This article is the second in a series of articles that seeks to provide the intelligent layman with sufficient knowledge of sound economic theory to enable him to understand what must be done to overcome the present financial crisis and return to the path of economic progress and prosperity. The first article in the series was “Falling Prices Are Not Deflation but the Antidote to Deflation.”
Capital, Saving, and Our Economic Crisis
Imagine an individual who is lethargic and lacks the energy to function at his normal level because of too little sleep. There are drugs that can make him feel fully refreshed, even after a night without any sleep whatever, and apparently capable of functioning the next day with full efficiency.
Nevertheless taking such drugs is definitely not a good idea. This is because the individual’s underlying problem of insufficient sleep is not only not addressed by his being stimulated but is actually worsened. For the stimulus further depletes his body’s already diminished energy reserves and takes him down the path of utter exhaustion.
This description applies to the current slowdown in our economic system and to the efforts to overcome it through the use of “fiscal policy” and its “stimulus packages.” The meaning of these terms is more government spending and lower taxes specifically designed to promote consumption. This includes giving income-tax refunds to people who paid no income tax and who, because of their low incomes, can presumably be most counted on to rush out and consume more as soon as additional funds are put in their hands.
The main difference between such economic “stimulants” and pharmaceutical stimulants is that the economic stimulants will not succeed even in temporarily restoring the economic system to anything approaching its normal level of activity.
An economic system entering into a major recession or depression is in a situation very similar to that of our imaginary, sleep-deprived individual. All that one need do is substitute for the loss of the sleep required for the body’s proper functioning the loss of something required for the proper functioning of the economic system.
Capital
In the case of the economic system, that something is capital. The economic system is not functioning properly because it has lost capital. Capital is the accumulated wealth that is owned by business enterprises or individuals and that is used for the purpose of earning profit or interest.
Capital embraces all of the farms, factories, mines, machinery and all other equipment, means of transportation and communication, warehouses, shops, office buildings, rental housing, and inventories of materials, components, supplies, semi-manufactures, and finished goods that are owned by business firms.
Capital also embraces the money that is owned by business firms, though money is in a special category. In addition, it embraces funds that have been lent to consumers at interest, for the purpose of buying consumers’ goods such as houses, automobiles, appliances, and anything else that is too expensive to be paid for out of the income earned in one pay period and for which the purchaser himself does not have sufficient savings.
The amount of capital in an economic system determines its ability to produce goods and services and to employ labor, and also to purchase consumers’ goods on credit. The greater the capital, the greater the ability to do all of these things; the less the capital, the less the ability to do any of these things.
Saving
Capital is accumulated on a foundation of saving. Saving is the act of abstaining from consuming funds that have been earned in the sale of goods or services.
Saving does not mean not spending. It does not mean hoarding. It means not spending for purposes of consumption. Abstaining from spending for consumption makes possible equivalent spending for production. Whoever saves is in a position to that extent to buy capital goods and pay wages to workers, to lend funds for the purchase of expensive consumers’ goods, or to lend funds to others who will use them for any of these purposes. Continue reading . . .
