I was having a look at "What Has Government Done to Our Money" by Rothbard, and got thinking about the problem of hoarding, or increasing one's cash balances. This may be relevant in the current economic climate if people are losing faith in the banking system and yet trying to rebuild their wealth after the excesses of a boom. This primary analysis of hoarding, however, takes place in the context of an idealised free society. These thoughts are rough and I would very much like to tighten them up. Would greatly appreciate corrections and suggestions.Reference: http://mises.org/money/2s9.aspTo begin, recall that the supply of money means the total money stock (e.g. 3000 tonnes of gold) while the demand for money means all of the goods and services produced in exchange for money plus cash balances and money not spent.Someone who hoards increases their cash balances, yet one may assume that their productivity remains the same. If you think about it in terms of the flow of goods and services, then what is happening is that the hoarder is continuing to supply goods and services to other people, while the share of other people's goods and services which the hoarder consumes drops in accordance with how much money they choose to retain.The supply of labour is unchanged. The hoarder's cash balance gradually rises, while the rest of the population shares the economy's output amongst themselves. Money's purchasing power rises with the deflationary impact of the hoarder's actions. The losers are those who would otherwise have satisfied the hoarder's immediate demand for goods and services. The hoarder has chosen to transfer this demand to suppliers at some future period of time. And note that the flow of money to the hoarder, if it were to continue indefinitely with a constant supply of money, must eventually slow to a trickle. This is because of the deflationary impact of hoarding. Since prices express relative preferences for goods and services, ie. since prices are types of ratios, they must contract in proportion to the supply of money. Therefore prices paid, including those to the hoarder for his own output, must decline.It might be instructive to compare the consequences of hoarding with the consequences of deliberately destroying all cash balances available to you. This is purely deflationary (since the money can then never be spent, not even at some point far in the future) and the result is that the person who does this is quite simply donating their share of economic output to the rest of society, to each other actor in proportion to the amount of still existent cash held by that actor.So far there is no problem. Now imagine that there is a generalised apprehensive mood among economic agents. For some reason (suppose fear of a catastrophe), all of them want to grow their cash balances. Hoarding is intimately related to uncertainty: as Rothbard observes, if the future could be predicted with certainty, then there would be no need for cash balances at all. If any money was received it would be immediately loaned out with a guaranteed maturity at the future point when it was needed.What happens in this scenario? The supply of money is unchanged, yet the demand for money has changed because of an increase in cash balances. The supply of goods and services produced in exchange for money is unchanged. Therefore the purchasing power of money goes up, and anybody who continues to offer the same prices as before everybody began to hoard will find that they can afford to purchase a much larger share of output. Their cash balances will dwindle because of the superior saving-to-spending ratio of the rest of the population.Yet, if there were no exceptions and if everybody did hoard at the same rate, what effect would that have? Clearly there would be a short-term deflation, as there was with the individual hoarder. Surprisingly to me, however, in terms of the distribution of goods and services, there is no reason to expect an immediate change. Since everybody has cut back at the same rate, they will find when they go to market that they can afford to purchase the same goods and services as they could before.What practical purpose could this possibly achieve then? Rothbard writes:"Now, suppose, for whatever reason--perhaps growing apprehension--people's demand for cash balances increases. Surely, it is a positive social benefit to satisfy this demand. But how can it be satisfied when the total sum of cash must remain the same? Simply as follows: with people valuing cash balances more highly, the demand for money increases, and prices fall. As a result, the same total sum of cash balances now confers a higher "real" balance, i.e., it is higher in proportion to the prices of goods?to the work that money has to perform. In short, the effective cash balances of the public have increased. Conversely, a fall in the demand for cash will cause increased spending and higher prices. The public's desire for lower effective cash balances will be satisfied by the necessity for given total cash to perform more work.Therefore, while a change in the price of money stemming from changes in supply merely alters the effectiveness of the money-unit and confers no social benefit, a fall or rise caused by a change in the demand for cash balances does yield a social benefit--for it satisfies a public desire for either a higher or lower proportion of cash balances to the work done by cash."I would like to explore what kind of social benefit this could be. For suppose that the reason there is a greater demand for cash balances is a greater apprehension about some future event. Now if that future event - an earthquake, for example - were to strike