On Cash Balances and Saving
First, I have to apologize if I have sounded condescending to those who have questioned my views on cash balances and savings. I truly thought I was relaying standard economics–including the views of Austrian economists–and that’s why I was at times impatient with the challenges. However, since one of the leaders of the modern Rothbardian movement, Joe Salerno, is equally baffled by my position, obviously things are not as straightforward as I had assumed.
I am not going to link to the blog posts leading up to our current discussion. There were a lot of things going on, involving Keynes’ theory of interest etc. It will muddy the waters here if newcomers go back and look at those posts.
To keep things as focused as possible, in the present post I will make one major claim: A person’s cash balances should always be considered part of his savings.
To start things off, here was the original thought experiment that sowed so much controversy:
15-year-old Johnny mows my lawn every week, and I pay him $20 each time. Every week, he spends $15 of it going to the movies with his friends, but he puts $5 in a piggy jar on his bureau.
After a year, he has accumulated $5×52 = $260 which he uses to buy a nice watch. Johnny says, “I’m sure glad I consumed less than my income all year, saving $5 per week. Then I used my accumulated savings to buy a watch. I deferred consumption all year in order to buy a nice good later on.”
When I first wrote that, I thought everybody would have to agree with Johnny–surely he was right in classifying his behavior all year as “saving.” Yet to my surprise, some people flat-out denied this interpretation, while even Joe Salerno was not comfortable with my argument. (Note: I’m not certain, but I believe Salerno is actually a lot closer to my position than is, say, Major Freedom or Bob Wenzel. I think Salerno might agree that sometimes cash balances could be construed as part of savings, depending on the use to which the owner puts them. But he never says so, one way or the other.)
So what was it about my example of Johnny, that made Salerno hesitate? He commented:
Unspecified in Murphy’s example is exactly when little Johnny goes to the movies. Let us suppose that he regularly cuts Murphy’s lawn and receives his pay of $20 on Monday and spends $15 going to a matinee with his friends the following Sunday. Everything else remains as specified in the original example. Thus, in order to carry out this plan, Johnny must retain $15 of his weekly income in his cash balance for a full week. The question that immediately arises is whether this would also be considered saving by Murphy. Indeed little Johnny could easily say, presumably without fearing contradiction from his economist-employer, “I deferred consumption all week in order to see a good movie later on.”
Yes, little Johnny could easily say that, and he would be right to do so. Is Salerno denying this?
Let’s think this through. Suppose in addition to hiring Johnny to cut my lawn, I also hire Sally to trim the bushes. On Monday, I give each kid $20. On Tuesday, Sally spends all $20 at the mall with her friends. Johnny, in contrast, spends nothing all week, until Sunday afternoon.
At the movie theater, I see Johnny and Sally trying to buy tickets. Johnny hands over $15 to the guy, getting a ticket and some popcorn. Sally tries to walk in too, but is stopped. Oh no! She has no cash on her, because she spent it on Tuesday. She runs over to me, outraged. But I explain, “Well Sally, you already consumed your $20 back on Tuesday, remember? Johnny, in contrast, saved it until today. That’s why he is able to consume today, while you cannot. He is drawing down his savings, because back on Tuesday, he decided to forgo present consumption in exchange for future consumption five days later.”
Is Salerno challenging the above interpretation? Is there any other answer he could give Sally, besides saying that she had already consumed the $20 while Johnny had not? Next, if Salerno is in fact OK with my explanation, then what is “not-consuming” but “saving”?
Let’s go back to Salerno, to get at the root of the confusion. I think I know why he is resisting my analysis, but his fears are unnecessary. So here’s Salerno:
Now, let’s tweak the example a bit. Let us say that Johnny is always thirsty after he cuts Murphy’s lawn, because Murphy refuses to supply him with refrigerated bottled water and permits him only to drink the warm, coppery-tasting swill from his garden hose. So Johnny routinely goes to the local convenience store and orders a big Slushy for $2 one hour after he cuts Murphy’s lawn. (He therefore foregoes a large tub for a small bag of popcorn at the movies the following Sunday.) But this wouldn’t this be just as much saving according to Murphy, because Johnny holds the $2.00 in his cash balance, refraining from consumption for a full hour?
The broader point that emerges from this analysis is that Murphy is simply defining “saving” as the holding of cash balances. For consider the ineluctable fact that in a monetary economy everyone must retain a money payment in his cash balance for a shorter or longer period of time, whether he intends to purchase an immediately consumable service like a movie or restaurant meal, a consumer durable like a car or a house, or an investment asset of some kind. In other words, all income and spending (on both consumption and investment) must flow through cash balances. It follows from the very nature of money as the general medium of exchange that there is always a lapse of time between monetary receipts and expenditures. Whether it is a matter of hours, weeks or years, money income once received must always be held in cash balances before it can be spent.
As I said, now I think I see why so many people are reluctant to endorse my analysis. It seems like every dollar that is earned in income would be “savings” in my book, and clearly that can’t be right! We all know the savings rate is way less than 100%.
Yet that’s not my position at all. I am claiming that every dollar in cash, is part of someone’s savings. But that’s not the same thing as saying that all income is saved.
To see why, first we have to remember that saving, like income, is a flow variable. So you need to define it for a certain period of time. When an accountant prepares an income (aka “Profit & Loss”) statement, it is for a period, such as “3rd quarter of 2010.” (In contrast, the balance sheet is a stock concept, defined at a particular moment in time. E.g. what did the balance sheet look like, last Tuesday at the close of the business day?)
Let’s say Andrew starts out the month with $20,000 in his cash balances. On the 15th day, he gives a speech and earns $10,000. (Andrew used to be a popular TV host, and now in his semi-retirement just does one-off speaking engagements about once per month.) During the course of the month, he spends $9,000 on rent, groceries, gas, and other consumption items.
So how do I account for all this? I would say that over the course of the month, Andrew’s income was $10,000, and his consumption was $9,000. Therefore Andrew saved $1,000. His savings rate is 10%, not 100%.
Now what form does Andrew’s savings take? If he ends the month with $20,000 in cash, and a newly-purchased bond with a market value of $1,000, then it’s clear he invested this new savings into the bond. On the other hand, if he ends the month carrying cash balances of $21,000, then he still saved, and (I would say) he invested the savings in the form of cash.
Here’s where people are getting tripped up: What happens if we shrink the time period? Nothing changes, except the numbers. The principles are still the same.
For example, suppose Andrew’s first outflow of cash occurs on the 1st of the month, when he goes out to dinner with his lady friend and spends $500. His cash balance drops from $20,000 to $19,500. If we are reckoning in terms of days, not months, then yes, on that 1st day, I would say Andrew lived beyond his means. He dissaved by $500. His income that day was zero, and he consumed $500 worth of goods and services.
In contrast, on the 15th day of the month, suppose Andrew spends $100 on food and other consumption goods. During that 24-hour period, I would say his income was $10,000, while his consumption was $100. So yes he saved $9,900 that day, which is reflected by the jump in his cash balances of an equal amount, from their level the night before.
Of course, during the rest of the month, he dissaves, whittling down the cash balances.
I submit there is nothing odd about these statements, and I invite Salerno or other critics to give me an alternate way of handling it. Yes, it’s sounds a bit weird to talk of dissaving 29 days of the month, and a massive amount of saving on the one day. And that’s precisely why we would normally reckon in terms of months, or even years, when talking about someone’s saving behavior.
(Note that I chose someone who gives speeches, because if a person works at a regular job and just gets paid a paycheck, the accounting is more confusing. Technically the person is earning an income every day he goes to work, and then that accrued asset is given in the form of cash on payday.)
Another point to mention is that not all forms of cash intake are “income” in an accounting or economic sense. For example, if Andrew sells shares of stock for $25,000, making his cash balances go from $20,000 up to $45,000, he hasn’t saved. Rather, he has transformed his savings from one form to another. So the $25,000 in new cash balances are a part of his savings, but he didn’t need to save (in the current period) to acquire them. He had already saved in the past, and invested in the stock.
Salerno then says:
Let us change Murphy’s example one more time to illustrate the point from another angle. Suppose that Murphy is the franchise owner of the local multiplex theater and also a silent partner in a local jewelry store. Assume further that he makes a deal to pay Johnny a voucher for a matinee ticket and concession items worth $15 plus a $5 credit to Johnny’s layaway account for a watch at his jewelry store. In this scenario Johnny receives and holds no cash balances, precisely because money enters the transaction only as a numeraire or accounting device and not as a true medium of exchange; in effect, Johnny’s income and expenditures are simultaneous, i.e., he purchases the movie voucher and layaway account credit instantaneously upon receiving his money. Nonetheless Johnny achieves exactly the same ends on the market—a movie every Sunday and a watch at the end of the year—as he does when he is compensated in money.
Ironically, this seems to play right into my hands; I was thinking of a similar argument to show why I must be right.
Let’s simplify it even further. On January 10th, Johnny spends all day in backbreaking work, painting my barn, cleaning the stables, blah blah blah. I pay him with a voucher that says, “The bearer of this voucher can redeem it for a new watch on December 10th.”
OK, now Johnny clearly earned an income that day, and I would say he clearly saved it. He quite literally exchanged his labor for a future good (the claim to a future watch). So this is clearly saving. Now if Salerno agrees that in many respects, this is equivalent to me paying Johnny in cash, and then him waiting a year to buy the watch…?
Let me close with some questions for those who still resist classifying all cash balances as part of people’s savings:
(1) Cash is a financial asset, and thus part of someone’s capital. So how could it not be part of savings?
(2) Do you agree that the cash owned by a business is part of its savings?
(3) Go back to the case of Johnny, who earns $20 on Monday cutting a lawn. Johnny plans on spending the full $20 at the movies on Sunday. While he’s holding the money in his (now higher) cash balances, I think Salerno wants to say that that $20 isn’t really savings, because Johnny has earmarked it for consumption. But then on the way to the theater Sunday afternoon, Johnny runs into a guy who convinces Johnny to put the money into a CD yielding 100% per month.
So how does Salerno handle this? Clearly, Johnny ended up investing the $20 he earned on Monday. So clearly that income must have been saved; you can’t invest what you haven’t first saved. Yet the decision to invest it occurred on Sunday. Therefore, it seems Salerno has to say that Johnny didn’t save his income from Tuesday to Sunday, at which point he saved it.
How can that be? Johnny obviously didn’t consume the income in the intervening days. So if he didn’t consume it, and he eventually saved it…I want to say he was saving it all along. What would Salerno say?
I know if you have already read the book, but given your views on cash balances (which I mostly agree with) you might be interested in re-visiting Selgin’s The Theory of Free Banking.
I don’t know*…
So what now? The time lag between the deposit of my paycheck and the time when I deplete my cash balance by consuming it (which btw, one may wish to call this time lag “savings” because he is “investing” in his money, and speculating that it will be worth something when it comes time to spend it) means the money is sitting “idle” and can be loaned out?
“A person’s cash balances should always be considered part of his savings.”
I don’t see how this cannot be true, it seems to flow forth from Y-C=S. It doesn’t really matter what you do with it, when you haven’t consumed it, you have saved it, even if you only did so for the smallest possible amount of time. The reason why you did not consume seems quite immaterial to me.
A more simpler question to anyone opposing this true statement would be, how would they classify their deposit account? This is essentially an interest bearing cash balance. Would they deny that it fulfills a consumption smoothing function? Would they deny that it is as liquid as cash?
For those more so inclined, how would they convert the problem into a Max U problem in continuous time? You have only flows there, surely you then have to come to the conclusion that if not C it is S.
