The Benefits of a Saving Culture
Savings are a vital component of any successful economy, and the foolishness behind the paradox of thrift is exposed in this article. It has been a huge error for Keynesian policy makers to discourage savings in the interests of temporary boosts to consumerism.
It is probably too late now but encouraging people to save by removing all taxation from savings makes an enormous contribution to reducing price inflation and trade deficits, while enhancing national wealth. This is evidenced empirically and demonstrated by reasoned theory.
Furthermore, there is an error in assuming that there is no alternative to Triffin’s dilemma, which posited that for a nation to produce a meaningful level of reserve currency for external circulation it must run trade deficits. Triffin was describing the problems the United States gave itself under the Bretton Woods agreement, leading to the failure of the London gold pool in the late sixties. It still informs US policy makers today, and wrongly leads American commentators to believe that the dollar cannot be toppled from its pre-eminent position.
But Triffin’s dilemma assumes that central banks must accumulate currency reserves. Unless a government has foolishly indebted itself in a foreign currency, there is no need for them to do so. Currency reserves add nothing to a domestic currency’s stability. Gold fulfilled this role successfully, and likely to do so again in future.
It is a savings ratio of 45% which is at the root of China’s power. The lack of savings in America and its western alliance is their Achilles heel.
Empirical evidence
If there was one taxation policy which would reduce consumer price inflation, stabilise a fiat currency, encourage capital allocation for productive purposes, and improve government finances for the longer-term, what would it be?
Remove all taxes from savings.
This is the lesson from past-war West Germany and Japan, both of which suffered absolute defeat and economic destruction in the Second World War. Their currencies were worthless. But they recovered to become economic powerhouses in Europe and Asia respectively in little more than two decades. Both implemented savings-friendly taxation policies, which made capital available at stable interest rates for new industries to invest in production. Germany developed its Mittelstand, and Japan built on her vertically integrated Zaibatsu.
Germany was fortunate in its Economy Minister, Ludwig Erhard. A free marketeer who on 20 June 1948 took the bull by the horns, Erhard unilaterally ended rationing on the same day as the new mark was introduced, presenting it as a fait accompli to the military governors in the British and American zones. In a week, shops had begun to reopen, and goods became widely available.[i]
In negotiations with the military governors, Erhard managed to obtain income tax concessions for savings, which through the banking system were invested making capital available for private sector reconstruction. While he struggled against both military governments in the two zones to retain lower taxes and for favourable treatment for savings into the 1950s, Erhard had laid the foundations for a savings driven, free market economy. By the 1980s, the only tax on savings was a 10% withholding tax on bank interest and bond coupons, which was not generally pursued by the German tax authorities in the knowledge that attempts to do so would simply drive savings beyond their reach into Luxembourg and Zurich.
For this reason, Germany remained a savings driven economy with a strong currency right up to the mark’s incorporation in the new euro. Much to the confusion of British and American neo-Keynesians subscribing to their cherished savings paradox, Germany became the wealthiest of the European nations, other than perhaps Switzerland. In both cases, hard currencies accompanied wealth creation.
Erhard’s post-war opposition was principally from General Sir Brian Robertson, the head of the British occupation government, and from the French. The commander of the American occupation zone, General Lucius Clay was more sympathetic with free market solutions. The Americans had promoted A Plan for the Liquidation of War Finance and Financial Rehabilitation of Germany (1946), written at Clay’s behest, one of the co-authors being Joseph Dodge.[ii] In 1949, Dodge was then appointed to advise the Japanese government on its post-war reconstruction as an aide to General MacArthur. And Dodge was instrumental in ensuring that up to a certain level, post office savings accounts were entirely tax free. It was probably a deliberate oversight on his part, but the tax law didn’t stop an account holder merely opening another savings account when the tax-free limit on an existing account was reached.
Dodge implemented what became known as “The Dodge Line”. By insisting on a balanced national budget and shutting down the printing presses, he ended hyperinflation. The exchange rate between the yen and the dollar stabilised. Government economic intervention and interference was slashed across the board. Echoing John Cowperthwaite’s free market policies in Hong Kong, Dodge realised that the best economic progress was obtained by eliminating state interference, leaving it to Japan’s businessmen and entrepreneurs who, despite the war, retained the skills and connections to run their businesses. With MacArthur’s support, he ruthlessly eliminated subsidies and price controls. Dodge was eventually recalled to America, becoming Truman’s Director of the Budget where in the space of only a year he had cut the US federal deficit in half.
Dodge’s free market approach was supplemented by the assistance of another American adviser, W Edwards Denning. Denning introduced quality control techniques to Japanese manufacturing which revolutionised production. As a consequence of Denning’s contribution, Japan rapidly evolved from a source of shoddy goods into a producer of the best consumer technology and the manufacture of world-beating high quality consumer goods.
Behind this revolution was the tax incentive to save – a simple approach of assuming that taxed earnings put aside should not be taxed again. In both Germany and Japan, these were not the only factors that led to a successful emergence from total desolation, but they are the elements that ensured that both nations continued to flourish. And in Japan, despite the government fully embracing Keynesian philosophy in the wake of the late-eighties speculative bubble, the savings culture of “Mrs Watanabe, the Japanese housewife” persists to this day.
After his stint in Japan and while Joe Dodge worked his budget magic for Truman, the British were going in the opposite direction, eschewing free markets, embracing Keynesianism, persisting with rationing until 1954, and imposing punitive taxes on savings. The decline of post-war Britain and much of Europe need not enter our narrative, but it was a feature of all nations which implemented economic policies of taxing savings.
The theory behind savings
The empirical evidence is clear. Since the Second World War, economies that embraced free markets and the role of personal savings outperformed those which saw savings as an easy source of tax revenue. Furthermore, we can easily explain why free markets succeed in creating wealth for all, while a state directed economy is anti-progress. It was demonstrated by the Austrian economist, Ludwig von Mises, who in an essay written in 1920 explained the futility of central planning due to a lack of the ability to perform economic calculation. Admittedly, he compared the full-blown socialism which Russia had embraced with free markets. But his conclusions, that the state is unable to allocate economic resources including capital as efficiently as profit-seeking capitalists applies equally to less aggressive forms of socialism.
In a free market economy, individuals are compelled to make provision for the unknown vagaries of the future. Often through the medium of insurance policies and pension plans, they put aside a portion of their income to protect themselves from the financial consequences of ill-health and incapacity, provide for their old age, and to ensure there is something to pass on to their heirs. If the circulating medium is sound, no financial skill is required to preserve the value of savings in these ar
Article from LewRockwell