and to hurt each person simultaneously and proportionately such that they all wished to dispose of their cash balances at that point, there appear to be some strange consequences. The inflation that would be thus caused by the arrival of everybody's cash to the marketplace would prevent any person from having a financial advantage over any other which they would not have had if nobody had chosen to hoard. Prices would rise universally!This suggests that hoarding is only useful in this scenario if ones hoards at some kind of higher rate to other people. Hoarding less than others will cause money to flow to them, while hoarding at the average rate will yield no advantage after the catastrophe. The efficacy of hoarding is relative to the hoarding behaviour of others.Of course, if the potential catastrophes are specific to each individual and not simultaneous, then hoarding will serve to manage the risk by allowing each person to purchase a larger share of the total economic output with their cash balances at the time when the need arises, though each such spending of savings will reverse the previous deflationary effect of that hoarder.What about the rate of hoarding itself? Since each hoarding rate can have an equivalent effect on the distribution of goods and services, is it in some sense arbitrary? I would say that it is not, for the reason that hoarding should settle at the point which equilibrates demand for current goods with the uncertain demand for future goods. It is resolved by supposing that each person attempts to hoard at the rate of 100%. This abrupt and total deflation would permit any person to purchase any good and service, or indeed the the entire output of the economy, using the smallest existing units of money. Of course by so doing they lower the rate of hoarding from 100%. This helps us to understand that as long as there is still at least some kind of underlying demand for current goods, the rate of hoarding can never reach 100%. On the other hand, if there is really no demand for current goods then exchanges will cease to take place and the rate of hoarding can reach 100%.From the point of view of society at large, the hoarding rate serves to inform us of the scale of uncertainty and to distribute goods and services according to the relative strength of the preferences of various agents to prepare for an uncertain future.
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graham34:I would like to explore what kind of social benefit this could be. For suppose that the reason there is a greater demand for cash balances is a greater apprehension about some future event. Now if that future event - an earthquake, for example - were to strike and to hurt each person simultaneously and proportionately such that they all wished to dispose of their cash balances at that point, there appear to be some strange consequences. The inflation that would be thus caused by the arrival of everybody's cash to the marketplace would prevent any person from having a financial advantage over any other which they would not have had if nobody had chosen to hoard. Prices would rise universally!
I always like to think in real terms, not monetary terms. Suppose you're a bunch of squirrels and your weather forecasters are talking about a seriously nasty winter coming on. All the squirrels who hear these forecasters (and believe them) decide that what they'll do is delay (more than usual) immediate consumption of nuts so that they can save more for the winter (with the expectation that the winter will be longer than usual). They keep on collecting nuts, to be sure, but they don't eat as many as usual - they store more instead.
Presumably, what people who are hoarding money are trying to achieve is more or less the same. One assumption that you make, in your above argument, is that if everyone gets anxious and starts hoarding at the same time that the quantity of goods/service available will remain unchanged. Is this the case though? It might well be the case that levels of production will remain the same, but surely by refusing to spend their money those people who are hoarding are implicitly saving those resources that they decide not to purchase. So hoarding on mass will not only result in a decrease in the quantity of money in circulation but will also result in increasing stockpiles of real goods available to be sold. It is the ratio between these two things that causes prices to fall - but your argument above assumes that the only factor in this ratio (of goods / money) that changes when people hoard is the quantity of money in circulation. If this is so, it's certainly not what those people hoarding were intending to be the consequence of their hoarding - what they wanted was to keep resources in reserve for whatever event they were anxious about - and it is their belief that money is synonymous with goods (because it can be easily traded for those things that one generally needs).
So ideally what people want is for the quantity of real goods held in reserve to increase (irrespective of what happens to the quantity of money in circulation). Will this actually happen though? Perhaps if people stop buying stuff then production will slump. If less people are buying my bread then I won't bake as much bread... so I'll buy less flour. The miller, as a consequence, will start accumulating stockpiles of flour... having already planted and harvested his wheat. So the stockpiles of real goods, such as flour, will increase. Similarly the quantities of all sorts of other basic goods (such as oil, wood, metals etc.) will also increase... having much the same effect as the decision by squirrels not to consume as many nuts.