As you said Bob, income and savings are flow variables, thus one has to specify the relevant time period. Changing the time period can change how we view either one, but surely, as you say, we tend to think of the relevant time periods as those linked to the frequency with which we get paid and spend, e.g., a month.
I have to admit I thought your perspective here was as obvious as you did.
I appreciate it, Steve, but I think some of my most vociferous critics will take your endorsement as further evidence that I am wrong. 🙂 Sorta like when Gene Callahan agrees with me on something…
Just a small point, about
“Yes, little Johnny could easily say that, and he would be right to do so. Is Salerno denying this?”
I read that part of Salerno’s post as an attempt to fill a gap in the assumptions to proceed with the analysis and nothing more. So no, Salerno isn’t denying that part.
As for the merit, if you just could tell me what is the economic significance of this debate? I mean, we can use whatever definitions we like, as long as we use them consistently, right?
The significance is that Bob is claiming this has an impact on the time preference theory of the interest rate.
I’ve heard that Bernanke’s newest tool is to allow the Fed to raise/lower CoinStar’s cut to help expand/limit cash balance hoarding.
The argument is not over the definition of savings. The original argument from Wenzel is that Keynes uses the term savings with two different meanings within the same passage: (a) both bank deposits and cash holdings and (b) only bank deposits, and switches between the two ambiguously. These two definitions are not equivalent nor are they compatible. Keynes is using two different contradictory definitions within the same thought.
It doesn’t really matter whether we call holding cash balances “savings” or “hoarding” or “pizza” or “blue.” As long as we are agreed on the concept being represented, it doesn’t matter. As Wenzel points out, Keynes does not use the term with consistent meaning within his own writing, which causes the confusion.
Bingo.
No Captain Anarchy, it is Wenzel who is flipping about inconsistently. Keynes said, “Interest can’t be the return to savings, because I can save by holding cash, and cash doesn’t earn interest.”
To refute that, Wenzel said, “Silly Keynes thinks holding cash balances is the same thing as lending out money. What an idiot.”
So Wenzel is wrong; the only way his argument works, is if he denies that holding cash balances is a form of saving.
Let me give an analogy:
Keynes says, “It’s not true that eating meat is always a good idea. For example, if I eat my brother, I will go to jail.”
Wenzel says, “Ha, what a moron! Of course eating meat is always a good idea. To argue against this claim, the fool Keynes supposes that going to McDonalds is the same thing as cannibalism.”
No Captain Anarchy, it is Wenzel who is flipping about inconsistently. Keynes said, “Interest can’t be the return to savings, because I can save by holding cash, and cash doesn’t earn interest.”
To refute that, Wenzel said, “Silly Keynes thinks holding cash balances is the same thing as lending out money. What an idiot.”
That’s not what Wenzel was criticizing or refuting. Wenzel argued that there are three things you can do with money, 1. Hold as cash, 2. Consume with it, 3. Invest it and earn profit/interest.
Keynes treated 1. and 3. simultaneously, as the same thing, and flipped flopped between the two. After equivocating the two, he then declares that “Interest can’t be the return to savings.”
You don’t get paid for holding cash (which Keynes calls savings). You do get paid for loaning out your money (which Keynes also calls savings).
Keynes uses the term savings in these two different senses. He then concludes that you don’t get paid for savings. He then circles around to say you do get paid interest for “liquidity” by which he means for extending out your time preference, i.e. saving your money.
By Keynes’ use of the term savings to mean two different things, he reaches the crazy conclusion that you don’t get paid interest for savings. He then circles back and introduces “liquidity” as the reason interest is paid, which is the Austrian sense of time preference and why you are paid interest in the first place.
Let me give an analogy:
Keynes says, “It’s not true that eating meat is always a good idea. For example, if I eat my brother, I will go to jail.”
Wenzel says, “Ha, what a moron! Of course eating meat is always a good idea. To argue against this claim, the fool Keynes supposes that going to McDonalds is the same thing as cannibalism.”
That analogy fails, because analogically speaking, Keynes should treat eating at McDonalds and eating your brother as simultaneous, as the same thing.
Keynes would say “It should be obvious that the feeling of satisfaction cannot be a return to eating as such. For if a man eats poison, he gains no satisfaction, though he eats as much food as before.”
Wenzel would then say “Keynes here is treating food and poison simultaneously, as the same thing. Austrians would separate food from poison, and say that you only get rewarded for eating food.”
“Keynes treated 1. and 3. simultaneously, as the same thing, and flipped flopped between the two.”
No, he didn’t. He treated them as different species of the same genus.
Wouldn’t saving the money in cash cause the value of cash to go up, other things being equal? If so, does this not present an answer for those claiming interest is the time preference of current goods vs. future goods?
The more I read on this debate the more I find your way of explaining interest the easier to comprehend because of examples like cash balances but I also think the differences are more semantical than anything else. I could be missing some important difference though that your explanation is able to solve that can’t be explained by the PTPT.
Yes! “Wouldn’t saving the money in cash cause the value of cash to go up?” The payment purely for foregoing consumption is the change in the value of money. This is why natural economies (with real money) are characterized typically by deflation. Keyne’s fails to see the inflation rate as an endogenous variable but rather thinks that we can reduce the holding of cash balances simply by causing inflation (a cost to holding cash) through printing increasing amounts of money. And if that happens to also bring about the “euthanasia of the rentier class” then so much the better…
‘m with Dan (above) that I’m still confused on how this all relates interest. I kind of feel like this debate started out with the liquidity preference theory of interest, but now it got side tracked to talking about the definition of savings.
I’ve been pondering this an will give two examples which seems to suggest both time preference and liquidity preference are responsible for interest:
1.) I have $3,000 on hand that I plan on using to purchase a new big screen TV tomorrow. You come to me and ask me to borrow my $3,000 for one year. If I agree to this I am foregoing satisfaction of my wants today for satisfaction a year from now. Obviously, I would only agree to this exchange if I value what I’m getting more than what I’m giving up, i.e. The TV one year from now plus interest.
