The Paradox of Thrift is Bunk

Yesterday I got into a conversation with somebody about being frugal. Said person softly condemned me for basically being a cheapskate. I hate to spend money on stuff that will never be used. I also hate having too much of a thing. Too much clothing, too many pairs of shoes, too much electronic equipment; that stuff drives me crazy.

We went back and forth. She told me to loosen up. I told her to stop being profligate with her money. Neither side could gain the upper hand.

Then she went in for the clincher: saving too much hurts the economy. If you don’t spend, businesses lose money, people get fired and the economy tanks. Because of people like me, the world is falling apart.

This is the old paradox of thrift argument. It goes something like this. Yes, saving is good. Preparing for the future, investing in new businesses, socking away a down payment for a house; these are all good things. But if everybody saves in excess, it is terribly detrimental to the economy. A consumer economy requires that people spend a lot of money to keep the good times rolling.

As the title says, this argument is bunk. However, the refutation requires a depth of explanation that is difficult to employ in a casual back and forth. I tried to quickly explain it anyways. I think I was moderately successful. Her eyes were a bit glazed over by the end though.

First of all, most savings go into banks nowadays. Any money you put into a bank gets loaned out. It doesn’t matter if you have a checking account, savings, account, or CD. Banks are able to offer so many free services because they loan out your money. Thats why if you go to the bank and try to withdraw, say, $100,000 they can’t give it to you right away. The bank needs some time to scrape it together. Interest payments on your money pay for your free debit card.

The money gets loaned out in the form of mortgages, credit cards, business lines of credit, and more commonly these days, goes into government bonds.

So, right off the bat we see that saving, at least in the modern sense of putting your money in a free checking or savings account, has no adverse affect on the amount of money that gets spent in the economy.

Of course, some people hoard their money. They cash their checks and keep dollar bills in a shoe box in their house. This can cause temporary hiccups in the economy but ultimately markets adjust to a lower supply of money and keep humming along.

In any event, the amount of money hoarded is minuscule. You earn no return on hoarded money. Most people hoard for the feeling of security that comes with having money readily available. Hoarders hoard until they feel secure. Any money above and beyond what makes them feel safe gets invested in a business or put in a bank.

The real issue with saving is not whether the money gets spent but rather how the money gets spent. If you use your money to consume, you get pleasure now. If you save you get an increased quantity of pleasure at some point in the future. One is not better than the other. It all depends on each individual’s preference.

Another interesting wrinkle is that all items available for current consumption are the result of some previous act of saving. Somebody had to save in order to to pay the workers and buy the machines needed to make the stuff we can buy.

So, you see, savings get spent too, just on different things. Saving is not bad for the economy.

Actually, come to think of it, there is one way that savings can make the economy worse. If savings, either directly or through the banking system, end up in government bonds, that makes the economy worse.

If you buy a bag of chips at the store, you benefit, the store benefits, and the chip maker benefits. Everybody wins. If you save and invest in a chip making machine, you win because you want to be in the chip making business. The chip machine maker wins because he makes a sale. The customer wins because they will eventually get the chips they want.

In contrast, when money is loaned to the government not everybody wins. Take war for example. You loan money to the government. The money gets spent on attack helicopters. The helicopter gets blown up. The helicopter company wins because they get to keep making sales. The government wins because they get more money to spend. You win because you get interest on your loan. However, there is some hapless loser out there who will get taxed to pay you interest.

Unlike the chip example where all exchanges are voluntary, there is a poor schmuck who gets dragged in against his will.

To conclude, savings and consumption are equally good. What one does with their money depends on their individual temperament and preferences. Savings is bad, though, when the savings go into government loans. Consumption can be bad too, when bureaucrats do the consuming.


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