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?