So this is an example of time preference effecting interest.
2.) I wish to put a $40,000 down payment on a new home. In order to do this I decide to save $10,000 per year for four years. At the end of the first year I have $10,000 in my cash balance. Now of all of the things I can do with this $10,000, I rank saving it for the next three years (for the down payment) at the top of my value scale. Say you come to me and ask to borrow $10,000 for three years. If we assume no risk, why should I object to making this loan? I have no intention to spend this money over the next three years. Time preference, or a desire to consume my $10,000 today, is not affecting my decision. At best according to the PTPT I should be indifferent about the loan no? But there is value in holding the $10,000 in my cash balance because should some unforeseen event occur that would create a need to change my plans and spend the $10,000 immediately, I would be much better off with the money in my cash balance than I would be should I make the loan. Therefore, I will only make the loan if you offer me sufficient interest to compensate me for my loss of liquidity.
Doesn’t this suggest interest in this scenario has nothing to do with time preference and everything to do with liquidity preference?
Are we able to say both time and liquidity preferences effect the rate of interest?
Yes! (see above comment) you just need two prices, one for foregoing consumption and one for foregoing liquidity. As I mentioned above the deflation rate would be the payment for postponing consumption (currently negative and in my opinion, unsustainable due to monetary interference by the Fed) and the nominal rate is the payment for liquidity. Notie that the real rate then equals both payments combined (and will be equal to the MRS between current and future consumption. That is if you believe in MRS….) (=
In his Capital Based Macroeconomics Roger Garrison says, like most macro textbooks, that S=I. If cash balances are considered a part of S then S cannot equal I. Until cash balances are spent we don’t know whether they are C, I, or G (taxes).
I think you can say S=I if you think of it in terms of physical resources. Saving cash would cause prices to adjust downwards and all resources not devoted to the production of consumer goods would be invested. In terms of money S=I would not be possible.
Tom,
Either you agree with Chris Pacia, or you adopt the free banking approach, where fiduciary expansion makes up for increases in cash balances.
Tom, no that’s not right. You are getting mixed up between the stock of savings (which is the size of the cash balance) and the amount of saving during the period.
When we say S=I, that is a flow concept. Over a certain period, if a person’s cash balances go up, then that difference is his saving during the period, and it increases his total stockpile of savings. Because S=I, that means we have to say adding to your cash balances is a form of investment.
Give me a specific example where you think my view means S can’t equal I, and I’ll show you why it does.
Is it possible, in your understanding, for a cash balance, i.e. a stock concept, to NOT also be “saving” over a period of time, i.e. a flow concept?
If not, what exactly is holding cash in a balance?
An excerpt from ‘The Paradox of Interest Revisited’ by Antal Fekete:
“Re-setting the paradigm from exchanging present and future goods to exchanging income and wealth has other important consequences besides disposing of the paradox of interest. It is the point of departure towards a synthesis between the time preference and productivity theories of interest.
It is commonly assumed that an irreconcilable conflict obtains between the two. But as we shall now see, the time preference and the productivity theories are in fact complementary. The instrument of exchanging income and wealth is the gold bond. By definition the rate of interest is that rate which amortizes the market price of the bond by maturity when the face value of the bond falls due. If the bond sells at par, then the rate of interest coincides with the coupon rate. It is higher or lower than the coupon rate according as the bond sells below or above par (so that the rate of interest varies inversely with the bond price).
However, following Carl Menger, we ought to consider not one but two market prices: the higher asked price and the lower bid price. The former determines the floor and the latter the ceiling of the range to which the rate of interest is confined. These two rates are regulated by two independent market processes with different protagonists in charge, as we shall now spell out.
The floor for the rate of interest is determined by the rate of marginal time preference. This is just the rate at which the opportunity cost of holding the bond becomes critical to the marginal bondholder. At the next down-tick in the rate of interest he will sell the bond — in view of his opportunity to carry wealth in the form of a present good, gold, rather than a future good, the gold bond.
The ceiling for the rate of interest is determined by the rate of marginal productivity of capital, that is, the rate at which the opportunity cost of carrying capital stock becomes critical to the marginal entrepreneur. At the next up-tick in the rate of interest he will sell the stock — in view of his opportunity to carry his earning assets in the form of a higher-yielding gold bond. Thus the rate of interest is regulated from below by the arbitrage operations of bondholders between the bond market and the gold market, and from above by the arbitrage operations of entrepreneurs between the bond market and the market for capital stock.
In more details, bondholders will not let the rate of interest go through the floor. In selling their overvalued bonds they will take profit and put the proceeds into gold — until bond prices fall and the rate of interest bounces back to the rate of marginal time preference. At that time they will buy back their bond.
Likewise, entrepreneurs will not let the rate of interest go through the ceiling. They will stop production, discontinue maintenance of capital stock, abolish depreciation quotas, and put their savings into the undervalued bond — until bond prices rise and the rate of interest falls back to the rate of marginal productivity of capital. At that time they sell the bond at a profit and put the proceeds back into capital stock. The persistent selling of bonds at the floor, and the persistent buying of the same at the ceiling, will confine the rate of interest to a range and keep it on an even keel.
Note that the arbitrage of the marginal bondholder between the bond and the gold market lends teeth to time preference as it forces the banks and the government to yield to the wishes of the savers. Without it time preference would remain a mere prayer, just a cry in the wilderness.
Gold withdrawal by bondholders, and also by holders of bank notes or deposits, is not a drawback of the gold standard. Rather, it is its main excellence placing as it does the ability to install or to retire capital, and the power to create or to extinguish money, squarely where they belong: into the hands of the people. It is precisely these spontaneous gold flows that prevent the government from usurping the power to create money, and the banks from usurping the privilege to form capital. The idea that the government can organize debt into currency, and that the banks can organize credit into capital, is pernicious and will ultimately lead to the self-destruction of the monetary system and the economy.”
