Wednesday, July 25, 2007

Moving wealth into the future through money

Saving is good, but what does it mean? If in the future we will need some grain, then it is wise to save some. If in the future we will need something perishable then maybe we can save something non-perishable that we can swap for the perishable item at that time. We treat money as such a non-perishable item. This works in a small way, for individuals, but not for a whole society.

Suppose I save some money in a suitcase under the bed. That reduces the amount of money in circulation (by a small amount), thus making all the money that is in circulation more valuable (deflation). When I later put the money back into circulation it acquires its value from all the other money in circulation by making that other money fractionally less valuable (inflation). In this way an individual or a group can move wealth into the future through money. Society as a whole can't move wealth into the future through money. This is slightly confused by the fact that an individual country might be able to do it in the context of all other countries. However since there is no global economic control, or global currency, a country can only do it by putting itself at the mercy of some other country, as countries holding US dollars do today.

There is also a problem when too many individuals try to move wealth into the future. In so far as they try to hold money they cause deflation. However governments can't allow that, so more money is put in circulation. The trouble is that this leaves the potential to cause inflation in the hands of consumers, and the government has more trouble taking money out of circulation when inflation starts. The other way people try to move wealth into the future is by buying assets. This leads to bubbles when there is too much money chasing too few assets of genuine long term value.

Money has three roles: as a mechanism for efficient exchange of goods, as a unit of value, and, as discussed above, as a way of moving moving wealth into the future. The first two are related and inseparable. The third doesn't work and gets in the way of the other two, because stored money is always threatening to flood onto markets causing inflation and bubbles.

More on this another day.

2 comments:

  1. I forgot that I already had an OLD post on this. Here it is:

    2005/03/14: You can't move wealth into the future through money

    If we put money in the bank, or under the bed, and get it out a year later then we have, from a private point of view moved some wealth into the future. This is the essence of saving for a rainy day. Politicians and journalists love to take this private commonsense activity and apply it community wide. Indeed I finally got sick of Paul Krugman (nytimes.com) for his cynical repetition of arguments that he didn't actually believe.

    For the individual it works if they are embedded in a world of other people that keeps going at about the same rate. When we put money under the bed then there is less in circulation and every dollar in circulation is thus worth minutely more. When we take it out every dollar is worth minutely less as our money returns to circulation.

    Suppose the government says "In 20 years time we'll need extra money for government services so we'll save for it". They run a taxation surplus and put the money in the vault to get it out later. What happens is that running a tax surplus takes money out of circulation which is deflationary and benefits people holding money. When they later bring it out, that is inflationary and taxes people who happen to hold money at that time. This is not actually different from printing money, something that governments should only do in an emergency. Governments running taxation deficits or surpluses is an important economic lever for controlling the economy now. It has nothing to do with saving for the future, or the reverse.

    In "the novel that will never be written" the story kicks off with a discovery that is expected to lead to everyone becoming immortal. The newly elected first female president of the US dedicates her term in office to ensuring that immortals will never live on Earth. "We believe in the cycle of life and that is the way life on Earth must continue. If you want to live forever then the rest of the Universe awaits you. Start saving. In 40 years people over 100, other than the genuinely elderly, will be removed from Earth and that age will be reduced to 80." The president's words receive worldwide support. A sufficient number start saving to bring the world economy to its knees. The governments could pump money into the economy so that those who aren't saving would be richer and would take up the slack of consumption, but then the wrong things would be produced. The real problem would be in 40 years time when people start trying to turn their savings into a comfortable life in space: this would produce inflation but couldn't suddenly materialize the goods and services needed to meet that demand. What the savers really need to achieve is to reorient much of the world's productive capability to building cities in space for the billions who will wish to take the road to immortality. This is a social effort that needs government action to be achieved. Everyone realises that capitalism has its limits and sometimes a bit of socialism is the right answer. The end.

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