Posted by: Dirk | November 10, 2011

Why Financing is not Saving, or: Fable of the Breads

I must admit that it took me some time to understand this: financing is not saving. You may finance all sorts of things, and savings are not a necessary part of this story. The reason why this is so is the existence of a fractional reserve banking system. While normally it takes a longer time to explain the details and some knowledge of economics is certainly helpful (see this exposition by Randall Wray), I think I have spotted a short story which leads you on the right path. This is Steve Randy Waldman:

Suppose that land to grow wheat is scarce but labor to farm and bake it into bread is abundant. Land-owners and laborers are paid their marginal products, which at the limits of land scarcity and labor abundance means that land-owners receive approximately all the bread and laborers receive approximately none of it. Suppose that people prefer a bite of bread now to a bite of bread later, but that in each period, no individual can eat more than twice what their share of total output would be if total output were evenly divided. Land owners at full gluttony can eat no more than a small fraction of potential output, and they cannot store the surplus. Technology and population are stable, but land owners face negative real interest rate. There are laborers who would be glad to borrow the surplus bread, but they have no capacity to repay. The real interest rate on the bread lending market would be -100%.

Now Paul Krugman has picked up the scent:

OK, I like little parables. But I have a problem with this one, for one simple reason: any such story, basically an underconsumptionist story, would seem to depend on the notion that rising inequality has led to rising savings. And you just don’t see that.

That, I would argue, doesn’t fit with the story.Remember that [l]and owners at full gluttony can eat no more than a small fraction of potential output, and they cannot store the surplus, so there cannot be any saving! Not to speak of rising saving, which is absolutely impossible in this story. Nevertheless, laborers can finance their consumption by lending  borrowing from land owners. What you would expect in this story is a two-step ending. And it is not a happy one:

  1. Rising inequality should lead rising household indebtedness when the poor still seem creditworthy. However, when it is clear to the land-owners that the laborers cannot repay, we come to step
  2. Land-owners lower production until they reach the level where they consume all the output and nothing is left over. Employment will be lower (although GDP might rise as long as productivity is rising).

Let us now see whether data series from FRED2 support the fable of the breads for the US. #1 is about rising indebtedness (NINJA loans, etc.), #2 about a dent in the GDP growth trend through a permanent fall in employment. (In order to show the three data series in a graph with only two scales I decided to index GDP and employment.)

As so often when thinking about the crisis, we are back at Keynes. Here is an excerpt from chapter 23 of the General Theory (quotation put in italics by me):

But it was by Bernard Mandeville’s Fable of the Bees that Barbon’s opinion was mainly popularised, a book convicted as a nuisance by the grand jury of Middlesex in 1723, which stands out in the history of the moral sciences for its scandalous reputation. Only one man is recorded as having spoken a good word for it, namely Dr. Johnson, who declared that it did not puzzle him, but “opened his eyes into real life very much”. The nature of the book’s wickedness can be best conveyed by Leslie Stephen’s summary in the Dictionary of National Biography:

Mandeville gave great offence by this book, in which a cynical system of morality was made attractive by ingenious paradoxes. … His doctrine that prosperity was increased by expenditure rather than by saving fell in with many current economic fallacies not yet extinct.[33] Assuming with the ascetics that human desires were essentially evil and therefore produced “private vices” and assuming with the common view that wealth was a “public benefit”, he easily showed that all civilisation implied the development of vicious propensities….


  1. […] Why Financing is not Saving, or: Fable of the Breads « econoblog101Dictionary of Phrase and Fable. 1898. Bread. He took bread and salt, i.e. he took his oath. Bread and salt were formerly eaten when an oath was taken. 1 … […]

  2. This is the reference to the Wray paper:

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s


%d bloggers like this: