On Economic Progress: Hoarding!

On Economic Progress: Hoarding!
By Rick Kelo

Money is only useful for exchange value, true, but it is not only useful at the actual moment of exchange. This truth has been often overlooked. Money is just as useful when lying "idle" in somebody's cash balance, even in a miser's "hoard."
~ Murray Rothbard, “What Has Government Done to Our Money”

This is the third article in a series discussing the economic theory behind why economies expand & prosper.  Previous articles are viewable here:

On Economic Progress: Raising Standards of Living
On Economic Progress: Sustainable Capitalism & Bubbles

One particular concern that’s mentioned frequently is the notion of groups hoarding money.  So let’s take a look at the economics behind hoarding.  Universities are known to “hoard” endowment funds during recessions.  Its also common to people assert that corporations are “hoarding” cash: "If only these misers were forced to consume, instead of save, the economy would recover!" - or so the narrative goes.

Now when people say “hoarding” they’re applying a value judgment to a value-neutral action.  This is the issue of “Normative” versus “Positive Economics.”  I’m going to give you the Positive Economics: the value free presentation of one major theory on how this works.  You can decide for yourself what is “good” and “bad.”  So from here on out, instead of “hoarding,” I will refer to this behavior as the demand to hold money.

First, we have to understand a couple motives for holding money:

1. Transactions Demand for Money =  This is the money people keep around for things they routinely buy.  People buy groceries, firms pay their bills, therefore, each demands money to conduct those transactions.  The econ abbreviation for this is T_D, DMT or MD_T
2. Speculative (& Precautionary) Demand for Money = all that is earned is not spent in the same period.  Sometimes agents choose to hold onto money today on the belief it is wiser to invest it in the future.  (Or conversely they believe they're avoid a loss they would take if they invested it today).  Other times agents hold onto a certain amount of money believing they could encounter unexpected future expenses… an “emergency slush fund” if you will.  Speculative demand is abbreviated S_D, DMS or MD_S

EFFECTS OF INTEREST RATES ON MONEY DEMAND

The first thing to note in this theory is that when the interest rate goes down, the amount of money demanded goes up.  In other words, low interest rate = more “hoarding.”  That's because the "cost" of holding onto cash is the foregone interest you'd have instead earned.  The reason why this happens is a little more confusing.  I’m going to give you the explanation according to one of the 3 main schools of economic thought, Keynesian economics:

The speculative demand for money has a negative relationship with the prevailing interest rate.  That means one goes the opposite direction of the other.  So, if the current interest rate is considered “low” the market believes it will rise in the future more than it has risen previously.   Those conditions also mean that bond prices are believed to fall in the future.  (Bond prices share a negative relationship with the prevailing interest rate, which means they move in opposite directions to one another).  That means it is more optimal for individuals to hold onto money right now than to invest in bonds because bond prices are expected to fall.

HOW INTEREST RATES ARE DETERMINED

Now let’s look at the role that the speculative demand for money plays in setting the current interest rate in the Keynesian system.  This theory is called the Theory of Liquidity Preference, and originated in Chapter 13 of Keynes' General Theory.  Not only does the speculative demand for money have a negative relationship with the interest rate, but it also plays a role in setting that rate because it is one of the two factors that set the market rate of interest:

1.     The speculative demand for money
2.     The amount of money (the money supply; MS)

Since we’re adding in money supply as well I’ll mention the impact it plays: if the money supply goes up, then the interest rate goes down.

Above I mentioned that if the market thinks the current interest rate is “low,” then it is bearish on bonds… meaning a “low” interest rate today is bad for bonds in the future (the term "bonds" is used broadly by Keynes to mean all less liquid assets so stocks and other time deposits in the money market).  This is important because when you think about buying an investment your future expectations determine whether you buy that bond or keep your funds in cash.  So when people are “bearish” on bonds they hold onto cash and there’s more money available in the money supply.  See Figure 1 below.  That shift means that investors want to hold onto more money at every possible interest rate, consumers want to spend more, and businesses will take out more loans for expansion.  This is how the economy starts to get "over-heated" since production takes place at a time long after the money supply changed.  This is not much different than the way artificially lowering interest rates pushes past the Production Possibility Frontier (shown here).