In nominal terms, this might not be great for people like the miller - who might go bankrupt... He'll likely find funding from someone who has a big fat cash balance though, in exchange for a percentage of his mill or something - so there's no reason to suppose that production will be seriously affected. Certain entrepreneurs who started accumulating cash balances earlier (or more effectively) than other people will essentially win out in this scenario and entrepreneurs (such as perhaps the miller) who made long term investments/plans based on expectations of demand that turned out to be false will loose out - but that's just the big game of life. Effectively, if the miller does go bankrupt, it will be because he didn't have much in the way of cash savings (and thus he'd been one of the squirrels eating everything he collected up until the crisis occurred). The Entrepreneurs that buy his mill will be those squirrels that were saving the most nuts before the crisis hit and, for their foresight, they will be rewarded... So it's the systems way of rewarding people for having savings at a time when they were so desparately needed.
I'm writing all of the above with a little bit of optimism, to be honest, that the free market system can work - I'm trying to think of a way that it would (I'm far from certain that it really works as I'm describing above - I'm just trying to throw some ideas out there). I'm sure Keynes wouldn't agree with the above, and nor would a whole flock of monetarists who like to think that they can increase production by "creating demand"... I'm pretty sure the chap that argued the most with Keynes about this was Hayek though, so he's probably the man to read if you want to get a well informed Austrian response. Maybe Rothbard and Hazlitt as well (although you're already reading Rothbard, so presumably you haven't found the answers you're looking for there).
Jimmy, your example using squirrels is totally awesome.
In any case, to the question. What the OP is describing isn't hoarding. Hoarding is when someone just takes in lots and lots of money and never spends it. Hoarding doesn't really have that much of a negative effect on the economy, it might cause some price deflation if done on a massive scale.
What the OP is talking about is saving. The difference is that saving means that you save money so that you can have more in the future. Saving is a very good thing. As people save more, they will have more money (duh). If you have more money, you'll begin to spend it on more expensive things. More expensive goods are usually goods that take longer to create (i.e. houses, cars, computers, patios for your house, etc.). This creates a "lengthening" of the production process, as goods with more stages of production are in higher demand.
At the same time, this lower time preference which caused the increase in saving, also causes an increase in direct investment (stocks) and indirect investment (loans or CDs on the individual level). This means that there is more money that can be loaned out now, which means lower interest rates. Because of these lower interest rates, businesses close to the first stage of production (the ones that produce the cheapest consumer goods) will begin to invest more in capital goods since that will lower production costs. The workers replaced my capital goods will in turn be hired by companies that produce capital goods.
The resulting deflation in consumer good prices (due to less demand and a switch from manual labor to machinery) means that real wages rise and everyone ends up all happy dory ALL THANKS TO SAVING. :)
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Hi jimmy, thank you very much for your reply. With respect to the squirrels example, I am not sure if it represents the phenomenon I am trying to explain. Obviously there is a difference in that nuts, unlike money, have significant non-monetary uses. Yet the specific concept of hoarding is concerned with personal accumulation of money, which is assumed to be demanded mostly for its functions qua the medium of exchange.
Note that I haven't specified any particular change in consumption patterns. While it's clear that market participants may choose to delay consumption as well as hoarding money, this need not be the case. I can conceive of circumstances where this there are constraints on consumption so that it is not actually possible to hoard the goods in demand (for example in the case of perishable foodstuffs).
The fact that no change in consumption patterns is specified is relevant to the further points made.
One assumption that you make, in your above argument, is that if everyone gets anxious and starts hoarding at the same time that the quantity of goods/service available will remain unchanged. Is this the case though? It might well be the case that levels of production will remain the same, but surely by refusing to spend their money those people who are hoarding are implicitly saving those resources that they decide not to purchase. So hoarding on mass will not only result in a decrease in the quantity of money in circulation but will also result in increasing stockpiles of real goods available to be sold.
