How the Economy Really Works: Savings, Investing, Consuming and Market Distortions
27:01 Share

Walking the money for the rest of us. This is a personal financial on money, how that works, how to invest IT and how to live without worrying about IT. I'm your host, David stein.

Today is episode four seventy. It's title how the economy really works, savings, investing, consuming and market distortions. In today's episode, I want to go back to the basics, how everything is connected, the important linkages between spending, income, production, investing and we're about holding and other market distortions.

There are some identities, some relationships that are so key to the economy that we really need to understand them and Frankly, be fascinated by them, how this economic dance works. We can understand the linkages, but we're never sure how businesses will react, how houses lds will react with the government will. So let's take this review look at how everything is connected together.

The first identity is that spending in the economy equals income. Every dollar spent in the economy is someone else. Se's income are sorry.

Our income that we get from our employer is is an expense of our employer when our employer buys desk for its employees that boost the income of the manufacturer of the desk. That's the first identity. Spending equals income.

The second identity is that savings equals income, less spending. If we're trying to save personally, we have to spend less than we receive in income. We're trying to save ten percent of our income and we spend ten percent less than what we took in in the U.

S. The personal savings rate last month was three point eight percent. That's the amount that households saved as a percent of their disposable income. Disposable income is income after paying taxes.

Now that personal savings, household savings businesses also save when a business spends less than IT receives in revenue in its sales, that savings is called profits, corporate profits, our business savings. The more our employer spends on salaries, the lower its profits or business savings. Now that brings up sort of a conflict spending equal income.

But in order to save, we have to spend less than our income. And that means when we save, we're depriving someone else of their income. What happens then if everyone tries to increase their savings at the same time? This is known as the paradox of thrift is associated with the economist john main, or canes.

When a large version of the population increases their savings, then spending decreases. Because in order to say we have to spend less businesses, then because they see less demand, produce less. And if businesses are trying to save more, boost their profit, then theyll buy less from other businesses, they may have fewer workers and to across the economy over all income false as household and businesses try to save more because they're spending less and because every dollar spent is someone else's income.

If everyone is trying to save more by spending less than overall income can fall. Karena verman wrote about this for the same Lewis fed. He wrote to assume I want a new computer, so I start saving extra hundred dollars each month that I would otherwise spend going out to eat by choosing not to spend one hundred dollars, I deny the weight staff at my favorite restaurant some work hours and tips.

I eat some portion income. As result, these workers also have to reduce their consumption because they are earning less. If society, as opposed to individual, follows the saving pattern, this snowball cancian multiply effect could ultimately lead to decrease consumer spending and lower income for everyone.

Lower income means that the economy doesn't grow as fast IT becomes more difficult to save. That's the paradox of thrift. So those are two first identities.

Spending equals income. Every dollar spent is some other entities or person's income. Second, identity savings equals income less spending.

Every dollar saved deprives someone else of income. Now, a word from our response. Or at veteran, sometimes it's just nice to sit back, relax, maybe even take a nap.

That's not what you want your money to be doing. You wanted to be working hard for you earning interest, generating returns. That's where the veteran automated investing and savings APP can help elements. Technology gives you advanced tools that are built to help you maximize returns.

They have diversified portfolio OS of low cost E T S that have been constructed by experts, high yed cash accounts where your money can earn eleven times the national average, and automated investing technology, like automated rebalancing these tools can help you reach your savings and investing goals Better. Man is a fiduciary. That means it's their job to act in your best interest.

They will never recommend an investment or give you guidance unless they believe that will help you reach your financial goals. So visit Better, man, not come to get started. Learn more about the highest cash accounts at beta dot com, investing in all risk performance, not guaranteed cash reserves offer through Betterment, L, L, C, and veteran securities.

Veteran is not a bank. What about borrowing money? Where does debt fit? Debt reduces future savings. Or we can put in another way. When we take on debt, we are spending future savings today.

If I go out and take out alone to purchase the car, I get the car today. And that spending flows through the economy, its income for the car dealership and the car manufacturer. But IT accelerate that spending today.

Now in the future, I have to spend less so that I can repay the debt, and that can increase income, purchasing power and savings across the economy. The cardinal ship that sold me the car could save more by taking that revenue that IT received for me and not spending and saving IT. When we barrel, we can borrow from someone else, an individual person alone.

And in that case, they're taking some of their savings and they're giving IT to me are the ways that, that savings can be allocated to someone else or a business through borrowing is corporate bonds. Corporations will issue debt, a bond that pays an interesting and has a set maturity. Households and other businesses could purchase that bond, allowing the the cellars of the bond to to raise some capital to spend, such as to to build a new factory. So that's borrowing within the economy.

