Saturday, 7 March 2009

"Savings" - what they are and what they're not.

I believe that most people have a shorthand model of "savings" in their minds which goes, very crudely, something like this:

I work in a factory producing "stuff".... if I want to "save" then instead of consuming my "stuff" right now, I will put it aside in a huge warehouse where it will be stored, so that when a rainy day comes in the future I can go to the warehouse where I will find my "stuff" has been preserved in pristine condition ready for me to consume at some point in the future.

Now we all know that it doesn't work exactly like this... but many people feel its a good approximation to work with. The problem with this mental picture is that it leads to some important false conclusions....

False conclusion 1. Everyone can save.
False conclusion 2. Savings are safe.

Now to explain why both conclusions are false we have to consider what savings really are:

I work in a factory producing "stuff"... if I want to "save" I have to find a second person to make an agreement with. The agreement is that I give him some of the "stuff" I have just made for him to consume immediately. In return for this he promises that at some point in the future (when a rainy day comes) he will then make some new "stuff" in his factory and give it to me to consume.

From this truer model of savings it should be obvious that not everyone can save at the same time! Savings are in fact a zero sum game! It should also be obvious that if the person you made the savings agreement with has lost his job or his factory burnt down, then your "savings" will have vanished.

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