Figure 1. Speculative demand along w/ amount of money determine the interest rate

EXAMPLE

Think of it from a common sense perspective: if you need to borrow money and you’re having a hard time getting someone to lend to you then you’ll agree to pay a higher interest rate on the loan than you would if you had 20 offers from lenders.  Think of it that way when you look at Figure 1.  If there is $600MM of money available to circulate in the economy at a given point in time, and given the current speculative demand for money, then that tells us that the interest rate is going to be 2%.  But, if that changed in the future and the money supply increased to $800MM that means there’s a larger pool of money that people are able to hold as speculative demands, but that money can only make it into idle cash balances if the interest rate is bid down (or bond prices are bid up).  An influx of money into the system puts more money in people’s hands than what they wanted to hold onto before, and that implies they will then choose to invest that money, bid up the price of assets like bonds, and drive the interest rate down from 2% to 1% in response to the money supply increase from $600MM to $800MM.

ENTER THE FED

Below is Figure 2.  It shows you what happens if the money supply stays the same, but the Central Bank sets the interest rate artificially low.  In this case the amount of money demanded increases.  Because there is no more money available consumers respond to this incentive by borrowing.  When the Central Bank sets interest rates artificially low it makes it cheaper to borrow since loans & credit cards now have lower interest rates.  It also makes the alternative, saving, less attractive because savings accounts now pay less interest.  There are several other ways the Central Bank can create this exact same increased money supply shown in Figure 2:

Figure 2: When the Fed pushes interest rates artificially low it fuels debt-drive over-consumption

WHEN SPECULATIVE DEMAND TO HOLD MONEY INCREASES

Now to the other possible change: people become more bearish on bond prices.  When that happens the money demand curve shifts right at every possible rate of interest.  See Figure 3 below.  This implies that individuals now hold onto more money for speculative purposes.  Since the money supply remains constant the only way to satisfy this increasing need to hold speculative cash balances is through an increase in the rate of interest and a fall in bond prices.

Figure 3. When the demand for money increases the interest rate goes up at every possible point.

ENTER BIG BROTHER

There's an awful lot of ways that a Central Bank influences this whole process.  The Central Bank can create money out of thin air, and they do.  The Central Bank can also force the interest rate artificially low, and they do that as well.  However, the two main policy actions always parroted as a response to increased demand to hold money aren't, in any way, implied as legitimate responses to too much perceived "hoarding."  Those being that neither deficit spending nor stimulus plans necessarily follow in response to existence of the demand for money.  The policy action that does logically follow is to remove the Central Bank distortions (low interest rates, QE, etc) that impact this behavior.

HOARDING!

Let's finish where we started.

Many like to vilify “hoarding” in a way to compare very rational time preferences & money demand to Scrooge the miser.  Except that holding onto money, really withdrawing those funds from circulation, doesn’t harm anyone else.  Even in a closed economy with a fixed money supply there is no harm created by agents holding idle cash balances.  Therefore there certainly cannot be any harm in a fiat regime like ours where the Federal Reserve is always increasing the money supply.  In fact, in recent years under Bush in 2001, 2008 and then Obama in 2009, we’ve seen government give people a lot of money to spend in the various demand-side fiscal stimulus like the tax-rebate checks in response to the Dot Com Bubble.  Telling people to unhoard (AKA to spend) is easy; what's difficult is producing goods not consuming them.  Consuming is easy.  The only way to have more goods produced is to increase savings and reduce the proportion of funds used for consumption, and that means more "hoarding" not less.

You can't be good at everything: trade

Trade creates wealth.

Trade is peaceful.
Trade is voluntary
Trade is non-coercive.
Trade is cooperation.

Capitalism is based upon service to your fellow man.  The next step after this video ends occurs when the guy cutting the lawn goes to the grocery store.  He tells the store clerk: "I want 2 pounds of steak and a bag of potatoes that my fellow man produced for me."  The store clerk replies: "So you want your fellow man to serve you, what have you done to serve your fellow man?"  The worker replies: "I mowed his lawn for him," and produces the money Professor Camden paid him as proof.

African Economic Experiments: Zimbabwe vs. Botswana

Why Is Africa Poor?

The simple answer to why sub-Saharan Africa is poor is that they have less capital per person than richer nations.  That's the definition of a poor nation.  In the word's of famed economist Ludwig von Mises:

There is but one means available to improve the material conditions of mankind: to accelerate the growth of capital accumulated as against the growth in population. The greater the amount of capital invested per head of the worker, the more and the better goods can be produced and consumed. This is what capitalism, the much abused profit system, has brought about and brings about daily anew.~ Ludwig von Mises, The Anti-Capitalist Mentality, p. 10

The real question is why, in sub-Saharan Africa, is the process of capital accumulation that makes other regions of the world rich seeming not to work?  Africa's sad story owes in large part to the fact that socialism and Marxism swept across most of the continent during the Cold War.  I am going to tell you the tale of 2 nations.  Neighbors.  Two different economic systems, two SHOCKINGLY different results.

