The enemies of saving are not through. They begin by drawing a distinction, which is proper enough, between “savings” and “investment.” But then they start to talk as if the two were independent variables and as if it were merely an accident that they should ever equal each other. These writers paint a portentous picture. On the one side are savers automatically, pointlessly, stupidly continuing to save; on the other side are limited “investment opportunities” that cannot absorb this saving. The result, alas, is stagnation. The only solution, they declare, is for the government to expropriate these stupid and harmful savings and to invent its own projects, even if these are only useless ditches or pyramids, to use up the money and provide employment.
There is so much that is false in this picture and “solution” that we can here point only to some of the main fallacies. Savings can exceed investment only by the amounts that are actually hoarded in cash. Few people nowadays, in a modern industrial community, hoard coins and bills in stockings or under mattresses. To the small extent that this may occur, it has already been reflected in the production plans of business and in the price level. It is not ordinarily even cumulative: dishoarding, as eccentric recluses die and their hoards are discovered and dissipated, probably offsets new hoarding. In fact, the whole amount involved is probably insignificant in its effect on business activity.
If money is kept either in savings banks or commercial banks, as we have already seen, the banks are eager to lend and invest it. They cannot afford to have idle funds. The only thing that will cause people generally to try to increase their holdings of cash, or that will cause banks to hold funds idle and lose the interest on them, is, as we have seen, either fear that prices of goods are going to fall or the fear of banks that they will be taking too great a risk with their principal. But this means that signs of a depression have already appeared, and have caused the hoarding, rather than that the hoarding has started the depression.
Apart from this negligible hoarding of cash, then (and even this exception might be thought of as a direct “investment” in money itself) savings and investment are brought into equilibrium with each other in the same way that the supply of and demand for any commodity are brought into equilibrium. For we may define savings and investment as constituting respectively the supply of and demand for new capital. And just as the supply of and demand for any other commodity are equalized by price, so the supply of and demand for capital are equalized by interest rates. The interest rate is merely the special name for the price of loaned capital. It is a price like any other.
This whole subject has been so appallingly confused in recent years by complicated sophistries and disastrous governmental policies based upon them that one almost despairs of getting back to common sense and sanity about it. There is a psychopathic fear of “excessive” interest rates. It is argued that if interest rates are too high it will not be profitable for industry to borrow and invest in new plants and machines. This argument has been so effective that governments everywhere in recent decades have pursued artificial “cheap-money” policies. But the argument, in its concern with increasing the demand for capital, overlooks the effect of these policies on the supply of capital. It is one more example of the fallacy of looking at the effects of a policy only on one group and forgetting the effects on another.
If interest rates are artificially kept too low in relation to risks, there will be a reduction in both saving and lending. The cheap-money proponents believe that saving goes on automatically, regardless of the interest rate, because the sated rich have nothing else that they can do with their money. They do not stop to tell us at precisely what personal income level a man saves a fixed minimum amount regardless of the rate of interest or the risk at which he can lend it.
The fact is that, though the volume of saving of the very rich is doubtless affected much less proportionately than that of the moderately well-off by changes in the interest rate, practically everyone’s saving is affected in some degree. To argue, on the basis of an extreme example, that the volume of real savings would not be reduced by a substantial reduction in the interest rate, is like arguing that the total production of sugar would not be reduced by a substantial fall of its price because the efficient, low-cost producers would still raise as much as before. The argument overlooks the marginal saver, and even, indeed, the great majority of savers.
The effect of keeping interest rates artificially low, in fact, is eventually the same as that of keeping any other price below the natural market. It increases demand and reduces supply. It increases the demand for capital and reduces the supply of real capital. It creates economic distortions. It is true, no doubt, that an artificial reduction in the interest rate encourages increased borrowing. It tends, in fact, to encourage highly speculative ventures that cannot continue except under the artificial conditions that gave them birth. On the supply side, the artificial reduction of interest rates discourages normal thrift, saving, and investment. It reduces the accumulation of capital. It slows down that increase in productivity, that “economic growth,” that “progressives” profess to be so eager to promote.
The money rate can, indeed, be kept artificially low only by continuous new injections of currency or bank credit in place of real savings. This can create the illusion of more capital just as the addition of water can create the illusion of more milk. But it is a policy of continuous inflation. It is obviously a process involving cumulative danger. The money rate will rise and a crisis will develop if the inflation is reversed, or merely brought to a halt, or even continued at a diminished rate.