Comments please.
“I would say that over the course of the month, Andrew’s income was $10,000, and his consumption was $9,000. Therefore Andrew saved $1,000. His savings rate is 10%, not 100%…”
“During that 24-hour period, I would say his income was $10,000, while his consumption was $100. So yes he saved $9,900 that day…”
Notice the contradiction there Bob?
You are claiming that Andrew is earning an income of both $10,000 per month, and $10,000 per day. Why? Because that is the only way your treatment of savings can remain consistent. It’s to “free up” the constraint of time on the concept of income, a flow concept, because consumption is a timeless variable, a stock concept.
THAT confusion is why I say “saving = income minus consumption” is a muddled formula. It should read “cash holding = money received minus money spent.”
Income is money earnings per unit (period) of time, which is flow, while consumption is a single act of spending on consumer goods, which is stock. In order to make the units match, you have to pick an arbitrary period of time of holding cash, which stands as a proxy for the time period of income, which is then lumped into a single timeless variable called “income”, after which you then compare it to an arbitrary single act of consumption, after which you finally then define the difference as “saving.”
Imagine a single act of consuming by buying a consumer good for $100, which you spent out of a prior existing cash balance of $1,100. Now imagine the time period surrounding the consumption act, before and after. Perceive a line representing time, with a dot representing the act of consumption, and then imagine both sides of the dot along the time line, and then in your mind make the size of the line become larger and larger, until you imagine hitting two other dots, one on each side, which represents prior and future acts of consumption, say another $100 for each dot.
Here’s the problem Salerno and I have with your treatment. Your logic forces us to conclude that one micro second in each direction around the original $100 consumption, this is “saving”, and thus the savings is $1,000 / $1,100 = 91%. This savings is applicable to the 2 microseconds surrounding the single act of $100 consumption, so we must say the savings rate is 91% per 2 microseconds, or $1,000 per 2 microseconds. Is there any way an individual can avoid such saving? Not in your treatment.
Let’s now consider 2 microseconds in each direction, for a total of 4 microseconds. The same consumption act now carries a $1,000 / $1,100 = 91% savings, but this time applicable to 4 microseconds, so we must say the savings rate is $1,000 savings per 4 microseconds. This savings rate is DIFFERENT from the first consideration, even though the same history exists, that is, the same distance between consumption acts exists.
Now consider 1 minute in each direction, for a total of 2 minutes. The same consumption act now carries a $1,000 / $1,100 = 91% savings, but this time applicable to 2 minutes, so we must say that the savings rate is $1,000 savings per 2 minutes. Again, this savings rate is DIFFERENT from the other considerations solely because we picked another arbitrary time period.
Now consider 2 minutes in each direction, for a total of 4 minutes. Now it’s $1,000 savings per 4 minutes.
Now consider 30 minutes in each direction, for a total of 1 hour. Now it’s $1,000 savings per hour.
Now consider 1 hour in each direction, and here it just so happens that 1 hour in each direction coincides with prior and future acts of consuming $100. What’s the savings rate now? Now it’s $800 savings per 2 hours.
Here’s the kicker: All we are doing in the above analysis is looking at the time period that cash is held, and treating acts of consumption as boundary points in order for you to generate a constant unchanging quantity of cash holding. If you consider 1 year, then nobody in any of your examples are saving anything. If consider other time periods, their savings range from 0% all the way to 100%, and this is for the same exact histories.
If you admit that an individual would be “saving” 100% of his cash for the 1 microsecond, 2 microseconds, 1 minute, or 30 minutes after an act of consumption spending is made, then all you are doing is DEFINING “holding of cash” as “saving.” Well golly, I’ll just define savings differently! After all, we are free to define things any way we want!
Just look at all what you said above and substitute “cash holding” every time you say the word “saving.” Nothing will change! But by defining the mere holding of cash as “saving”, then it does lead to muddled formulas that lead to confusion, as is evidenced by your “I would respond by saying” contradiction that Andrew earned an income of both $10,000 per month, and $10,000 per day, in order to make income a timeless variable, so that you can compare it to another timeless variable called consumption, to get to a definition of a stock variable of cash holding.
It’s simply baffling to me how you can call savings a flow variable, when cash holding is a stock variable, and everything you have said about “savings” are just statements of someone’s cash balance. You think you are saying anything meaningful outside of “Andrew has a stock $1,000 quantity of cash at this time on this day” when you say “Andrew is saving $1,000 cash per month”? You’re not saying anything other than how much cash Andrew is observed to have when you observe his cash balance. In reality, Andrew can be said to be saving 0% per year, or 100% per microsecond, or anything in between. Depending on when you peak at his balance, you may perceive a different cash balance, but you cannot know what his savings rate is without fudging in an income variable that you treat as a stock variable when it’s really a flow variable. “Andrew has $9,900 in cash? Bah, I’ll just say he earned $10,000 that day and say he spent $100 that day to get a cash savings of $9,900 per day. What’s that? I originally said he earned $10,000 per month? OK, then I’ll just say he earned $10,000 that month and say he spent $100 that day to get a cash savings of $9,900 per month.”
Go back to the case of Johnny, who earns $20 on Monday cutting a lawn. Johnny plans on spending the full $20 at the movies on Sunday. While he’s holding the money in his (now higher) cash balances, I think Salerno wants to say that that $20 isn’t really savings, because Johnny has earmarked it for consumption. But then on the way to the theater Sunday afternoon, Johnny runs into a guy who convinces Johnny to put the money into a CD yielding 100% per month.