Zimbabwe's GDP per Capita Since Mugabe Took Office
(Source)

When asked why Africa is poor the class warfare types have a standard answer that Africa is exploited by rich, non-African nations.  I'll show you shortly this socialist/communist rich exploitation mindset is actually the cause of Africa's poverty, and is exactly what's keeping much of the region in poverty.  Plus, the facts are firmly against that foreign exploitation notion anyway since almost all the capital being accumulated in the sub-Saharan African nations today came from their trade with other nations in the first place.

The cause of the persistent poverty in this region of the world is easy, and I'm going to use Zimbabwe as an example.  The first graph above is Zimbabwe's declining GDP per capita since their Marxist president, Mugabe, came into power in 1980.

Zimbabwe vs. Botswana GDP/Capita 1975-1985
(Source)

In 1980 Botswana (their neighbor) was just as poor as Zimbabwe.  To the left are the 2 neighboring nation's GDPs per capita from 1975 - 1985.  At the end of the article I'll show you what GDP per capita looks like now so you can contrast the growth under capitalism with the increased poverty under socialism.

Zimbabwe, Marxism & Seizing Control of The Means of Production

What socialism fails to realize is that stealing assets ensures poverty.  That is why you have never, on the face of this earth, seen any nation become rich through socialism.  You have seen some nation's become rich through the mechanism of free-market capitalism, then later adopt socialism.  However, contrary to what socialists will tell you about wanting to solve the boom/bust cycles of capitalism in order to help the poor, in reality, their methods only ensure poverty.  

Zimbabwe is a fine example of this; the country recently had its "elections."  The incumbent president/dictator (Mugabe) got "re-elected."  Mugabe is a Marxist.  Like all socialists & communists he speaks of equality then proceeds to treat people very unequally.  His specific take on Marxism is he wants to create a:

"socio-economic system ... which is planned and operated by those who are chosen by the people."  Asked what kind of society he hoped to lead, Mugabe replied, "A truly democratic society devoid of racism... a society where there is equality, where there are civil liberties. ... And as far as our own program is concerned, we are for a socialist society, you see."(Source: PBS interview)

After the last election Mugabe announced that Zimbabwe is tired of being exploited!  In typical socialist & Marxist fashion Mugabe announced that the proletariat of Zimbabwe were no longer going to be oppressed by the rich (mainly white) bourgeois!

His party is calling this policy "indiginization."  If Zimbabwe is to reduce the control of the rich and empower the people, then all stocks on the Zimbabwe stock market must have 51% of their shares taken (without pay of course) for the benefit of the people of Zimbabwe.  In 2000 Mugabe did something similar and seized the land of the richest farmers (also without compensation) because they were too rich.  "How can Zimbabwe say we are an independent country when our resources are controlled by others?" (referring to white land and business owners). Mugabe's party spokesman asked.  Mugabe is taking his cue straight from the the great book itself:

Yes, gentlemen, the Commune intended to abolish that class property which makes the labor of the many the wealth of the few. It aimed at the expropriation of the expropriators. It wanted to make individual property a truth by transforming the means of production, land, and capital, now chiefly the means of enslaving and exploiting labor, into mere instruments of free and associated labor.~ The Communist Manifesto

When Zimbabwe went through its earlier Marxist - "we hate the capitalists!" - moment back in 2000 they seized land, today it is socializing the ownership of all the businesses.  The 2000 farm seizure went against property rights (the very core tenet of liberalism and of free market capitalism), and it had consequences.  It lowered production, which lowered tax revenues, which caused the government to have to print money.  By 7 years later they were into inflation so bad people were using $100 million dollar bills to buy groceries.

Zimbabwe's Fall in GDP After the 2000 Land Seizures
(Source)

That is the effect of Marxist action against the means of production: in the name of fighting inequality you attack the only thing in the economy that produces output, employment, and is growing.  The effect of this: Zimbabwe's GDP shrunk every year from the farm seizures until 2009.  How's that for a recession?

Zimbabwe's Keynesian Stimulus Ahead

The Mugabe Administration announced that once they "get" this money from indiginization of these stock shares, then "the people" of Zimbabwe have decided to spend it on new roads, infrastructure and social programs.  The country can't otherwise afford these things because their treasury is empty.  Well that's not the real cause, let me take it back a step.  Their treasury is empty because they have created a strongly anti-business climate and no one other than a lunatic would do business there if they had a choice.

