Savers Are an Economy’s Most Valuable Benefactors
Capitals are increased by parsimony, and diminished by prodigality and misconduct.
—Adam Smith, The Wealth of Nations
Peter Bogdanovich, best known for the films he directed in the early 1970s, surely merits mention in any discussion of the most venerated “auteurs” from that period, which included Francis Ford Coppola, William Friedkin, and George Lucas. Among his films were The Last Picture Show, Paper Moon, and Daisy Miller. Bogdanovich’s conquests weren’t limited to film. He enjoyed a close friendship with the legendary Orson Welles, conducted a very public romance with Cybill Shepherd, the beautiful star of The Last Picture Show, and carried on an affair with the Playboy playmate Dorothy Stratten (until she was murdered by her estranged husband). As the saying goes, Bogdanovich “had it all.”
But in 1985, with only $21.37 in the bank, he filed for bankruptcy.1 The principle cause of his financial catastrophe was his purchase of the rights to They All Laughed, the movie in which he was directing Stratten when their affair began. As he explained in the Wall Street Journal in 2014, “I spent $5 million of my own money buying back the film from the studio and distributing it myself. In retrospect, this move was crazy. It’s nearly impossible to distribute a film on your own, and I lost my shirt.”2
Yet, the purchase of They All Laughed was not the sole cause of his financial troubles. Prodigality was also a major problem. Reports indicated monthly expenses of two hundred thousand dollars with only seventy-five thousand in monthly income. Those expenses included sixteen thousand dollars per month for lawyers, more than fifteen thousand dollars in agent and management fees, two thousand dollars for transportation, and a thousand dollars for laundry.3 Bogdanovich spent his way to the poorhouse.
With its grand tradition as a college football powerhouse, the University of Texas boasts a long line of gridiron luminaries—players like Bobby Layne, Earl Campbell, and Ricky Williams. But the greatest of them all is surely Vince Young. In the early 2000s, this Longhorn quarterback almost single-handedly revived a team and a program that were wandering in the wilderness. Young carried his team to a thrilling 38–37 victory over the Michigan Wolverines in the 2005 Rose Bowl. One year later, back in the Rose Bowl, Young dismantled number-one USC’s defense in a 41–38 win that gave Texas its first national championship since 1970. It was arguably the greatest individual performance in the hundred-year history of the storied bowl game.
After his emergence from that game as the best quarterback in college football, Young was the third player taken in the pro draft. Unlike most quarterbacks, who take a few years to adjust to the advanced defenses of the NFL, Young was a star in his first season with the Tennessee Titans, winning the 2006 Rookie of the Year award. Then his star began to dim. He slumped in his sophomore season, throwing nine touchdown passes versus seventeen interceptions, and the Titans cut him by the 2010 preseason. Young joined the Philadelphia Eagles for one season and then migrated to the Buffalo Bills, who cut him before the season began.4 In 2013, he signed a contract with the Green Bay Packers, but they too released him during the preseason.5 His fortune turned even more dismal in 2014. Just seven years after signing a twenty-six-million-dollar contract with the Titans, Young filed for bankruptcy (though the filing would later be reversed). While spending two hundred thousand dollars per month, he took out a loan of $1.8 million during the 2011 NFL lockout. His expenses included a three-hundred-thousand-dollar birthday party. On top of everything else, he is supporting four children conceived with four different women.6
The sad stories of Bogdanovich and Young exemplify the fallacy, embraced by too many economists and reporters in the financial press, that consumer spending is the cause of economic growth. Just before becoming chairman of the Federal Reserve, Janet Yellen defended the Fed’s program of quantitative easing in an interview with Time: “Our policy is aimed at holding down long-term interest rates, which supports the recovery by encouraging spending.”7 A few days later, the Wall Street Journal chimed in: “A slowdown in U.S. income growth could short-circuit the surge in consumer spending that propelled the economic recovery in recent months” (emphasis added).8
Yellen and other believers in spending our way to prosperity are correct that individuals produce in order to consume, but they ignore the importance of production. To state the obvious, production precedes consumption. If you doubt me, ask yourself how you are able to consume. You can consume because you have a job that allows you to or because you can borrow from other producers willing to shift their consumptive power to you. Despite what you read in the newspapers or hear on CNBC, people trade products for products. In order to consume, they must produce first.