It remains to be pointed out that while new injections of currency or bank credit can at first, and temporarily, bring about lower interest rates, persistence in this device must eventually raise interest rates. It does so because new injections of money tend to lower the purchasing power of money. Lenders then come to realize that the money they lend today will buy less a year from now, say, when they get it back. Therefore to the normal interest rate they add a premium to compensate them for this expected loss in their money s purchasing power. This premium can be high, depending on the extent of the expected inflation. Thus the annual interest rate on British treasury bills rose to 14 percent in 1976; Italian government bonds yielded 16 percent in ‘977; and the discount rate of the central bank of Chile soared to 75 percent in 1974. Cheap-money policies, in short, eventually bring about far more violent oscillations in business than those they are designed to remedy or prevent.
If no effort is made to tamper with money rates through inflationary governmental policies, increased savings create their own demand by lowering interest rates in a natural manner. The greater supply of savings seeking investment forces savers to accept lower rates. But lower rates also mean that more enterprises can afford to borrow because their prospective profit on the new machines or plants they buy with the proceeds seems likely to exceed what they have to pay for the borrowed funds.
We come now to the last fallacy about saving with which I intend to deal. This is the frequent assumption that there is a fixed limit to the amount of new capital that can be absorbed, or even that the limit of capital expansion has already been reached. It is incredible that such a view could prevail even among the ignorant, let alone that it could be held by any trained economist. Almost the whole wealth of the modern world, nearly everything that distinguishes it from the preindustrial world of the seventeenth century, consists of its accumulated capital.
This capital is made up in part of many things that might better be called consumers’ durable goods—automobiles, refrigerators, furniture, schools, colleges, churches, libraries, hospitals and above all private homes. Never in the history of the world has there been enough of these. Even if there were enough homes from a purely numerical point of view, qualitative improvements are possible and desirable without definite limit in all but the very best houses.
The second part of capital is what we may call capital proper. It consists of the tools of production, including everything from the crudest axe, knife or plow to the finest machine tool, the greatest electric generator or cyclotron, or the most wonderfully equipped factory. Here, too, quantitatively and especially qualitatively, there is no limit to the expansion that is possible and desirable. There will not be a “surplus” of capital until the most backward country is as well equipped technologically as the most advanced, until the most inefficient factory in America is brought abreast of the factory with the latest and finest equipment, and until the most modern tools of production have reached a point where human ingenuity is at a dead end, and can improve them no further. As long as any of these conditions remains unfulfilled, there will be indefinite room for more capital.
But how can the additional capital be “absorbed”? How can it be “paid for”? If it is set aside and saved, it will absorb itself and pay for itself. For producers invest in new capital goods—that is, they buy new and better and more ingenious tools — because these tools reduce costs of production. They either bring into existence goods that completely unaided hand labor could not bring into existence at all (and this now includes most of the goods around us—books, typewriters, automobiles, locomotives, suspension bridges); or they increase enormously the quantities in which these can be produced; or (and this is merely saying these things in a different way) they reduce unit costs of production. And as there is no assignable limit to the extent to which unit costs of production can be reduced—until everything can be produced at no cost at all—there is no assignable limit to the amount of new capital that can be absorbed.
The steady reduction of unit costs of production by the addition of new capital does either one of two things, or both. It reduces the costs of goods to consumers, and it increases the wages of the labor that uses the new equipment because it increases the productive power of that labor. Thus a new machine benefits both the people who work on it directly and the great body of consumers. In the case of consumers we may say either that it supplies them with more and better goods for the same money, or, what is the same thing, that it increases their real incomes. In the case of the workers who use the new machines it increases their real wages in a double way by increasing their money wages as well. A typical illustration is the automobile business. The American automobile industry pays the highest wages in the world, and among the very highest even in America. Yet (until about 1960) American motorcar makers could undersell the rest of the world, because their unit cost was lower. And the secret was that the capital used in making American automobiles was greater per worker and per car than anywhere else in the world.
And yet there are people who think we have reached the end of this process, and still others who think that even if we haven’t, the world is foolish to go on saving and adding to its stock of capital.
It should not be difficult to decide, after our analysis, with whom the real folly lies.
(It is true that the U. S. has been losing its world economic leadership in recent years, but because of our own anticapitalist governmental policies, not because of “economic maturity.”)