Saving, Investing and the Paradox of Thrift

Posted by PITHOCRATES - August 12th, 2013

Economics 101

(Originally published August 27th, 2012)

Healthy Sales can Support just about any Bad Decision a Business Owner Makes

“Industry, Perseverance, & Frugality, make Fortune yield.”  Benjamin Franklin (1744).  He also said, “A penny saved is a penny earned.”  Franklin was a self-made man.  He started with little.  And through industry, perseverance and frugality he became rich and successful.  He lived the American dream.  Which was having the liberty to work hard and succeed.  And to keep the proceeds of his labors.  Which he saved.  And all those pennies he saved up allowed him to invest in his business.  Which grew and created more wealth.

Frugality.  And saving.  Two keys to success.  Especially in business.  For the business that starts out by renting a large office in a prestigious building with new furniture is typically the business that fails.  Healthy sales can support just about any bad decision a business owner makes.  While falling sales quickly show the folly of not being frugal.  Most businesses fail because of poor sales revenue.  The less frugal you’ve been the greater the bills you have to pay with those falling sales. Which speeds up the failing process.  Insolvency.  And bankruptcy.  Teaching the important lesson that you should never take sales for granted.  The importance of being frugal.  And the value of saving your pennies.

Saving and frugality also hold true in our personal lives.  Especially when we start buying things.  Like big houses.  And expensive cars.  As a new household starting out with husband and wife gainfully employed the money is good.  The money is plentiful.  And the money can be intoxicating.  Because it can buy nice things.  And if we are not frugal and we do not save for a rainy day we are in for a rude awakening when that rainy day comes.  For if that two income household suddenly becomes a one income household it will become very difficult to pay the bills.  Giving them a quick lesson in the wisdom of being frugal.  And of saving your pennies.

The Money People borrow to Invest is the Same Money that Others have Saved

Being frugal lets us save money.  The less we spend the more we can put in the bank.  What we’re doing is this.  We’re sacrificing short-term consumption for long-term consumption.  Instead of blowing our money on going to the movies, eating out and taking a lot of vacations, we’re putting that money into the bank.  To use as a down payment on a house later.  To save for a dream vacation later.  To put in an in-the-ground pool later.  What we’re doing is pushing our consumption out later in time.  So when we do spend these savings later they won’t make it difficult to pay our bills.  Even if the two incomes become only one.

Sound advice.  Then again, Benjamin Franklin was a wise man.  And a lot of people took his advice.  For America grew into a wealthy nation.  Where entrepreneurs saved their money to build their businesses.  Large savings allowed them to borrow large sums of money.  As bank loans often required a sizeable down payment.  So being frugal and saving money allowed these entrepreneurs to borrow large sums of money from banks.  Money that was in the bank available to loan thanks to other people being frugal.  And saving their money.

To invest requires money.  But few have that kind of money available.  So they use what they have as a down payment and borrow the balance of what they need.  The balance of what they need comes from other people’s savings.  Via a bank loan.  This is very important.  The money people borrow to invest is the same money that others have saved.  Which means that investments are savings.  And that people can only invest as much as people save.  So for businesses to expand and for the economy to grow we need people to save their money.  To be frugal.  The more they save instead of spending the greater amount of investment capital is available.  And the greater the economy can grow.

The Paradox of Thrift states that Being Frugal and Saving Money Destroys the Economy

Once upon a time this was widely accepted economics.  And countries grew wealthy that had high savings rates.  Then along came a man named John Maynard Keynes.  Who gave the world a whole new kind of economic thought.   That said spending was everything.  Consumption was key.  Not savings.  Renouncing centuries of capitalism.  And the wise advice of Benjamin Franklin.  In a consumption-centered economy people saving their money is bad.  Because money people saved isn’t out there generating economic activity by buying stuff.  Keynes said savings were nothing more than a leak of economic activity.  Wasted money that leaks out of the economy and does nothing beneficial.  Even when people and/or businesses are being frugal and saving money to avoid bankruptcy.