There is a special type of borrowing, borrowing ing from a bank, and when we borrow from a bank, the bank has a long receivable, and then the posit money in our account that we can then spend, and the act of borwick reasons, the amt of money in the economy is newly created money, unlike a corporation issuing a bond, and the funding of that bond comes from money that already exist in the economy in the form of savings. When a business borrows from a bank, the bank gates new money, it's it's an accounting entry. They simply created deposit, and that deposit is offset by a receivable, a long receivable on the bank's baLance sheet, because banks can create money as part of their lending activities, and that can increase the money supply.

The amount of spending in the economy that can lead to bubbles due to too much that issuance, and that dead issuance can certainly be from from banks, but also dead issuance from businesses issuing bonds and taking savings from households and businesses and investing them. We saw this in the nineteen, nineteen, twenty years. There were something called skyscrapers bonds, where bonds are being sold to raise money to build very tall buildings around the U.

S. Letha smith, president of the national association of building owners and managers, rote in one hundred and twenty six buildings are being put up entirely through the endeavor of bond houses to sell bonds, whether the buildings are needed or not. Over production, in this case of skyscrapers, is caused by speculators who borrow at four cost of construction regardless of return.

Then they sell the building at a profit and then proceed to erect another one somewhere else. And there was a skye scraped r bubble, a corporate real estate bubble in the twenty years that was funded by debt, the housing bubble in the U. S.

In the me, two thousands that was funded by debt, where barriers were taking on two, three mortgage in buying multiple houses that they couldn't afford because the debt was being issued without verifying income. Central bank seek to regulate the amount of borrowing by raising its policy rate. The short term interest rate, which in the us is over five percent right now that has LED to hire longer term is rate and has discouraged some borrowing.

It's more difficult to get a mortgage, more expensive to get a mortality, and that can reduce th Epace a o f b orrowing, spending and income growth. Central banks do that in order to make sure that demand of spending in the economy doesn't exceed the capacity of businesses to produce goods, services constrained capacity combined with increased spending power, increased money supply, can lead to inflation. And that's what we've seen the last few years.

So so far, we've discussed the private sector, households and businesses how spending equals income, how savings is income less spending, how that borrowing IT takes future savings and allows us to spend IT today. And this is domestically. There's also the foreign sector trade.

Businesses buy and sell goods and services with other countries, and government measure that a trade surplus is when businesses in a country sell more overseas, then businesses and households buy from overseas businesses. There is a trade surplus. More is being sold than as being bought and brought in.

A trade deficit is the opposite, where businesses and households purchase a greater monetary value of goods and services from outside the country, then businesses sell to households and businesses outside of the country. The impact of a trade surplus is IT increases domestic income and potentially savings because businesses have more income because are selling stuff to the private sector in other countries, and then that income could be saved. A trade deficit does the opposite.

That means income is flowing out of the country and potentially savings are being reduced as businesses and households buy a bunch of stuff and services more than what is being sold to the private sector outside of the country. So we have the domestic sector, but we also have the the foreign sector. And then there's the public sector.

No, governments typically don't save. They don't spend less than they receive in tax revenues and fees. That's called a budget surplus.

It's rare most of the time government, the federal government runs a budget deficit. IT spends more than IT receives in tax revenue. And that deficit spending allows the private sector to have a higher incomes and savings the federal government buys from businesses.

IT sends funds to households such as social security payments, food stamps, the government could pay for medicare. That deficit spending provides income to the private sector. The federal government funds that deficit spending by selling government bonds.

Households and businesses that have can purchase those bonds and earn interest, but the money that the government spends, the deficit spending, the amount of spending that goes out into the economy above and beyond, the tax revenue received, that creases purchasing power across the economy as a whole. Now there are some distortions when IT comes to the public sector, and that distortion is known as quantity easing. Central banks can purchase government bonds that would have been purchase by the private sector, or maybe or first purchased by the private sector.

but. The central bank buys us bonds and they buy them with newly created money. That act of the central bank creating money purchasing bonds leads to more money in the economy.

A greater money supply IT leads it's to more income in the economy, because the federal governments running a deficit is spending more than IT receives an income, and that deficit is being funded by central banks. And now we have more money, more income, greater network going out into the private sector economy. So those are all the sectors.

We have the private sector, we have the foreign sector, we have the public sector, the banking sector. We have money flowing through, money being created by banks, money created by the federal reserve, another central thanks. We have income being received.

We have households and businesses not spending some of their income to save IT. Much of the income is spent. Every dollar spent equal someone else's income. Every dollar saved deprives someone or some business of income can borrow money and take future savings and spend IT. Today, that's the flower funds.

But the whole point is to be able to buy what we need and want for that we need businesses to produce what we need and want. We have the flow of money, but we also have the flow of goods and service. And businesses are are never quite sure what and how much to produce.