Most economists and financial reporters would have viewed Peter Bogdanovich’s and Vince Young’s conspicuous consumption as an economic plus. Spending millions with abandon, each of these guys was a one-man “stimulus” machine. The problem is that the U.S. economy is a collection of individuals, and individuals who spend their entire paychecks—or worse, go into debt to spend even more—are self-destructive. If a person is going to spend profligately and take on debt in the process, he had better have a secure source of income for the foreseeable future. If he doesn’t, then he’s headed for bankruptcy, just like Bogdanovich and Young.
People who live beyond their means eventually run out of means. Big spenders become beggars dependent on the kindness of strangers. Sooner or later the profligate have to ask for help from the very people economists see as the bad guys—savers. What Yellen and the others miss is that you cannot elevate consumption and debt unless a lot of people are aggressively saving. Short of printing money without regard to production (more on that in a later chapter), there is no credit without saving first. The two go together.
In chapter six I explained why saving money is the best way to redistribute it. One billionaire’s miserly stockpiling of his wealth represents small business loans for thousands of entrepreneurs with potentially economy-changing ideas that need capital. When anyone—rich, middle class, or poor—saves his income rather than spending it, he expands the credit available for people to remodel a kitchen, buy a car, or best of all, start or expand a business. For an entrepreneur to turn his vision into reality, he must have either substantial savings of his own or access to the savings of others.
Let’s consider the basic economic principles with a simple example. When you pay twenty dollars to the Domino’s deliveryman you’re not really exchanging money for a pizza. You’re trading a portion of your work as a construction worker, salesman, or investment banker for the product on offer from Domino’s. We trade products for products; money is merely the accepted measure used to complete the exchange. Our production is our demand. Or better yet, to demand or consume anything in the marketplace, we must supply something first, and investment enables supply.
The critical role of investment becomes clear if we follow the story of a computer salesman earning seventy-five thousand dollars a year. He takes home forty-five thousand dollars in disposable income after taxes. The average economist would say that this salesman will stimulate the economy most if he spends all of that forty-five thousand on rent, restaurants, clothes, vacations, and other consumer goods. Heavy consumption, according to the conventional wisdom, boosts economic growth by making money rapidly circulate from one set of hands to others.
But our salesman knows that living on the edge is scary. A layoff could strike any day, so it’s best to stash some of that money. Even better, he realizes that much of his day is wasted driving around looking for the offices of potential customers, so he invests in a GPS navigation system that leads to a 20 percent increase in sales—an income boost of fifty thousand dollars.
Our salesman then discerns that too much of his day is spent on paperwork, not to mention cold-calling potential customers. He realizes that paying an assistant thirty-five thousand dollars a year, while expensive in the near term, will free him up for more of the person-to-person meetings necessary to close big deals. That thirty-five-thousand-dollar investment leads to two hundred thousand dollars of additional income over time.
As he learns more about the business and the specific needs of the customer base, the salesman realizes that with a two-hundred-thousand-dollar loan he could start his own business selling computers manufactured to his specifications overseas. The initial outlay would be large, but with much of the existing client base wedded to him and his attention to service, taking on debt and spending some savings in the near term could lead to a seven-figure income down the line.
