In a free society, individuals could save to build up nest eggs of financial capital. We would be wealthier, more resilient, relaxed and responsible. Democratic Socialism discourages independent saving and makes society fragile and dependent.
In a free society, individuals could save to build up nest eggs of financial capital. We would be wealthier, more resilient, relaxed and responsible. Democratic Socialism discourages independent saving and makes society fragile and dependent.
In ‘Human Action’ (I think) Mises says that every person, and indeed every family, can achieve its own economic growth. Economic progress in the Austrian Economics School tradition is understood as principally involving the accumulation of more and more fixed capital, and the associated working capital requirement.
Fixed capital comprises things like factories, production tools, offices, computers, lorries, docks and airports etc. (Working capital requirement is the accompanying need for businesses to stock up with inventory and extend credit to customers.) It’s the quantity and modernity of a society’s stock of fixed capital that determines how many jobs there are, and how highly paid those jobs are. Countries where it is difficult to establish and maintain an adequate stock of fixed capital equipment are poor and will remain so.
As explained in my posts on April 25th and April 29th (Thought Experiments 1 and 2), society’s stock of fixed capital entirely depends on people being able and willing to reduce consumption so that they can accumulate a stock of consumables. Savings are simply accumulations of stocks of consumable goods.
These savings then become financial capital when they are invested to sustain workers and managers building new pieces of fixed capital. In the April Thought Experiment posts mentioned above, the hapless inhabitants of the hypothetical Island of Brazil were initially unable to save at all. Therefore, they could not sustain the work effort needed to create physical fixed capital. So they could not create economic progress.
Mises’ point is that individuals in free societies can choose their own rate of economic growth simply by deciding to save more of their income. Over time, determined savers become owners of their small but growing share of society’s stock of fixed capital. Very roughly speaking, highly paid, productive workers typically depend on working with at least £100,000 of other people’s fixed capital. A saver can therefore pat himself on the back, quite deservedly, as his portfolio of investments expands to the point where he is indirectly providing employment for a handful of working people.
I would like to explore the scope for an individual saving his way to prosperity, and indeed families saving their way to prosperity over generations, in a free society. I plan to use, yes you’ve guessed it, another ‘thought experiment’. This time, for simplicity’s sake, we will assume our man works from 20 to 65 and earns the average UK gross annual income of £30,000 throughout his career.
He decides to save ten percent of his yearly income, or £3,000. This sum is not wildly different from what someone in the UK would pay in tax. In a free society there would be no tax - thus freeing up this £3,000 annually for saving. There is no inflation. Prices and therefore the purchasing power or value of money are assumed to remain constant. (Based on evidence from the 19th Century Gold Standard system, the purchasing power value of money would actually increase in a free society.) The average annual rate of return is assumed to be around 5%.
This 5% long term annual real rate of return assumes the saver buys a range of investments yielding returns in line with 19th century, Gold Standard era, expected rates of return. We might assume returns would mainly come from 4% or so in dividends from big companies and especially established infrastructure operators (railways and ports, for example), and from reputable corporate bonds, preferred shares and convertibles offering 4%-6% interest. For added spice there might be some 7% to 10% dividend or interest payments from riskier domestic manufacturing firms or overseas projects and plantations.
The saver’s portfolio would of course include no government bonds as there would be no governments in a free society. UK government bonds actually were risk free in the 19th century and generally yielded between 2% to 3%. Foreign governments offered rather more, but often carried a significant risk of default.
In the libertarian view, lending money to governments is immoral. They service their bond borrowings by extorting money with menaces. Diverting savings from productive investment to politically promoted consumption also reduces long term growth in earnings, and therefore overall returns to saving.
And now we go back to consider our patient saver putting £3,000 away each year. Assuming reinvestment of all dividends and interest payments, after 45 years our man has a nest egg of just under £500,000 in money of 2020 (which is assumed in a free society thought experiment to have the same purchasing power in 2065, 45 working years on). He has thus more than tripled his cumulative contributions of £135,000. He can easily afford to retire. He receives three quarters of his previous wages, without dipping into his capital at all.
Well so far so boring you may be thinking. Why should he have lowered his standard of living by saving when younger? Well younger people in the UK often engage in still heavier forced saving anyway – much more than £3,000 a year - to buy housing of uncertain long-term value. One result is a great deal of resentment and anxiety. Another is unsustainably low birth rates which will help bring down the Democratic Socialist state pension and welfare Ponzi scheme – leaving many people unprotected.
Leaving aside high state generated housing costs – which will inevitably lead eventually to a fall in real house values - it is not clear that young couples should be saving so heavily and so early. Better to invest in children and careers and in modest planned savings. Houses you live in cost a lot to maintain and do not directly yield income, unlike financial investments. In a free society housing (and rents) would be much cheaper and better – see May 24th ‘Cheaper, Better Housing after the Fall’. (Britain’s obsession with relatively sterile housing investment of course stems from government hostility to saving and savers, on which more below.)