And that's why I think of IT of this giant dance as businesses try to figure out what do we make, how much do we make, and consumers are trying to figure out, well, what do I want to spend money on? Do I want to borrow money in order to spend IT? How much I want to say how much income do I think i'll get this year before we continue, let me pause and share some words from this week.

sponsors. When you're hiring for your small business, you want to find quality professionals that are right for the role. That's why you have to check out linton jobs.

Linton jobs has the tools to help find the right professionals for your team faster and for free. I know when our business having the right candidates for the job is critical to keep our business running smoothly. Now lindon isn't just another job board.

Lindon has a vast network, more than a billion professionals, which makes IT the best place to hire. IT gives you access to professionals you can find anywhere else. Linked is all that while making the process easy and intuitive.

Hiring is easy when you have that many quality candidates. So easy, in fact, that eighty six percent of small businesses get a qualified candidate within twenty four hours. Lindon is constantly finding ways to make the process easier.

They even just launched a feature that help you write job descriptions, making the process even easier and quicker. So post your job for free at linked in. That comes flash, David, that's lindon.

That comes less, David, to post your job for free. Terms and conditions apply for businesses to make things and provide good and services. They need resources to produce them.

Primary resources, labor. They need employees to produce the goods and services. Sometimes they need natural resources to produce the goods and services, but they often need capital. Capital are tools, machinery, buildings and technology that are used to to make things and to provide services. And that capital comes from investors, from savers. We've mentioned how corporations can issue bonds that and they sell that debt to the private sector, to households and other businesses, to raise capital, to then use to purchase tools, machinery, buildings, new technologies, so they can produce more, more and Better things and do IT more efficiently, become more productive, so that they can learn more income per item produced. Businesses can also sell equity capital.

They can sell a portion of the enterprise, be a public enterprise, IT could be a private enterprise, but they can sell an equity stake in the company, or they can sell an equity stake in a commercial building, for example, that be a commercial real state Operator that wants to buy a something. So they borrowed some of the money and then they raise some equity capital to purchase the building. And then those rents portion of those rents are used to pay the service to debt and also cover expenses of the building, but also a portion could go as dividends to the equity horse.

Once debt capital and equity capital raised, a securities are issued, the security can trade in the secondary market for common stocks, they trade on a stock exchange. Most of the activity when IT comes to the financial markets is not providing capital directly to businesses, either debt capital or equity capital that's done once for a given security or or given fundraising, and then the security are spot and sold over over again in the secondary market. In the holders of those securities, the debt security, the bonds receive interest payments and the holder of the equity security, the stocks will often receive a portion of the profit and dividends or will hopefully receive the profit going forward.

Much of our investing is not done directly. It's done through an indirect investment vehicle such as a mutual fund or etf. So those are all the pieces we have, what's going on, on the the flower fn side, the income, the savings, the consuming, the borrowing.

And then we have the production side, the businesses deciding what to produce, producing them. And then we have the cross over. We have the investment by the private sector so that the businesses can raise capital to produce more and Better goods without anyone really knowing exactly what the demand will be for what is being produced.

There are some other distortions. One is holding. Holding means to hide something away for a future productive use, be its food that we're going to store and use later.

Maybe it's fabric to make something. A lot of very wealthy people like to purchase land like land that's not being bomb, just land that's hearted away. Ammunition could be hearted.

No, hoarding isn't necessarily bad, but it's a distortion. Because if everyone heard, then capital become scarce for businesses. IT becomes more difficult to issue debt bonds or to raise equity capital because savings are being put into things that are horses gold.

For example, gold is something that has no productive use rather than for jury. If the private sector decides they want own goal, and that's the most exciting thing in the Price of gold could skyrocket, but then the rest economy could be starved for capital because everyone wants to hold gold or a bitcoin. There is no productive use for bitcoin other than as a form of digital gold.

IT can be used for payments but is not terribly efficient. There is a huge energy drain to maintain the bitcoin t network. And I own bitcoin, my own gold.

I have some wording that I do, but it's not the primary way that I direct my savings. Most of my savings is an investment. Investments are an allocation of savings to areas that have a positive expectation return. They generally have some cash flow element to that, and they're used that capital is used in the productive economy. If it's if we're funding something directly initial public offering for a common stock or a bond issuance, much of the investing is in the secondary market, but that secondary market trading needs to be there so that companies are able to issue capital.

Nobody would buy an initial public affery of common stock if IT immediately fell in Price because there was no secondary trading, no way to get out of IT, no way to have see the value of the investment increase as profits increase in having that secondary market set, the consensus Price of the securities is incredibly important, even if that secondary market trading doesn't send more capital to the business. Is an interview part of the entire system. But a potential distortion is if the private sector doesn't want to invest in helping businesses raise or maintain their their capital base, if instead it's going to harding where there isn't a productive views and holding isn't is so a bad IT, just you can't have too much of IT.