I can see where I make that assumption, and agree that it requires clarification, though I am not yet ready to abandon it. What I should have said is that the productive capacities of the economic agents are unchanged. Recall the only certain change has been a preference for hoarding money instead of spending it (and include here a further clarification: that investment and entrepreneurial processes continue to be supplied as they would have without hoarding; in effect we include investment and other entrepreneurial-type activities in the category "labour", which is assumed constant).
If everybody is hoarding at the same rate, then we see that each person's demand for goods and services (as measured by the money exchanged for these goods and services) must decline, and in particular that it must decline proportionately. There may be friction effects as the price level changes, yet I can find no force which would change the distribution of economic output in any particular way.
For these reasons the productive capacities are unchanged and the distribution of output remains in its previous proportions. Since we have also not specified any change in consumption patterns, and may assume it is unchanged (as for the case where hoarding is motivated by a desire for perishable goods), then I believe my original description of the result holds firm. The economy continues as it did before.
It gets interesting when people react differently to their fear of the future. In that case those who hoard at a higher rate than others will have less influence in the marketplace than they did before, and so economic output in the short term will be more heavily influenced by the demands of those who hoard proportionately less, though the same amount of labour will have been used to produce it.
Hi kaju, many thanks to you also for the response. I would like to be as clear as possible with respect to the meaning of "hoarding". I mean the increasing of one's cash balances by holding money instead of exchanging it for consumption goods. When Rothbard talks about hoarding, he includes the accumulation of money with the intention of eventually spending it. As he writes:
People do not precisely know what will happen to them, or what their future incomes or costs will be. The more uncertain and fearful they are, the more cash balances they will want to hold; the more secure, the less cash they will wish to keep on hand.
People may hoard in order to buy more expensive goods, or because they would prefer to buy many cheap items at some future point. I haven't really specified this; my example concerns an increased apprehension about the future and a corresponding desire to be prepared with purchasing power in the case of a catastrophe. I do not say if the purchasing power will be used to purchase more or less expensive items.
And to make another point as clear as possible, hoarding is not an investment; the money has not been loaned out and can be used by nobody while it is being hoarded. Investment activities are classified with other types of entrepreneurialism as labour. I assume for the sake of illumination that labour is unchanged.
We probably have similar viewpoints but I believe we are using different terminologies, so it's hard to make a more useful reply.
graham34:While it's clear that market participants may choose to delay consumption as well as hoarding money, this need not be the case.
I'm not sure I agree here. Hoarding money (i.e. choosing not to spend it) and delaying consumption are one in the same... you cannot do one without the other, unless prices decline before you consume, in anticipation of your hoarding and the fact that you're taking your money out of circulation. Otherwise though, in spending less money you are also consuming less. So if production remains the same then savings of real goods will increase (not for you personally, but for all the merchants that you don't purchase goods from).
It's important to differentiate between the situation that Kaju was describing and the one that I'm describing. Kaju describes a market that resembles our present market - where banks are both deposit institutions and lenders. If you save money in such a market the bank automatically lends it out to entrepreneurs who invest it immediately in long term projects. In that scenario savings and investment are equivallent. The result of this is that things don't get saved/stockpiled at all - they simply get used by investors rather than consumers. What I was describing though (because I think it's likely this is what Rothbard was describing) was a market that uses the gold standard and where deposits must be redeemed on demand. Under such conditions, savings are held in demand deposit accounts and remain savings (the bank can't go lending these out) and so the money genuinely does fall out of circulation. Prices will react AFTER the money falls out of circulation though. In the present day, prices tend to lag monetary injection by around 18-24 months, in fact... which may serve as some indication of what one might expect in a deflationary environment in terms of the time it would take for prices to adjust downwards.
graham34: If everybody is hoarding at the same rate, then we see that each person's demand for goods and services (as measured by the money exchanged for these goods and services) must decline, and in particular that it must decline proportionately. There may be friction effects as the price level changes, yet I can find no force which would change the distribution of economic output in any particular way. For these reasons the productive capacities are unchanged and the distribution of output remains in its previous proportions. Since we have also not specified any change in consumption patterns, and may assume it is unchanged (as for the case where hoarding is motivated by a desire for perishable goods), then I believe my original description of the result holds firm. The economy continues as it did before.