In the Keynesian world when people save they don’t spend.  And when they don’t spend then businesses can’t sell.  If businesses aren’t selling as much as they once were they will cut back.  Lay people off.  As more businesses suffer these reductions in their sales revenue overall GDP falls.  Giving us recessions.  This is the paradox of thrift.  Which states that by doing the seemingly right thing (being frugal and saving money) you are actually destroying the economy.  Of course this is nonsense.  For it ignores the other half of saving.  Investing.  As a business does to increase productivity.  To make more for less.  So they can sell more for less.  Allowing people to buy more for less.  And it assumes that a higher savings rate can only come with a corresponding reduction in consumption.  Which is not always the case.  A person can get a raise.  And if they are satisfied by their current level of consumption they may save their additional income rather than increasing their consumption further.

Many people get a raise every year.  Which allows them to more easily pay their bills.  Pay down their credit cards.  Even to save for a large purchase later.  Which is good responsible behavior.  The kind that Benjamin Franklin would approve of.  But not Keynesian economists.  Or governments.  Who embrace Keynesian economics with a passion.  Because it gives them a leading role.  When people aren’t spending enough money guess who should step in and pick up that spending slack?  Government.  So is it any wonder why governments embrace this new kind of economic thought?  It justifies excessive government spending.  Which is just the kind of thing people go into government for.  Sadly, though, their government spending rarely (if ever) pulls a nation out of a recession.  For government spending doesn’t replicate what has historically created strong economic growth.  A high savings rate.  That encourages investment higher up in the stages of production.  Where that investment creates jobs.  Not at the end of the stages of production.  Where government spending creates only inflation.  Deficits.  And higher debt.  All things that are a drag on economic activity.

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2012 Endorsements: Benjamin Franklin

Posted by PITHOCRATES - October 15th, 2012

2012 Election

Franklin understood Wealth was not Money but the Talent and Ability of the Entrepreneurs and Artisans

Benjamin Franklin was born into the middle class.  A proud member of what he called the middling people.  Entrepreneurs.  And the very definition of what it meant to be American.  Hard-working people.  Who built success based on diligence, frugality and honesty.  People who strived to live a virtuous life.  Even if they sometimes faltered.  Franklin believed doing good works led to salvation.  He believed in God and was tolerant of all religions.  Especially if they were charitable and helped others, making the world a better place.  So when he could he gave back to his community.  And to his country.  He would die a famous rich man.  But he always thought of himself as that middle class printer.  Who worked hard.  And tried to be virtuous.  Sometimes he failed.  But he did a lot of good along the way.

When he arrived in Philadelphia he had only one Dutch dollar.  He secured employment with a printer where he worked with industry and frugality.  From his first days as an apprentice.  To when he was a small business owner.  Later, on a return trip from London, he came up with four resolutions to live a better life.  1.) It is necessary for me to be extremely frugal for some time, till I have paid what I owe.  2.) To endeavor to speak the truth in every instance; to give nobody expectations that are not likely to be answered, but aim at sincerity in every word and action—the most amiable excellence in a rational being.  3.) To apply myself industriously to whatever business I take in hand, and not divert my mind from my business by any foolish project of suddenly growing rich; for industry and patience are the surest means of plenty.  4.) I resolve to speak ill of no man whatever.

When Franklin opened his own business with a partner he put in long hours.  He worked late into the evening (even working overnight when the work required it).  And started work before most others started their workday.  Being a businessman he understood money.  And the cost of borrowing.  He favored the expansion of the money supply to lower interest rates to lower the cost of borrowing for business.  However, he also understood wealth was not money.  But the talent and ability of the entrepreneurs and artisans.  Those middling people who worked with industry and frugality who offered goods and services for sale.  Purchased largely by other middling people.  The basic barter system improved by money.

Franklin believed in Limited Government and worried about too much Social Engineering

When Franklin became a newspaper publisher (i.e., writer/printer/marketer of a newspaper) he refused to become partisan.  In part because he didn’t want to limit his income.  But also for another reason.  He believed in free expression.  And said, “Printers are educated in the belief that when men differ in opinion, both sides ought equally to have the advantage of being heard by the public; and that when Truth and Error have fair play, the former is always an overmatch for the latter.”  Words framed and hung in many a newsroom since.  But he wouldn’t print everything.  He refrained from printing things that were scurrilous.  Immoral.  Or might hurt someone personally.

