Does Consumer Spending Drive the Economy? (Hint: No.)

    A few of my other posts have touched on this, but I want to tackle it head on. Our country, our politicians, our economists, and our citizens believe that consumer spending drives the economy. However, that line of false logic is merely analogous to putting the cart before the horse.

     I’m going to steal an example from Peter Schiff. Imagine that there are five people stranded on an island: four Asians and one American. They get together and divvy up the work that needs to be done for survival. One of the Asians will fish so as to provide food. Another Asian will build a fire to cook the food. Another Asian will build shelter. The last Asian will forage for vegetation.

     The American will be given the role of eating, and living in the shelter structure.

     A modern economist, politician, average citizen, etc. would look at this situation and say, “Well the American is the key to this whole system. Without his demand, his appetite, the Asians wouldn’t have any jobs! They wouldn’t have anything to do all day!

     This is essentially the system we have today. In a later post, I’ll address how a global economy is supposed to work, and dissect this further. But here, I’ll stick to dispelling the false idea that consumer spending drives the economy.

Consumer Spending = Eating

     I like to think about consumer spending like eating. Eating is great, it's the fun part, and being hungry sucks. Food is delicious. The reason why I’ll toil in the kitchen for an hour is to be able to eat a nice fat steak. When we look at world hunger, no one thinks that lack of the desire to eat is the problem. We recognize that it’s lack of food, and lack of the means to acquire and produce food. However, in economics, we look at this situation and think that people just aren’t eating enough.

     Consumer spending is the equivalent of eating. Eating is the end game. You go out and hunt that animal, gather those berries, build that fire, and cook that meal so that you can eat. Once you eat that food, it’s gone. Likewise, you go to your job, you earn, and then you consume. You buy a dress, or a cruise, or a car. That money, that capital, once it’s spent, is gone. The goods or services you bought were already paid for by the producer. Sure the producer gets his money back, with profit (preferably). But those profits, if spent on consumption (like a yacht for the CEO of the cruise company), eventually get consumed as well. If you save or invest what you don’t consume, ,or if the cruise company CEO does the same, then entrepreneurs use that saved capital in order to build better products, all in the paradigm of satisfying a consumer demand.

     Again, our governments think there’s an eating problem: people just aren’t eating enough! We need people to eat more! Aggregate demand for food is down!, they’ll say. What our politicians, policy makers, and citizens don’t understand is that spending is the end game. Anyone can eat. If you print a bunch of money and make borrowing money easier by lowering interest rates, you’ll increase spending, sure! That’s easy! People will always spend free money. They'll eat free food if you put it in front of them, too. But all that does is make people eat food that’s already been hunted, cooked, and prepared. The hard part is finding the food. It’s saving the food: producing and underconsuming. It’s going out there, hunting for it, and then not eating all of it, saving it up for winter. If the government incentivizes everyone to eat more, it just means we’re running out of food that we had already gathered and saved for later consumption.

The More Food You Can Save, the Better

     The capital that we save, that we don’t consume, that we plow into new businesses and new products, is what drives the economy. It makes borrowing easier and cheaper for entrepreneurs. It leads to new efficiencies that make products cheaper, and hence more affordable to everyone (like cell phones), and to the satisfaction of novel consumer demands (like a cure for cancer). Saving and underconsumption accelerate this process.

     Sure, you need to eat in order to be able to have the energy hunt, just like you need to hunt in order to eat. But people will always spend enough to survive. They’ll always hunt for what they need: rent, food, insurance, etc. The more we don’t consume, the more we save, the better off we are. Just as I explained in the last post, people won’t suddenly stop spending on items that they can afford and enjoy (like indoor plumbing, a car to get to work, even cell phones). So, when politicians, economists, and policy-makers worry that people will suddenly stop spending, it’s silly, nonsensical, and leads to destructive legislation and policies, like low interest rates and money-printing.

     Sometimes, people are forced to stop spending because, say, they were spending the equity in their home on consumer goods. But, that’s because it wasn’t real in the first place. When spending falls in these cases, it’s because of previous artificial extension of credit, and not because people stop wanting houses and SUVs. This should be an argument AGAINST incentivizing borrowing and spending, not and argument for it. Unfortunately, we learn all of the wrong and contradictory lessons from our own misdeeds.

Politicians Economists, and Policy-Makers Have It All Backward

     Our politicians and policy makers are constantly trying to get us to spend more (eat more). Spend more, save less. Eat all of that food that we all saved. Our economic indicators are largely based on spending, and specifically on consumption-based spending. We think a rise in consumer spending, even a rise in borrowing, means the economy is improving. The truth is, a rise in consumer spending and borrowing COULD be a REFLECTION of a healthy economy, but it DOES NOT HELP the economy. In a normal economy, it would mean that people had saved up, and are now spending what they had previously saved. Great! We're finally being rewarded for our production and underconsumption. However, when consumer spending is artificially induced, ie by lowering interest rates or printing money, all it means is that both consumers and entrepreneurs are squandering all of the food that we had gathered and saved, all under the false illusion that consumers will have more to spend in the future. We’re eating more, but didn’t hunt or gather any more food. It leads to squandering of resources, misallocations of capital, painful corrections, and our “experts” learning all the wrong lessons and making the problem worse in a vain attempt to fix it.

How Much Longer Can This Last?

     I can’t say for how much longer the fallacy that consumer spending drives the economy will remain, but based on how often I see and hear that phrase, I think it will be a long time. Even when the US economy crashes, I believe that we’re still not going to realize that it was too much spending and borrowing that brought on the crash. We didn’t learn it from the housing bubble. We blamed greedy bankers and lack of regulation instead, ironically enough. I think we’re first going to blame Europe, or Japan, and claim that the fact that their economies crashed is the reason why ours did too (which will be partly right, but the essence of the reasoning will be wrong). We’ll think we need more stimulus, more government, and more spending, ie more alcohol.

     I don’t know what the end point will be. But the path to that point is going to be hell, because the US isn’t the only country operating under this premise that spending drives an economy. Our world is teetering on the brink of economic collapse precisely because of this idiocy, and we have only ourselves to blame.

     Stay tuned for an explanation of how a global economy is supposed to work, and how ours is actually “working.”

     Am I crazy? Is the world fine? Any Keynesians out there to tell me how dumb I am? I’d love to hear from all of you!