Another distortion is rents, not rent of a building, but rents the economic term, meaning an artificial profit that shouldn't exist in a fair competitive market. So called by IT digest, he's a belge in legal scholar. He writes, rents are in its ascent. The distribution side effects of market distortions.

They are the extra income that some people receive because of market distortions, they make some people wealthier, those who receive them the rent, and others poor, those who pay for goods and services whose Prices due to the market distortion, due to the rest are too high. An example of A A market distortion was back in the mid one thousand nine hundred and twenty years, where general electric in the us, phillips in the netherlands, german company osm and others met and they formed the the cartel. And they said quotas on how many late bulbs they would each produce, and they said standards for those light house, because light bobs are getting Better and Better.

They were lasting longer and they reduce the standard. Dead a light bob and inadequate light bob could last one thousand hours. And the reason why they're doing IT is because the businesses were producing more and more light bubs and the market was being flooded.

And then if the light pops were getting Better and lasting longer, they were worried, they were impacting the Price. And so they formed a cartel and they introduce planned obsolescence that the light bubs can only last so much time. And as as all their profits balloon, they earned rents, artificial profits, because of their collusion.

One of the worlds of government is to decide when these rents or artificial profits are occurring due to lack of fair competition. The U. S. The federal trade commission last month suit to block the proposed supermarket merger between koga and Albertsons.

The ftc said that a merger would eliminate competition between cogan abandons, and that would lead to higher Prices, and not only would IT lead to higher Prices, but IT would contribute to lower quality products and services. Now that's the F, T, C is view. That's a role, and they'll be a court case.

And Roger a will argue that IT won't reduce competition because of walmart and target and amazon also selling groceries. But that's a distortion we have holding as a distortion. We have artificially high profits as a distortion.

Planned obsolescence is a distortion first in the whole idea we thinks could only last so long or deliberately break so businesses can produce more and and individuals have to consume more. Now it's not always straight forward. IT was an article recently in the wall street journal about how kitchen appliances are getting more complicated and breaking more often.

American households spent forty three percent more on home appliances in twenty twenty three than they did in twenty thirteen on an inflation adjusted Price. So making out inflation, evd costs of home appliance went from three hundred ninety dollars to five hundred and fifty eight dollars, and they're breaking more frequently because they're becoming more complex. Some of that complexity was introduced as part of energy savings Mandates from the government, but they also have more computer chips.

And the reality is many of the parts are cheaper, more fragile. And so between some more fragile parts, greater. Complexity, they're breaking more and they're not lasting as long now.

Is that planned obsolescence? Or is this something else going on that for the ftc and other regulators to determine? But one plane technician says, and the majority of cases, I would say buying a new one, a new appliance, makes more economic sense than repairing IT because the costly pair is skyrocketing, because the equipment is more complex. So we have this amazing economic dance between consumers and producers.

We have all these linkages as households and businesses decide how much they want to spend and what do they want to spend IT on how much they want to save, businesses deciding what they want to produce and how much private sector deciding how much they want to invest and help other businesses raise capital to build out production capacity or how much they want to hold. Will the government deciding how much IT wants to spend on infrastructure that facilities, transportation and eases the ability of business to ship products and to produce things, how much as they want to spend on education. So we have an educated workforce to help businesses.

Government have to decide how, if they wanted to be, to prevent and cure distortions that occur. And then ultimately, as consumers, we have to decide what market signals we want to send by what we buy and how much we buy. And i'm tree, invest versus hold.

It's this pants linkages that keeps me doing the podcast, trying to understand and just watching things evolve and going through the process weekly of explaining what's happening. But sometimes it's just good to step back and to see how IT all fit together. And that's what we tried to do in this episode, upset for seventy.

Thanks for listening. You may be missing some of the best money for the rest of us. content. Our weekly insider guide email newsletter goes beyond what we cover in our podcast episodes and helps elevate your investment journey with information that works pressed in, written in visual formats.

With the insiders guide, you can discover actionable investing insights provided only to our new sudder subscribers, unlock greater investing confidence with high value slippers from our premium products plus membership and asset camp access exclusive news offers an events you won't hear about anywhere else. Further connect with the money for the restless team and community. And when you sign up, i'll also send you our exclusive investing checklist to help you invest with more confidence right away.

The inside of guide is the best next step to get the most out of your investment journey. If you're not on the list, go to money for the rest of us dot com and subscribe with to become a Better investor signa box. Everything I ve shared with you in the subscribe for general education, i've not considered your specific risk situation.

I've not provided investment advice. This is simply general education on money, investing in the economy. Have a great week.