Franklin believed in rugged individualism.  He worked hard to acquire wealth.  And after he did he helped his community.  He helped organize volunteer fire companies.  Suggested a progressive tax on property to pay for a full-time police force.  Improved the post office.  Organized the Pennsylvania Militia during King George’s War against the French and their Indian allies in America.  (The local militia company elected Franklin to command it but he declined, saying he was unqualified and, instead, served as a common soldier.)  He retired from his printing and media empire at 42.  Set for life financially.  Then he became a scientist.  An inventor.  Then statesman.  With always an eye to detail.  And favored being practical over being rigidly dogmatic.

Franklin believed in limited government.  And had a problem with authority.  But he also believed in order.  And a place for government.  He believed in public-private partnerships and created the matching grant (matching a sum raised privately with an equal sum from the government).  He believed in charity.  Offering a helping hand.  And he was a civil activist.  Always tried to improve his community.  However, he worried about too much social engineering.  And unintended consequences.  Even worried that by helping the poor too much government could make them dependent.  And lazy.  For he built his wealth after arriving in Philadelphia with one Dutch dollar in his pocket.  It was hard work that made his success.  Not charity or dependence.

If Benjamin Franklin were here Today he would likely Endorse the Republicans in the 2012 Election

Franklin would go on to be one of the strongest supporters of Independence from Britain.  He helped edit the Declaration of Independence.  Sat in the Constitutional Convention.  And signed both documents.  As well as the Franco-American treaties bringing the French into the American Revolution.  And the Treaty of Paris officially ending the American Revolution.  He was a Founding Father.  Perhaps as indispensable as George Washington.   So if Franklin were here today what would he think about the country he helped create?  And who would he endorse in the 2012 election?

First of all he would be appalled at the size of the federal government.  Which would be unrecognizable to him from the limited government he helped create.  He would find the taxes and regulations on business suffocating to the entrepreneurial spirit.  Dissuading who knows how many from working those long hours.  Like he did.  He spent his time doing what he loved.  Printing, publishing, writing, etc.  Not hiring lawyers and accountants to help him pay his taxes and comply with regulations.  He would like the cheap credit available to business but he would have been shocked by the level of government spending and the level of the federal debt.  For the federal government is anything but frugal.  And the size of the welfare state, the amount of people receiving federal benefits, would have confirmed his fears about too much social engineering.  The blatant bias in the media would have disturbed his nonpartisan senses greatly.  Finally, being someone who rose from the middle class and built his own wealth he would have been greatly offended by the class warfare in politics today.

So who would Franklin endorse in the 2012 election?  Well, the Democrats want to make government bigger.  They want to increase taxes and regulations.  With Obamacare being a big one that will discourage many small businesses from growing.  The current Democrat administration has been the least frugal of all administrations.  Their spending having even caused a credit downgrade.  Their stimulus bill did not benefit the middling people.  Instead, most of that money went to rich Democrat donors.  They want to increase an already immense welfare state.  Which under the current administration has set a record for the number of people on food stamps.  Other than one cable channel (FOX News) and talk radio most media has a liberal bias.  Where truth and error do NOT have fair play.  And it’s the Democrats that push class warfare.  Who want to transfer even more of the tax burden to the wealthy.  Even though the top 10% of earners are already paying about 70% of the taxes.  While the Republicans want to cut taxes and regulations.  Cut spending.  Shrink the size of government.  And provide a business-friendly environment.  So others may start a business and rise up from the middle class.  Who can then give back to their community.  Like Franklin did.  So it is likely that if Franklin were here today he would endorse the party that was closer to his political and business philosophies.  The Republicans.  And the Romney-Ryan ticket.