So how does Salerno handle this? Clearly, Johnny ended up investing the $20 he earned on Monday. So clearly that income must have been saved; you can’t invest what you haven’t first saved. Yet the decision to invest it occurred on Sunday. Therefore, it seems Salerno has to say that Johnny didn’t save his income from Tuesday to Sunday, at which point he saved it.
I can’t speak for Salerno, but I will handle it by saying that in order for Johnny to have invested the $20, he must have abstained from consuming the $20. OF COURSE any investment or consumption he makes must come from his cash balance, which you define as “saving.” That is a trivial point.
But then let’s switch it around. Suppose that Johnny had the $20 earmarked for investment, but then on his way to the seller of CDs, he decides to buy $20 in movie tickets instead. Should we say “Clearly Johnny saved, because you can’t consume what you haven’t first saved.”? If so, then you are saying that consumption, in addition to investment, requires savings, which is, you must admit, not a conventional way of understanding the implications and requirements of consumption at all. I don’t think I have ever heard of any economist saying that consumption requires a prior act of saving. I have only ever heard the statement “Investment requires a prior act of saving.”
First, I have to apologize if I have sounded condescending to those who have questioned my views on cash balances and savings. I truly thought I was relaying standard economics–including the views of Austrian economists–and that’s why I was at times impatient with the challenges. However, since one of the leaders of the modern Rothbardian movement, Joe Salerno, is equally baffled by my position, obviously things are not as straightforward as I had assumed.
I feel like Rodney Dangerfield.
He is not saying that he is earning both $10k a month and 10k a day. He is saying that he is either earning 10k a month OR 10k on a given day and the savings for that period depends on if you look at his cash balances for a month or day to day.
He is saying that he is either earning 10k a month OR 10k on a given day
Earning $10,000 a month and earning $10,000 a day are two very different conceptions.
Again it is 10k on a given day, not per day. If you can produce a quote where he says 10k PER DAY I will concede but I don’t see that quote.
There is no such quote. If I said, “Earth is in the solar system, and it’s in the Milky Way,” MF would accuse me of contradicting myself.
“During that 24-hour period, I would say his income was $10,000, while his consumption was $100.”
MF, that doesn’t contradict anything Dan or I have been claiming. I said, “During that 24-hour period…” and you seem to imply that I said, “During every 24-hour period…” which I obviously didn’t.
MF, that doesn’t contradict anything Dan or I have been claiming. I said, “During that 24-hour period…” and you seem to imply that I said, “During every 24-hour period…” which I obviously didn’t.
Saying “during that 24 hour period Andrew earned $10,000” and saying “during the month period Andrew earned $10,000” are two very different things.
Income is money per a definite unit of time.
MF wrote:
“I would say that over the course of the month, Andrew’s income was $10,000, and his consumption was $9,000. Therefore Andrew saved $1,000. His savings rate is 10%, not 100%…”
“During that 24-hour period, I would say his income was $10,000, while his consumption was $100. So yes he saved $9,900 that day…”
Notice the contradiction there Bob?
No MF, there is no contradiction there. Go ask an accountant how he would book the above. (Or, since a professional accountant probably doesn’t want to field random questions from some guy, find an accounting professor at a small school who probably is geeky enough to answer your email.)
Suppose my weight is 200 lbs on Sunday at 12:01 am, it’s 200 lbs on Monday at 12:01 am, it’s 205 on Tuesday at 12:01, am, and it stays there and is 205 lbs the following Sunday at 12:01 am.
I would say:
(A) My weight gain over the course of the week was 5 lbs.
and
(B) My weight gain on Monday was 5 lbs.
Yikes, did I just contradict myself?! Of course not. I can’t believe we are arguing over this kind of stuff.
Income is money per period of time.
What you are doing is taking a single payment of money, and then claiming that it doesn’t matter what period of time we choose around that payment, because it’s all the same.
A payment of $10,000 on the 15th is thus considered $10,000 per day, per two days, per week, per week plus one day, per any length of time. That makes no sense to me because income is money per unit of time.
You can’t say company XYZ earns $10,000 per quarter and $10,000 per day, and $10,000 per minute, and $10,000 per second, just by changing the time period around the payment.
Yes, this part is quibbling, yes this part is a tangent.
I mean, if my wage rate, my income, is $20 per day, then that means I am making $20 per day, which means I make $20 x 30 = $600 per month.
The way you understand this would enable me to claim that if I got a paycheck every other week, then it would also be true to say that my income was $300 on that day, indeed, it can be said to be $300 in that hour, in that minute, in that second, etc. I am making $300 per second, just because I physically received the cheque and arbitrarily pick just any old time period!?
This is not how I understand income, it’s probably not how many people understand income, which is why I can’t for the life of me understand how you can ignore the requirement of a definite unit of time in order to give meaning to the concept of income, such that you pick one and not change it.
If I work for one year, and then got a lump sum at the end of the year, say for $100,000, then would it make sense for me to claim that my wage was $100,000 for the day, just because I received it on a given day, indeed, a given hour, minute and second? No. I will say that my income is $100,000 per year, for the year, whatever, and ONLY $100,000 per year, for the year. It is crazy to say I made $100,000 for the second, just because I physically received the cheque during a given second.
We are arguing over this stuff because I think your way of thinking this particular issue is mind bogglingly difficult to pin down.
Some people are saying, “OK Bob, this is just a quibble over definitions. What’s the big deal?”
Well, the big deal is:
(A) If you are using the definition in a way that forces you to deny some of the other things you believe in (like saving = investment, or that when you consume income, you can’t change your mind later on and save it), then it’s a problem. My definition (I claim) avoids these conflicts with the rest of economics, whereas Salerno et al.’s approach leads to serious problems. I want MF et al. to answer my final questions.
(B) If you accept my definition, then Keynes’ point about the nature of interest comes back into play. That’s what started this whole thing.