There are in fact some major advantages to our hero’s saving campaign. Firstly, unlike most people in Britain and America, he is not anxiously living paycheck to paycheck. He has something to tide him over rougher times during his working life. He can take a more relaxed approach to the possibility of redundancy or retraining. He is not dependent on charity or politicians’ promises for unemployment dole or pension.
This is good because the likelihood that Democratic Socialist states will come through on public or private pension promises for most currently employed people is not high. Famously, if possibly apocryphally, more younger Americans believe we have been visited by aliens than believe they will receive the state pensions promised by the soon to be bust US Social Security system.
Our saving man does also have the satisfaction of knowing that three or four people somewhere in the world have high paying jobs working with the fixed capital equipment that his savings brought into being. On a more practical note he can take pleasure in leaving his heirs a considerable nest egg up front – there will be no inheritance taxes either. Perhaps this may allow them to take time or risks developing potentially more rewarding careers, or it may encourage them to get on with having more grandchildren.
Clearly a society where such a sensible approach to saving were common would be far wealthier, responsible, resilient, relaxed and family orientated.
However, back to the real world of decaying Democratic Socialist arrangements. Saving is heavily discouraged. This is partly the Keynesian consensus (see www.awah.uk post on April 29th ‘Why did Keynes want to Destroy Savers?’). It doesn’t understand that there is no substitute for real saving. It is partly because the tax wedge exacted by big government from productive people is so large that less money is available for saving.
Lastly it is because the state and its banking crony capitalists share the profits of deliberately destroying the value of people’s savings, especially their loans to the state and banks’ customers (see my post ‘How Banks and the State print Money to steal from You’, April 25th).
Of course, there are somewhat tax protected forms of saving. There are private pensions, some kinds of venture capital funds, and housing investment. There is every reason to suppose that these protections are less valuable than they seem, or even be downright counter-productive. One example is the way that tax privileged UK pensions are nevertheless obliged to buy UK government bonds. These will (not so) eventually be defaulted on or inflated to worthlessness – at which point the tax privileges of the pension fund will be beside the point. Another case is tax free ISAs (Individual Saving Accounts) where the tax concessions have a way of being eaten up by advisors’ fees.
Suffice it to say that government policies press down harshly on independent saving.
Let us briefly put some numbers on the damage done by the state to individuals’ chances of achieving financial independence through saving. We will return to our determined saver putting aside, initially, £3,000 or roughly one tenth of the average UK income.
In comparison with the equivalent saver in the free society discussed above, he is facing serious headwinds. He is already paying a serious tax wedge – especially when the tax inflated cost of his living costs is allowed for. He is operating in an unnecessarily poor economy because of exploitative state and crony capitalism intervention. Nevertheless, let us assume that our dauntless hero manages to save at the same pace as his luckier counterpart in a free society.
We will assume the same average real return of 5% per annum. But this time we will include a tax take of 40%. His income from investments is taxed as marginal income. His £30,000 annual income from employment is below the income 40% threshold but not so far if he develops significant investment income. On the other hand he will also face capital gains taxes – for which I have not made express provision - on sales of investments. This has historically been levied at rates which have varied between 20% and 40%. And there is no indexing to reduce gains by allowing for the loss of money purchasing power.
We assume that the currency loses 5% of its value annually as a deliberate result, as we know, of state policy. This is roughly the average rate of inflation experienced over the past century in Britain. We will also assume that income tax is levied on investment income without any allowance for the fact that roughly half of apparent investment returns are simply offsetting the loss of capital caused by government promoted price inflation.
And the result after 45 years of determined if hypothetical saving in 2065? At first sight our man may imagine that he has ‘made money’, but it is mere illusion and deception. After allowing for price inflation the poor saver has only £180,000 in money of 2020. That is only 1.3 times the £135,000 he has nobly salted away over 45 years. His real income in retirement would be just a third of his old wages. And only one guy is in a well-paid job created by our saver’s stunted accumulation of fixed capital - as opposed to three or four in the case of the free man. (Plus if our man’s house is worth much, his modest accumulated wealth will pay 40% inheritance tax at the margin).
Lastly we might consider the situation facing people who try to save from now on. Government’s have been creating more money out of nothing at exponentially increasing rates to delay the ‘emperor has no clothes moment’. That is when when big state moral and economic bankruptcy is clear to thinking citizens.
Interest rates have now been pushed below the rate of consumer price inflation. Bonds and equities are over-priced. Taxation is still applied without regard for inflation. The outcome for a saver starting now is hopeless. Our saver’s nest egg will be worth far less than the cumulative value of his annual savings. And that is before you factor in the likely destruction of state currencies within the next ten years.
It’s not so good. Saving is discouraged by the state because we are meant to be dependent on our political leaders’ pension promises. Only these promises will not be honoured in full. Years of state abuse means there are too few productive people and businesses, especially after the lockdown fiascos, to pay taxes and sustain living standards. Instead, we are now promised ‘helicopter money’ – general mass distributions of recently created (electronic) cash. The pension payments cheques may keep coming but they won’t buy much.
Wouldn’t it have been good if people had been allowed to save more ….