Well, let's look at the ways in which you can "save" money.
1) Mattress saving--Literally, sticking it under your mattress. Only you have access to your money. It garners no interest; it garners no risk (other than from fire or what-not). No multiplier effect takes place. No jobs are created. Eventually, though, the idea is that this money will be spent on something or other. That spending goes to people with jobs. Those people will most likely later use the cash to buy "Stuff" with a net end result of "Spending."
Why this form of Saving is Bad for the Economy
Conventional wisdom says that some portion of this money will be subtracted from the assets in the aggregate economy because it WILL catch fire, or be lost, or some other manner in which the cash will not be usable again.
Why It May Be Good for the Economy
Non-conventional wisdom says this may be a good thing. If you take that money and spend it, then you are creating demand for whatever it is you buy because you are increasing the scarcity of the commodity. If, however, that money is taken out of circulation, you are not creating demand by buying anything, and "deflation" occurs on EVERY commodity because you are not buying any of EVERYthing.
Clarification
It's also unclear whether this is deflation or just an advanced form of depreciation (if you wait a sufficiently long enough period of time, the value of your money becomes Zero (0). Burning money just speeds along that depreciation (but the depreciation of money is called inflation, so that's this issue is unclear).
Ancient Egyptian Counter-Argument
If, however, burning money is such a bad thing, then why did the ancient Egyptians do an equivalent thing and bury their dead with Assets, effectively taking them off the market and encouraging deflation? Well, they also had slaves... I digress.
2) Savings account--This is the way banks used to loan money. You save with a bank, the bank promises a low-interest for using your money to grant loans. Decades ago, this was pretty much the only reliable way to manage savings. I also lump CD's and other saving devices into this group. When the banks issue loans with your cash, jobs are created and the workers use their wages to buy "Stuff" with a net result of "Spending."
How Banks Loan Money Nowadays
Awhile back, banks figured out that they didn't actually have to have money in their coffers to issue loans because they figured out that not people rarely ask for their money back once they put it in the bank. That's because we use a nifty little thing like "Notes" that have no intrinsic value, except what we place on it (plus we use electronic transfers for upwards of 50% of our spending. I have no clue of an exact number).
Well, when banks figured out that they could issue loans with money they didn't have, they originally made sure that the loans they issued had an upwards of 99% chance of No-Default (Let's call it 3 standard deviations from the norm). The reason was if someone defaulted on a loan for which there wasn't any money to begin with, the bank would be screwed.
Well, after awhile, banks figured out that as long as their rate of default was abnormally low, they could issue more loans and even take a loss by issuing some loans at slightly higher risk levels. So, they could issue loans to people with a 95% chance of No-Default (Call this 2 standard deviations from the norm). As long as the banks issue more loans that are good than are bad, the bank will turn a profit and can still provide the cash to its depositors.
How can it provide cash to the depositors?
Well, a bank issues loans to somebody or a company. That entity typically either spends the loan outright and the person receiving the loan money deposits it into the bank, or the entity receiving the loan deposits it in the bank outright. Either way, the cash ends up in the bank for use.
So, essentially, banks loan out money that they then get back into their coffers.
The Federal Reserve requires that banks keep something like 10% of all money they loan out in liquid cash in the bank vaults, but banks have figured out using the above bogus accounting rules that for every $100,000 they loan out, they only need about $1,100 in liquidity.
Loophole in the Rule
Using real rules of the Federal Reserve, with that $1,100, they should be able to loan out a maximum of around $10,000. But since that $10,000 is going to end up back in the bank because somebody is going to deposit it somewhere down the line, the bank knows that it can use that $10,000 of loan money to issue $100,000 in loan, using the same Federal Reserve requirement rule.
Now obviously, the money that a bank loans out may not go back into the coffers of that bank. But when taken in the aggregate of all banks loaning to all individuals, statistically the money spreads itself around so that any money issued by a bank comes back to that bank at a future point in time. Statistically, there's no difference between the loan money going into this bank versus that one.
I think the current economic crisis, while based on the fact that banks are providing loans at high risk without the cash requirement to support it, is nothing more than a natural response to issuing all that money without "stuff" behind it. I also think that banks have relaxed their "stringent" 2 standard deviations for 1 standard deviation, which is closer to 68% chance of No-Default. The 95% makes sense because humans typically fall in the 95% range. The 68% NEVER makes sense, either in science, math, or in budgeting (which confuses me why the Office of Management and Budget and the Congressional Budget Office both use the 1 standard deviation when making sure that their figures are accurate).
But when you issue money at rates 100x the actual "money" that exists, it is only natural that eventually the market will "contract" to compensate for the difference between money having been spent in the past and the assets that actually exist. I'm sure if I had more knowledge of how bank loans were measured, I could calculate how much of the recent economic contraction was equal to the number of loans being issued at that 1 standard deviation level of 68%.
Paradoxically, banks almost always require collateral to issue a loan. Seems a double-standard, doesn't it?