This is an especially bad idea because, for those who don't know, Keynesian stimulus of this kind causes inflation.  Today, in 2013, Zimbabwe is preparing to embark down the same road to printing billion dollar bills that these anti-capitalist methods took it down in 2000.

Botswana, Capitalism & High Quality of Life

Bordering Zimbabwe to the west is Botswana who took a, thankfully, very different approach to their socialist neighbor.  That is why today they have one of the highest qualities of life in the Africa and Zimbabwe has one of the lowest.  Botswana adopted total free trade and total, unregulated, laissez-faire capitalism.  By doing so new businesses began to appear.  Zimbabwe has taken the opposite approach and, by attacking the small amount of remaining wealth, created a climate where you'd have to be insane to open up a business.

GDP per Capita = Capitalist Prosperity In Botswana vs Socialist Poverty in Zimbabwe
(Source)

   

Growth from Free trade: Botswana has overall mostly free trade.  This has caused a booming export industry to grow up in the last 30 years.  Botwana's economic freedom has attracted a lot of foreign investment into the country.  Remember where we started at the opening of the article?  The only method to improve the quality of life of the common citizen is to increase the amount of capital in a country per head of population  There is no other method, and this is exactly what capitalism has done in Botswana.  Today foreign assets account for 66% of all total bank assets in the country.  This foreign investment that has helped fuel growth and amplify the growth from the free enterprise / free market system.

Growth from Free Market Capitalism: The growth laissez-faire capitalism has caused in Botswana is seen in the new sectors in the economy that didn't exist even in 1980.  According to Botswana's Central Statistics Office mining has been largely unchanged, and today makes up 26% of Botswana's economy compared to 25% in 1980.  Manufacturing is also unchanged making up 4% of the economy.  The change has been the rise of modern industries that have sprung up due to the capitalist economic freedom the country enjoys.  Those growth industries include: trade, hotels, banking, insurance, telecom, transportation, construction, and utilities.  Manufacturing & mining haven't increased much, or, to coin the phrase used by authors who object to jobs created by capitalism: these are not "bad", "low paying" "wage slave" jobs. 

Growth from Responsible Government:  At a time when Americans consider why we have no economic growth we might want to compare ourselves to Botswana.  The country has:

• Kept national debt under 10% of GDP (the US is presently 105% of GDP)
• Kept annual budget deficits to 2% of GDP (the US deficit is 6.6% of GDP)
• Have nearly no barriers to free trade (the US government controls every aspect of trade)
• A federal income tax top bracket of 25% (the US is presently 39.6%)
• Corporate tax rates are either 5%, 15% or 25% (the US is presently 35%)
• Equipment imported into Botswana for use in business is tax & tariff free
• Raw materials imported are tax & tariff free (haha, the US even puts a tariff on oil at a time when we are paying $4/gallon at the pump)

The Good News

The good news is Zimbabwe could very easily transform itself from a poor, vacated, socialist shit-hole into a thriving, booming epi-center of Africa.  Neighboring Botswana (where every sane person living in Zimbabwe has long since fled to) has the most capitalistic, freest economy in all of sub-Saharan Africa.  It is also no coincidence that since it adopted those policies it has also had the highest economic growth rate of any nation in the world, even surpassing Hong Kong.  Private sector growth in Botswana has been in the double digits for going on 4 decades!  Also (which is an important point after this week's indignization announcement in Zimbabwe), Botswana's Constitution has a provision that expressly protects all private property from government seizure.  

To those who are unfamiliar there is a data set called the Penn World Table that tracks worldwide incomes.  Overall the world is become richer and richer in every country in an absolute sense.    The countries who engage in socialist or Marxist methods and deny their people access to the capitalist process of accumulating capital are the only exceptions. The Penn World Table can be viewed here.  

I am going to close you where we began.  And I'm going to again give you a von Mises quote because I happen to like his explanation on this topic more than other economists:

What constitutes the greater wealth of a capitalistic society as against the smaller wealth of a noncapitalistic society is the fact that the available supply of capital goods is greater in the former than in the latter. What has improved the wage earners’ standard of living is the fact that the capital equipment per head of the men eager to earn wages has increased. It is a consequence of this fact that an ever increasing portion of the total amount of usable goods produced goes to the wage earners.None of the passionate tirades of Marx, Keynes and a host of less well-known authors could show a weak point in the statement that there is only one means to raise wage rates permanently and for the benefit of all those eager to earn wages—namely, to accelerate the increase in capital available as against population. If this be “unjust,” then the blame rests with nature and not with man.~ Ludwig von Mises, The Anti-Capitalist Mentality, p.58