If you are using the definition in a way that forces you to deny some of the other things you believe in (like saving = investment, or that when you consume income, you can’t change your mind later on and save it), then it’s a problem. My definition (I claim) avoids these conflicts with the rest of economics, whereas Salerno et al.’s approach leads to serious problems. I want MF et al. to answer my final questions.
My understanding of savings, which is separate from holding cash, enables me to fully accept “savings = investment.” The way my position can handle it is by treating savings as abstaining from consuming (and not in the abstaining from consuming in the sense of holding onto money, because holding onto money is inevitable, unavoidable, and part and parcel of a monetary exchange economy).
For example, if I have $10,000, and I invest $5,000, then I abstained from consuming that $5,000, and invested the $5,000 instead.
You want to say that I saved $10,000, and out of those savings, I invested $5,000. But then that logic would compel me to also say that if I had $10,000 and consumed $5,000, then savings are required for consumption, and thus “savings = consumption.” After all, one needs money in order to spend it on anything, and thus consumption must be financed by savings. But which textbook, which economist, has ever written “savings = consumption”?
Defining savings as abstaining from consumption only, and not cash holding, avoids not only many conflicts with the rest of economics, but it also avoids all the problems you have found yourself in by equivocating saving with cash holding, for example adhering to the fallacious liquidity preference theory of interest, as well as all the problems you think are inevitable for the other side but are in fact not (such as denying “savings = investment”).
The statement: “or that when you consume income, you can’t change your mind later on and save it”, is weird because it does not follow from defining savings as abstaining from consuming only. It is not a logical implication of refusing to define cash holding as saving. For my position, I will respond to that statement and say that it does not fail to follow from defining savings as abstaining from consumption only, and that cash holding is its own concept. If you consume out of your income, then that is not abstaining from consumption, and so you cannot also invest with the same money. Investment requires an abstaining from consumption.
If you accept my definition, then Keynes’ point about the nature of interest comes back into play. That’s what started this whole thing.
And yet you still haven’t answered:
A. Wenzel’s main criticism that Keynes treated saving as cash holding and investment simultaneously, interchangeably, randomly moving back and forth between the two, whereas Rothbard, Mises, et al, as Wenzel has shown, kept the two types of “savings” as separate.
B. My three criticisms against the liquidity preference theory of interest.
Keynes’ trivial argument that you can’t earn interest unless you “part with liquidity”, i.e. give your money to someone else who pays you interest in return, which is meant to be a refutation of the classical doctrine that “interest is the reward for savings” is just a product of his own conflating of savings with cash holding. If you define savings as abstaining from consumption only, and not as cash holding, then the classical idea remains unchallenged.
When I see the formula “savings = investment” I see a formula that says if you are going to invest $10,000 then you must abstain from consuming exactly $10,000. You want to treat savings as cash holding, but then if savings is cash holding, then we should write “savings = consumption”, “savings = charity money”, “savings = investment”, “savings = exchange of money for anything.” Savings then becomes cash holding, and it is no longer abstaining from consumption only.
I will not define savings as cash holding, because I want to avoid the confusions that have clearly affected your thinking not only regarding savings and investment, but to the proper theory of interest as well.
B) NO it does not. The rate at which you increase and deplete your cash balance, or the average cash balance, does not affect the interest rate. This is your fundamental error in all of this. If not for this leap from defining cash holdings a savings to claiming that time preference does not solely account for the natural rate of interest, there wouldn’t even be a debate here.
You are bringing back to life the fallacy of interest is the price of money. This really is now about “saving Robert Murphy”.
Exactly. You hit the crux of this whole issue.
The rate of cash money depletion, or the quantity of cash held over a period of time, none of these things have anything to do with what actually generates interest rates.
I would rather not be so steeped in arguing over definitions of savings, but it seems like Murphy is equating a victory in having a correct definition of saving (cash holding), with a victory in defending the liquidity preference theory of interest. All he seems to want to do is try to convince people that cash holding should be defined as saving, instead of the elephant in the middle of the room, which is his clear inability, or refusal, to defend the liquidity preference theory of interest and why time preference is wrong.
You’re right, it’s a totally unjustified leap.
Well, I keep saying over and over again that one can both increase his reservation demand for money AND lower his time preference, but as far as interest rate, it is only the latter that matters. I envision Grandma stuffing her mattresses with cash over the years because she doesn’t trust anybody, but It is not the hoarded cash per se that frees up capital for investment, thus lowering the interest rate, it’s her lowering of her time preference. At the end of the day, it’s always the proportional allocation between future and present goods that determines the price differential between stages, which is the natural rate of interest in the final state of rest. There is no other possible way.
“Another point to mention is that not all forms of cash intake are “income” in an accounting or economic sense. For example, if Andrew sells shares of stock for $25,000, making his cash balances go from $20,000 up to $45,000, he hasn’t saved. Rather, he has transformed his savings from one form to another. So the $25,000 in new cash balances are a part of his savings, but he didn’t need to save (in the current period) to acquire them. He had already saved in the past, and invested in the stock.”
Since anything I buy, stocks, cars, shoes, even lettuce in my fridge could be turned around and sold do I count those amongst my “savings”? If I have a garage sale, am I converting savings from the form of old shirts, a box of motor oil and a lamp back into money savings? Do I count the assumed value of everything that I haven’t completely consumed as part of my savings rate? Honest question.
Good question. I would count it as savings but if you do that you have to allow for savings not equaling investment (which I think is actually the way to go). If you are going to insist on savings equaling investment I think you have to count having lettuce in your fridge as consumption. This is basically why I prefer not making savings necessarily equal investment. For a more practical example consider a situation with commodity money. If you hold a balance of silver or gold you don’t free up resources for investment or consumption by others you actually take a real reasource and hold it without consuming or investing it (at least by my definition). If you insist on making savings equal investment you have to call this consumption or investment somehow which seems to me to require some mental gymnastics.