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The Federal Reserve, Roaring Twenties, Stock Market Crash, Banking Crises, Great Depression and John Maynard Keynes

Posted by PITHOCRATES - September 25th, 2012

History 101

The Federal Reserve increased the Money Supply to Lower Interest Rates during the Roaring Twenties

Benjamin Franklin said, “Industry, perseverance, & frugality, make fortune yield.”  He said that because he believed that.  And he proved the validity of his maxim with a personal example.  His life.  He worked hard.  He never gave up.  And he was what some would say cheap.  He saved his money and spent it sparingly.  Because of these personally held beliefs Franklin was a successful businessman.  So successful that he became wealthy enough to retire and start a second life.  Renowned scientist.  Who gave us things like the Franklin stove and the lightning rod.  Then he entered his third life.  Statesman.  And America’s greatest diplomat.  He was the only Founder who signed the Declaration of Independence, Treaty of Amity and Commerce with France (bringing the French in on the American side during the Revolutionary War), Treaty of Paris (ending the Revolutionary War very favorably to the U.S.) and the U.S. Constitution.  Making the United States not only a possibility but a reality.  Three extraordinary lives lived by one extraordinary man.

Franklin was such a great success because of industry, perseverance and frugality.  A philosophy the Founding Fathers all shared.  A philosophy that had guided the United States for about 150 years until the Great Depression.  When FDR changed America.  By building on the work of Woodrow Wilson.  Men who expanded the role of the federal government.  Prior to this change America was well on its way to becoming the world’s number one economy.   By following Franklin-like policies.  Such as the virtue of thrift.  Favoring long-term savings over short-term consumption.  Free trade.  Balanced budgets.  Laissez-faire capitalism.  And the gold standard.  Which provided sound money.  And an international system of trade.  Until the Federal Reserve came along.

The Federal Reserve (the Fed) is America’s central bank.  In response to some financial crises Congress passed the Federal Reserve Act (1913) to make financial crises a thing of the past.  The Fed would end bank panics, bank runs and bank failures.  By being the lender of last resort.  While also tweaking monetary policy to maintain full employment and stable prices.  By increasing and decreasing the money supply.  Which, in turn, lowers and raises interest rates.  But most of the time the Fed increased the money supply to lower interest rates to encourage people and businesses to borrow money.  To buy things.  And to expand businesses and hire people.  Maintaining that full employment.  Which they did during the Roaring Twenties.  For awhile.

The Roaring Twenties would have gone on if Herbert Hoover had continued the Harding/Mellon/Coolidge Policies

The Great Depression started with the Stock Market Crash of 1929.  And to this date people still argue over the causes of the Great Depression.  Some blame capitalism.  These people are, of course, wrong.  Others blamed the expansionary policies of the Fed.  They are partially correct.  For artificially low interest rates during the Twenties would eventually have to be corrected with a recession.  But the recession did not have to turn into a depression.  The Great Depression and the banking crises are all the fault of the government.  Bad monetary and fiscal policies followed by bad governmental actions threw an economy in recession into depression.

A lot of people talk about stock market speculation in the Twenties running up stock prices.  Normally something that happens with cheap credit as people borrow and invest in speculative ventures.  Like the dot-com companies in the Nineties.  Where people poured money into these companies that never produced a product or a dime of revenue.  And when that investment capital ran out these companies went belly up causing the severe recession in the early 2000s.  That’s speculation on a grand scale.  This is not what happened during the Twenties.  When the world was changing.  And electrifying.  The United States was modernizing.  Electric utilities, electric motors, electric appliances, telephones, airplanes, radio, movies, etc.  So, yes, there were inflationary monetary policies in place.  But their effects were mitigated by this real economic activity.  And something else.

President Warren Harding nominated Andrew Mellon to be his treasury secretary.  Probably the second smartest person to ever hold that post.  The first being our first.  Alexander Hamilton.  Harding and Mellon were laissez-faire capitalists.  They cut tax rates and regulations.  Their administration was a government-hands-off administration.  And the economy responded with some of the greatest economic growth ever.  This is why they called the 1920s the Roaring Twenties.  Yes, there were inflationary monetary policies.  But the economic growth was so great that when you subtracted the inflationary damage from it there was still great economic growth.  The Roaring Twenties could have gone on indefinitely if Herbert Hoover had continued the Harding and Mellon policies (continued by Calvin Coolidge after Harding’s death).  There was even a rural electrification program under FDR’s New Deal.  But Herbert Hoover was a progressive.  Having far more in common with the Democrat Woodrow Wilson than Harding or Coolidge.  Even though Harding, Coolidge and Hoover were all Republicans.