If production remains the same but consumption drops then one of two things must happen (and probably both will happen, each in turn):
In the first instance, savings will probably increase since producers will not have anticipated the drop in consumption. Grain growers will have planted their crops the year before, foresters will have planted their trees (for wood) decads before, factories will have hired staff and invested in capital goods etc.
Eventually, as inventories start to increase and producers realize the change in consumption is here to stay, it will become uneconomic for many of these producers to remain in business. It simply doesn't make sense to keep growing wheat that noone will eat or keep building cars that noone will drive... so production will fall off.
So surely the most basic of economic forces (that of supply and demand) will serve to change the productive capacities of the economy quite predictably if sufficient numbers of people start to hoard money? Only when these people start to spend their money again and real demand for goods and services goes up again will it again be profitable for the same level of production as existed prior to the hoarding.
I have heard it said that hoarding was a cause of the Great Depression of 1929:
In a normal economy, Keynes said, there is a circular flow of money. My spending becomes part of your earnings, and your spending becomes part of my earnings. For various reasons, however, this circular flow can falter. People start hoarding money when times become tough; but times become tougher when everyone starts hoarding money. This breakdown results in a recession
My question is how can hoarding be a cause when most people are broke? I mean if many businesses are in debt, why would they not pay off their debts instead of hoard?
I read a variant of the italicized claim above at cnbc.com and was wondering how at the present time there can be hoarding when Americans have almost no savings to speak of?
I have read Gene Callahan's book Economics for Real People but I don't recall him speaking of hoarding. Can anyone recommend an elemetary book that explains why hoarding causes or prolongs a depression ?
Hoarding doesn't cause or prolong depressions. Preventing prices from adjusting correctly (either upward or downward) prolongs depressions... one reason the Great Depression lasted so long is because governments put in place tight labour laws restricting the correction of prices in the market (for labour in particular), which basically ensured prolonged unemployment and low productivity.
Your request is the equivallent of "Can anyone recommend a good book that proves the existence of the tooth fairy?"... the theory that you're trying to explain is false in the first place.
CatLover:I have read Gene Callahan's book Economics for Real People but I don't recall him speaking of hoarding.
He does cover the affect of the velocity of money on prices (hoarding, of course, reduces the velocity of money), and I know that he has something about the affect that expectations (of prices) have in a recession.
If people hoard, prices have to falls, however, some economists will argue, because of the price expectations (some from the bubble years) and some social constrains, people will not lower the price of their house, the wage of their employees, etc. Monetary inflation, they argue, can help the recession heal faster (in effect, it's a way to fool people so nominal prices meet their expectations).
Equality before the law and material equality are not only different but are in conflict with each other; and we can achieve either one or the other, but not both at the same time. -- F. A. Hayek in The Constitution of Liberty
jimmy: If production remains the same but consumption drops then one of two things must happen (and probably both will happen, each in turn): Savings of real goods must increase (inventories in factories etc.) Production must drop
Both of those will happen in order as you say, but only if consumption is merely dropping. I.e. if people just don't want to consume as much, as opposed to desire an increase in cash balance. There is an important difference between the two.
In the first case, where people merely desire less consumption (going on a diet?) and do not also desire increased cash holdings, they will likely decrease production. They don't need the extra money, and the marginal value is likely spent better on relaxation. Thus in this first situation production would decrease.
However, if everyone wanted to increase their cash balances as much as possible (extreme hoarding case) as well as decrease consumption, they will likely maintain their current production rate or even increase it. When the marginal effort required to earn the marginal dollar is too high, they will stop increasing their productive capacity. Thus a country wide situation of "hoarding" will create an increase in productive capacity and an increase in total purchasing power.
Thus after a period of real "hoarding" everyone is wealthier than before, due to the steady or increasing rate of production. In a situation of decreasing demand, everyone just has more free time.
"...yet one may assume that their productivity remains the same. "
i am not sure if savers or hoarders particulary want to have less.
with cash balances increasing - spending decreasing - wouldnt producers who could provide the same for less cash be more productive?
would large scale saving trends promote methods of getting the same for less - increasing productivity rather than it staying the same.