Yeah I agree with your views here, Free Radical, except that I go the other route. I want Savings = Investment and that’s why I insist that acquiring larger cash balances is a form of investment. But I see why you want to go the route you are taking.
And Greg, right, the way I would handle it is to say the stuff you got rid of in your garage sale was technically part of your capital. You obviously didn’t consume those goods; that’s why you were able to sell them for money.
What you can do is call them more specifically “durable consumer goods,” but I would still say durable consumer goods should be included as part of your capital stock. You get a flow of services from them (consumption) each period, it’s true, but they also entitle you to a stream of future consumption. That’s what capital does.
If I follow this correctly, then Bob, everything is investment (in capital for example), until it is completely consumed, and then it is a consumption good? Since savings = investment, then everything is essentially savings until it is consumed (old shoes, lettuce, etc). As strange as it sounds, I think that is right, Bob. It is a stronger statement than saying that all cash balances are savings though. It is basically saying that everything not consumed is savings. I think that makes sense in a Rothbardian Crusoe on the island type of way though.
I agree Bob, definitions are very important – otherwise words can mean whatever people want them to mean, I think Wenzel was pointing that out.
When I look at the definition of “save” at dictionary.com, I infer that the meaning is in this context: you have set an amount of ‘something’ you’re are going to ‘expend’ (see below for clarification on this word), in the course of your ‘expending,’ you decide to keep (reserve?) a portion of that set amount, this kept portion is what you ‘saved’ from being ‘expended.’ So the act of ‘saving’ is to “keep something from happening,” that is, keep resources (capital?) from being expended. So I think, ‘saving’ is a word that should only be used in relation to ‘spending.’
Antal Fekete has written about there being a difference between the ‘discount rate’ and ‘interest rate.’ How this jives with our use of the words, ‘investing,’ present good, future good and exchange I cannot say just yet, but I believe there is a connection to this discussion.
Clarification on ‘expend’ from dictionary.com – looking up ‘spend’:
—Synonyms
1. Spend, disburse, expend, squander refer to paying out money. Spend is the general word: We spend more for living expenses now. Disburse implies expending from a specific source or sum to meet specific obligations, or paying in definite allotments: The treasurer has authority to disburse funds. Expend is more formal, and implies spending for some definite and (usually) sensible or worthy object: to expend most of one’s salary on necessities. Squander suggests lavish, wasteful, or foolish expenditure: to squander a legacy. 2. use, apply, devote.
Disclaimer: I am not an economist. I enjoy reading the blog, especially things like this post, where the concept seems basic yet there can be such well-reasoned disagreement.
If income is money per period of time, don’t you need to define what unit of time is the standard unit (the denominator) and also the period of time you are taking a snapshot of (the x-axis variables, x1 to x2). So for example, let’s say you both agree that the standard unit is one day. And consider Tom, who makes $1000 on the first on the month but nothing else the rest of the month.
For that month (x1st = 1, x2 = 30th), his income is 1000/30 = $33.34/day
For some specific days (x1 = x, x2 = x), his income is 0/1 = $0/day
For other days (x1 = 1, x2 = 1), his income is 1000/1 = $1000/day
It’s not that his income is both A and not A at the same time, it’s that as you change the time you measure, you get a different answer.
So are you two really saying a different thing?
Frank Stein wrote:
It’s not that his income is both A and not A at the same time, it’s that as you change the time you measure, you get a different answer.
So are you two really saying a different thing?
Your treatment is right, Frank.
Go back to my weight example above. (A) If I’m just focusing on Monday, then I lost 5 lbs. that day. (B) If I focus on the whole week, then I lost 5 lbs. that week.
MF thinks I am contradicting myself. He thinks statement (A) implies I’m losing 5×7 = 35 pounds per week, whereas (B) implies losing 5 pounds per week. Contradiction!!
But of course there’s no contradiction. Just because I lose 5 lbs on the day of Monday, doesn’t mean I am losing 5 lbs every day. The rate of weight loss can change from day to day.
By the same token, if accountants report that in the 3rd quarter of 2010, Exxon made $1 billion, we can’t conclude that Exxon since its founding a century ago must have made $400 billion.
I really hope people who are on the fence, can at least see that MF is making really basic mistakes in his reasoning, over and over again. Sure, that by itself doesn’t prove I’m right and he’s wrong, but it should give you pause.
Go back to my weight example above. (A) If I’m just focusing on Monday, then I lost 5 lbs. that day. (B) If I focus on the whole week, then I lost 5 lbs. that week.
MF thinks I am contradicting myself. He thinks statement (A) implies I’m losing 5×7 = 35 pounds per week, whereas (B) implies losing 5 pounds per week. Contradiction!!
See how you just casually say you “focus” from one time period to another?
Income is a DEFINITE time period. It means that if you have a number for income, it means it refers to a definite time period. You can’t then say it is income for ANY time period, such that you go from saying $10,000 income per a month, to $10,000 income per a second. It’s one or the other.
If I say I earn $20 an hour in income, say as a wage, then yes, I would be contradicting myself if I then said that I earned $20 in a minute, on the basis that I received a paycheck during a given minute, or in a second, if I received the paycheck in a given second! My income is FOR THE HOUR I WORKED.
Income is, again, money PER UNIT OF TIME. That means you can’t just go around and change the time period haphazardly solely because you realize that a paycheck is a one time event, and you have to consider “a” time period so that you can turn a stock concept cash balance into a flow concept savings rate.
Income requires a set unit of time. If you say $10,000 per month, then you CAN’T say anything other than $10,000 per month.
Why can’t you see this basic fact? How can you even say I’M confused about this?
“Income is a DEFINITE time period.”
Ah, yes, I earned the month of July last year.
MF you’re confused….
” really hope people who are on the fence, can at least see that MF is making really basic mistakes in his reasoning, over and over again. ”
Bob, I think it’s better to call what Major Freedom does “automatic typing” or something like that, rather than “reasoning.”