Also, paradoxically, as banks issue more loans without the necessary cash reserve, the excess flow of money causes inflation, which drives up the price of goods. As the price of goods increase, people require more loan money in order to buy these assets. Inevitable result: Market contraction to the actual value of the assets in question.
3)Investments--Large risk if you're investing for quick bursts of cash. Lesser risk if you're doing long-term portfolio investing in stable markets. The important part when considering investments is that since the money is usually channeled through the stock market, the money you are providing is being used as capital by the company itself. So, the $100,000 in your 401(k) is being used by car companies to retool their factories, thus creating jobs. The people in these jobs use their newfound salary to buy "Stuff" with a net result of "Spending." Not to mention you earn the equivalent of Interest from your investment. As a company's value increases, so do the share of your assets you own in the company. Hopefully, these assets increase at rates greater than the rate of inflation. If the interest is re-invested, then you almost always get a return greater than inflation. If you start using dividends to "Spend", while this is good for local economies, it's not so good from an investment standpoint because you personally lose Rate of Return. No, it's better to leave money invested for as long as possible. Ideally, retirement.
How Risk is Really Decided
Stock market investment is really only risky if you invest for the short-term for quick profit, of if you invest in risky companies. Given time, short-ranged market contractions cancel out and your initial investment always nets a gain. This isn't to say that if you plan on retiring and all of a sudden the market takes a nose-dive and your 401(k) loses about 50% of its value that you'll come out on top. Sure that 50% is still worth more than your original investment. But you'll have to reconfigure your retirement plans by either working another couple of years, or by planning on withdrawing less from your stash while you're in retirement. Both options suck, but then again, you invested in the free market instead of municipal bonds like Suze Orman told you to, which I guess are still free market, but a lot less risky.
The only other way it's risky is if you get companies like Enron, WorldCom, etc. that use faulty accounting practices to "prop up" their value. In the case of WorldCom, the accounts were actually using the depreciation of their assets and calling it "re-capitalization," i.e. buying new assets. It's the equivalent of saying that the $2,000 in value your new car loses every year is being spent "buying $2,000 worth of new car." Doesn't make sense. Since depreciation is on a paper a "profit" it looked like WorldCom was doing good. Not so. I think their stock is back up to twenty cents a share if you can find a market that still carries it.
There's no real way to prevent accounting fraud, except to have a well-funded and well-policed SEC (the guys in charge of making sure companies on the stock exchange obey accounting rules). If WorldCom hadn't had exorbitant Top-Level-Management Salaries, WorldCom might still be around. CEO pay=A bitch.
4) Asset Ownership--This is buying houses and land and holding your cash in the value of a property or other asset. Classic cars, antique vases, etc. These typically involve a direct transfer of assets (cash) for another one (house) with the belief that the second asset will increase in value faster than inflation diminishes the value of the first asset. This isn't a reliable method of savings, but I put it here because many people erroneously think it is. If you think you're saving money by buying a house, just look at all the factors that go into determining property values (Value of house; Perceived value of house; Desirability of house in relationship to neighboring houses, property values in the area; job market in the area; desirability of the city; many other factors not directly related to the actual value of the house). As you can see, there's a lot of risk that goes into buying a house, so much so that it's not investing so much as it's just pure risk-taking.
Can Assets Truly be Saving
You can, of course, hedge your bets by buying properties and then renting them out, but that brings about an entirely new set of headaches. At that point, asset ownership becomes more along the lines of investing, which is a truer form of savings. The difference is that you become the business you're investing in. Most people wouldn't invest in someone like themselves, so I would invest in you either. :D
Assuming that at some point you do sell/auction off your asset, a transfer of cash occurs. Regardless of whether you sell your house at a loss or a profit, someone will pay you for the value of your house, and you turn around and use that cash to buy "stuff". So, in the end, asset ownership still nets a result of "Spending," not to mention that someone just "Spent" money on your house.
I think I covered all the basics of saving money. The point, however, is that any saving done has an end result of "Spending." Or to put it another way:
"Saving=Spending"
Is this true Socially?So if Saving=Spending, then what doesn't equal spending?
I shall take the economics easy way out and say, "It depends." If someone spends 100% of their earnings, but no more, then that constitutes Spending. Notice how I make a distinction between Spending and spending.
If, however, someone spends 100+% of their earnings, then the percentage higher than 100% DOES NOT equal Spending. I would classify this as the equivalent of WorldCom recapitalizing their assets. Until the debt is fully paid off, any multiplicative effect from this debt-spending is not true spending. Also, as a corollary, if a person spends 100% of their earnings, but no more, and a portion of their earnings is spent on interest on debt, then that interest does not equal Spending.
So, when all these "economists" (i.e. populist political commentators) say that people aren't spending money because they're saving, they're missing the point. Money saved is money Spent! And how you save depends on how much money gets Spent in the end. Money invested nearly always has a higher multiplier effect than money put put into a savings account, and always has a Multiplier effect compared to Mattress-Stuffing.
Populist Political Commentators only know how to do one thing: Be full of themselves.
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