Activist Intervention into Market Forces turned a Recession into the Great Depression

One of the things that happened in the Twenties was a huge jump in farming mechanization.  The tractor allowed fewer people to farm more land.  Producing a boom in agriculture.  Good for the people.  Because it brought the price of food down.  But bad for the farmers.  Especially those heavily in debt from mechanizing their farms.  And it was the farmers that Hoover wanted to help.  With an especially bad policy of introducing parity between farm goods and industrial goods.  And introduced policies to raise the cost of farm goods.  Which didn’t help.  Many farmers were unable to service their loans with the fall in prices.  When farmers began to default en masse banks in farming communities failed.  And the contagion spread to the city banks.  Setting the stage for a nation-wide banking crisis.  And the Great Depression.

One of the leading economists of the time was John Maynard Keynes.  He even came to the White House during the Great Depression to advise FDR.  Keynes rejected the Franklin/Harding/Mellon/Coolidge policies.  And the policies favored by the Austrian school of economics (the only people, by the way, who actually predicted the Great Depression).  Which were similar to the Franklin/Harding/Mellon/Coolidge policies.  The Austrians also said to let prices and wages fall.  To undo all of that inflationary damage.  Which would help cause a return to full employment.  Keynes disagreed.  For he didn’t believe in the virtue of thrift.  He wanted to abandon the gold standard completely and replace it with fiat money.  That they could expand more freely.  And he believed in demand-side solutions.  Meaning to end the Great Depression you needed higher wages not lower wages so workers had more money to spend.  And to have higher wages you needed higher prices.  So the employers could pay their workers these higher wages.  And he also encouraged continued deficit spending.  No matter the long-term costs.

Well, the Keynesians got their way.  And it was they who gave us the Great Depression.  For they influenced government policy.  The stock market crashed in part due to the Smoot Hawley Tariff then in committee.  But investors saw the tariffs coming and knew what that would mean.  An end to the economic boom.  So they sold their stocks before it became law.  Causing the Stock Market Crash of 1929.  Then those tariffs hit (an increase of some 50%).  Then they doubled income tax rates.  And Hoover even demanded that business leaders NOT cut wages.  All of this activist intervention into market forces just sucked the wind out of the economy.  Turning a recession into the Great Depression.

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Saving, Investing and the Paradox of Thrift

Posted by PITHOCRATES - August 27th, 2012

Economics 101

Healthy Sales can Support just about any Bad Decision a Business Owner Makes

“Industry, Perseverance, & Frugality, make Fortune yield.”  Benjamin Franklin (1744).  He also said, “A penny saved is a penny earned.”  Franklin was a self-made man.  He started with little.  And through industry, perseverance and frugality he became rich and successful.  He lived the American dream.  Which was having the liberty to work hard and succeed.  And to keep the proceeds of his labors.  Which he saved.  And all those pennies he saved up allowed him to invest in his business.  Which grew and created more wealth.

Frugality.  And saving.  Two keys to success.  Especially in business.  For the business that starts out by renting a large office in a prestigious building with new furniture is typically the business that fails.  Healthy sales can support just about any bad decision a business owner makes.  While falling sales quickly show the folly of not being frugal.  Most businesses fail because of poor sales revenue.  The less frugal you’ve been the greater the bills you have to pay with those falling sales. Which speeds up the failing process.  Insolvency.  And bankruptcy.  Teaching the important lesson that you should never take sales for granted.  The importance of being frugal.  And the value of saving your pennies.

Saving and frugality also hold true in our personal lives.  Especially when we start buying things.  Like big houses.  And expensive cars.  As a new household starting out with husband and wife gainfully employed the money is good.  The money is plentiful.  And the money can be intoxicating.  Because it can buy nice things.  And if we are not frugal and we do not save for a rainy day we are in for a rude awakening when that rainy day comes.  For if that two income household suddenly becomes a one income household it will become very difficult to pay the bills.  Giving them a quick lesson in the wisdom of being frugal.  And of saving your pennies.

