Wednesday, January 25, 2017

Panic on the Street

. . . on Wall Street, that is.  It seems that the “Baby Boomers,” who have an estimated $10 trillion in tax-deferred savings accounts according to the Wall Street Journal (“Boomers to Start Mandatory 401(k) Exit,” 01/17/17, A1, A10), are going to have to start receiving the mandatory distributions required under law in the year in which someone turns age 70½.
And what’s wrong with that, you say?  Weren’t they told they have to save for retirement, and aren’t most people retired by the age of 70½?  Now’s the time to spend some of that money, which is why they saved it in the first place, right?
Panic on the Street, à la 1907
WRONG! . . . at least according to all the financial advisors, brokers, bankers, and other financial types whose livings depend on managing all that cash.  They don’t want people to spend their money, stimulating demand for the goods and services already being (over) produced, and on which all the savers deferred gratification in the past to be able to indulge themselves now.
No, the experts say the real reason you saved was not for retirement, but to invest so you can accumulate even more wealth . . . which is where the whole thing kind of falls apart.  Why deprive yourself of something in the past in order to have it in the future, only to be told you have to put it off again?
It's a living . . . oh, wait. . .
For your retirement?  But you’re already retired!  What comes next?  Does the Grim Reaper charge a fee?  (Charon does, but that's the toll for the ferry across the River Styx once you're already dead.)
Now you’re catching on.  All the Boomers who were told to save were not given the real reason they were told to save.  They thought it was so they could enjoy themselves in retirement.
No, it was to create jobs in the financial services industry managing their money.  If the Boomers take the money and spend it, all the jobs managing that estimated $10 trillion in savings are going to disappear.  To save their jobs, the experts are frantically trying to convince Boomers to take their mandatory distributions and reinvest them, deferring the income even longer, preferably until after they die, so that the experts can then continue to manage the money for the heirs.
"Consumption is the sole end and purpose of all production."
All of this flies in the face of the first principle of economics.  As Adam Smith put it, “Consumption is the sole end and purpose of all production.”  From the experts’ point of view, however, accumulation, hoarding, and never spending is the sole end and purpose of all production.  Let the government take care of creating demand by printing money . . . which also creates jobs in the financial services industry.
The fact is — as the Boomer situation demonstrates — saving for investment by cutting consumption in the past is a mug’s game.  It doesn’t benefit the saver, and it’s not intended to.  It’s intended to benefit the people whose job it is to manage other people’s money.  Massive or even moderate saving by cutting consumption actually harms the economy because it decreases the consumer demand that drives the economy, as Harold G. Moulton demonstrated eighty or so years ago in his classic refutation of Keynesian theory, The Formation of Capital (1935).
But (you reasonably ask) if the funds for new investment don’t come from reducing consumption in the past, where do they come from?
As Moulton again demonstrated, the best source for investment funds for forming new capital is not reducing consumption in the past, but increasing production in the future.  That is, instead of past savings, it should be future savings.
But (you again reasonably ask) I can see where the investment funds come from when I reduce consumption and accumulate money savings.  Where does the money come from when I use future savings?
Henry Thornton, "the Father of Central Banking."
The first principle of finance is to know the difference between a mortgage and a bill of exchange (yes, this is answering your question).  A mortgage is a contract conveying an ownership interest in past savings, that is, existing wealth owned by the issuer of the mortgage.  A bill of exchange is a contract conveying an ownership interest in future savings, that is, wealth that the issuer doesn’t have now, but reasonably expects to have when the bill comes due.
That, by the way, is why mortgages bear interest: they’re loans on existing wealth, and the lender is due a share of the profits (if any).  Bills of exchange are discounted, based on the probability that the issuer will make good on his promise, e.g., a fifty/fifty chance means a bill will be discounted by half, or 50% . . . which is a pretty bad credit rating, by the way.
Thus, a mortgage usually passes at face value, because the issuer already owns 100% of what the mortgage conveys.  A bill of exchange usually passes at a discount because the issuer does not yet have what the bill conveys, and there’s a chance he might not.  (Sometimes there’s a premium on a bill because what the bill promises to deliver is worth more on maturity than expected, which can cancel out the discount.)
The bottom line here is that, given financially feasible investments, i.e., investments that pay for themselves out of future profits and thereafter provide consumption income for the investor, there should never be a question of whether there’s enough savings accumulated in the economy to finance all the necessary new capital.  Using future savings, there can always be enough money in the economy — and past savings can safely be spent on consumption, which is their purpose, as they represent unconsumed production from the past.
But what about all the jobs that will be lost in the financial services industry if people stop saving?  You mean, all the jobs that will be created?  If everyone was able to use future savings to finance investment for income instead of past savings to finance a hoard for their heirs to waste, there would be quite a few new jobs created, not lost.  After all, if there were 7 billion investors with portfolios they need help in managing, don’t you think they might need someone whose job it is to help them? That's millions of new jobs right there, created naturally, not by complicated redistribution schemes.

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