This story of the enterprising computer salesman is simplified, but it demonstrates the wonders of saving. Consumption depends on production, and re-investment of profit often increases production. As John Stuart Mill said, profits are “the remuneration of abstinence.”9
Imagine if Henry Ford had been a prodigal spender who blew the profits from Ford Motor Company on booze, women, and toys. More than a few owners of the two thousand-plus U.S. car companies10 in the early twentieth century probably did just that. Maybe his talent was so prodigious that it could have kept him flying high anyway. But what made Ford an entrepreneur for the history books was religiously reinvesting his company’s profits in the perfection of his manufacturing systems. Delaying consumption in favor of investment allowed Ford to mass produce cars with ever greater efficiency, and America’s consumption of those cars grew at the same pace. If today’s establishment economists had been around in Ford’s day, they would have bewailed his parsimony.
Having become enormously wealthy thanks to his company’s success, Ford could have settled back into tight-fisted retirement. And as far as the well-being of the broader economy was concerned, that would have been fine. Unless he stuffed his profits under a mattress, Ford’s “hoarded” savings would have migrated to others, including entrepreneurs seeking funds for new businesses.
The relentlessly ambitious Steve Jobs could have retired and thrown as many three-hundred-thousand-dollar birthday parties as he liked. He would have won the applause of the economics profession for it. But the “unseen” in that scenario would have been the wealth and jobs he never would have created if he had pursued a life of conspicuous consumption.
Investment is the only wealth multiplier. As Adam Smith wrote, “It is by means of an additional capital only, that the undertaker of any work can either provide his workmen with better machinery, or make a more proper distribution of employment among them.”11 Increase investment, expand output, and watch wealth increase over the long term. In consuming their income, Young and Bogdanovich stripped themselves of wealth and the economy of the capital to create more of it.
Americans are actually great savers. The vast wealth on deposit in this country belies the frequent reports to the contrary. But we’re inclined to misunderstand the nature of the biggest purchase most of us make—housing. It’s common to consider your house an “investment.” It’s not. Housing is a consumptive good. The purchase of a home will not make you more efficient. It won’t lead to software or healthcare innovations that make businesses more efficient, cure cancer, or open up foreign markets. The purchase of a house consumes capital.
Looking back on the housing boom of the 2000s, it is no surprise that it coincided with a rather dormant market for shares in initial public offerings. The 1980s and ’90s were marked by the IPOs of Microsoft, IBM, and Cisco (to name but three), while Google was the only high-flier issue that made much noise amid the rush to housing in the 2000s. With housing the place to be, entrepreneurs in need of investment suffered a capital deficit. In short, capital consumption rose at the expense of the capital formation that drives economic growth.
Janet Yellen, in that interview with Time, seemed unconcerned about housing’s eating up too much capital. Eager to justify the Fed’s allocation of capital toward treasuries and mortgage bonds that would drive down interest rates, Yellen explained that “part of the [economic stimulus] comes through higher houses and stock prices, which causes people with homes and stocks to spend more, which causes jobs to be created throughout the economy and income to go up throughout the economy.”12
Yellen was forgetting her Adam Smith, and John Stuart Mill for that matter. Never mind that stock markets were much healthier and unemployment much lower in the ’80s and ’90s, when the Fed was not aggressively trying to push interest rates down. Any central bank policy meant to stimulate home buying will retard economic growth because the purchase of a house takes money out of capital markets for business. Stimulating consumption, of housing or anything else, decreases investment in production. That increased production would, in turn, increase wages. Henry Ford could pay his employees an industry-leading wage because his continuous reinvestment in manufacturing enhancements rendered the labor of his workers enormously productive.
With economists, politicians, and advertisers pushing consumption as a patriotic duty, it’s easy to forget that thrift and temperance were once considered bedrock American virtues. “Buy what thou hast no need of, and ere long thou shalt sell thy necessaries,” warned Benjamin Franklin in Poor Richard’s Almanack. In Dividing the Wealth, Howard Kershner invites us to come back to our senses: “The man who accepts the responsibility of denying himself the pleasure of current consumption in order to save and accumulate capital is the real hero and patriot who is conferring vast blessings upon his fellows.”13