The Money People borrow to Invest is the Same Money that Others have Saved

Being frugal lets us save money.  The less we spend the more we can put in the bank.  What we’re doing is this.  We’re sacrificing short-term consumption for long-term consumption.  Instead of blowing our money on going to the movies, eating out and taking a lot of vacations, we’re putting that money into the bank.  To use as a down payment on a house later.  To save for a dream vacation later.  To put in an in-the-ground pool later.  What we’re doing is pushing our consumption out later in time.  So when we do spend these savings later they won’t make it difficult to pay our bills.  Even if the two incomes become only one.

Sound advice.  Then again, Benjamin Franklin was a wise man.  And a lot of people took his advice.  For America grew into a wealthy nation.  Where entrepreneurs saved their money to build their businesses.  Large savings allowed them to borrow large sums of money.  As bank loans often required a sizeable down payment.  So being frugal and saving money allowed these entrepreneurs to borrow large sums of money from banks.  Money that was in the bank available to loan thanks to other people being frugal.  And saving their money.

To invest requires money.  But few have that kind of money available.  So they use what they have as a down payment and borrow the balance of what they need.  The balance of what they need comes from other people’s savings.  Via a bank loan.  This is very important.  The money people borrow to invest is the same money that others have saved.  Which means that investments are savings.  And that people can only invest as much as people save.  So for businesses to expand and for the economy to grow we need people to save their money.  To be frugal.  The more they save instead of spending the greater amount of investment capital is available.  And the greater the economy can grow.

The Paradox of Thrift states that Being Frugal and Saving Money Destroys the Economy

Once upon a time this was widely accepted economics.  And countries grew wealthy that had high savings rates.  Then along came a man named John Maynard Keynes.  Who gave the world a whole new kind of economic thought.   That said spending was everything.  Consumption was key.  Not savings.  Renouncing centuries of capitalism.  And the wise advice of Benjamin Franklin.  In a consumption-centered economy people saving their money is bad.  Because money people saved isn’t out there generating economic activity by buying stuff.  Keynes said savings were nothing more than a leak of economic activity.  Wasted money that leaks out of the economy and does nothing beneficial.  Even when people and/or businesses are being frugal and saving money to avoid bankruptcy.

In the Keynesian world when people save they don’t spend.  And when they don’t spend then businesses can’t sell.  If businesses aren’t selling as much as they once were they will cut back.  Lay people off.  As more businesses suffer these reductions in their sales revenue overall GDP falls.  Giving us recessions.  This is the paradox of thrift.  Which states that by doing the seemingly right thing (being frugal and saving money) you are actually destroying the economy.  Of course this is nonsense.  For it ignores the other half of saving.  Investing.  As a business does to increase productivity.  To make more for less.  So they can sell more for less.  Allowing people to buy more for less.  And it assumes that a higher savings rate can only come with a corresponding reduction in consumption.  Which is not always the case.  A person can get a raise.  And if they are satisfied by their current level of consumption they may save their additional income rather than increasing their consumption further.

Many people get a raise every year.  Which allows them to more easily pay their bills.  Pay down their credit cards.  Even to save for a large purchase later.  Which is good responsible behavior.  The kind that Benjamin Franklin would approve of.  But not Keynesian economists.  Or governments.  Who embrace Keynesian economics with a passion.  Because it gives them a leading role.  When people aren’t spending enough money guess who should step in and pick up that spending slack?  Government.  So is it any wonder why governments embrace this new kind of economic thought?  It justifies excessive government spending.  Which is just the kind of thing people go into government for.  Sadly, though, their government spending rarely (if ever) pulls a nation out of a recession.  For government spending doesn’t replicate what has historically created strong economic growth.  A high savings rate.  That encourages investment higher up in the stages of production.  Where that investment creates jobs.  Not at the end of the stages of production.  Where government spending creates only inflation.  Deficits.  And higher debt.  All things that are a drag on economic activity.

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