic on which we’ve produced some original research for your delight.
It’s going to be spent someday.
Don’t Worry About Your Increased Savings Rate! Your Conscience is Clean.
All of that goes to say: assuming that a working age person is ‘evil’ or ‘hurting the economy’ for increasing their savings rate is a bit absurd. Savings almost never means money sitting in a pile – it generally goes to productive means through proxies like banks, companies, and the government. Furthermore, some spending exists as a baseline – people will not stop eating, wearing clothes, heating and cooling their homes, or living under a roof just because it happens to be a recession. And, finally, the majority of people trying to increase their savings are relatively young – when they age, if they followed today’s personal finance advice, they will be spending a lot of money in retirement – a whole lot more than people who spend 100% of their income today.
So, if you were somehow worried that your savings was bad for the broader economy, put it out of your mind. Unless you have your money buried in holes in various fields, your money is likely going to productive activities – even if you only provided the funds without any advice attached to them.
Did you ever consider savings to be evil? Are you planning on spending your money someday, or do you believe your net worth will be posted on a scoreboard somewhere when you die? Do you spend money because you believe that it’s good for the economy? Can you believe people argued increased savings is bad?