The Consumer Spending Myth

There is no bigger misconception held among the financial press and within academia than that of consumer spending. A typical example of this comes from a recent Reuters release entitled: “Strong Consumer Spending, Factory Data Buoy U.S. Growth Outlook.” The first sentence of the article reads, “U.S. consumer spending recorded its largest gain in more than 4½ years in March . . . reinforcing views the economy was regaining steam.”

The supposed importance of consumer spending as a gauge of economic well being is a modern notion ushered in during the Keynesian Revolution, which took place in the 1930s. J.M. Keynes, a British economist, mistakenly believed that the Great Depression was the result of a “lack of aggregate demand.” Thus, demand had to be stimulated (mostly through government spending) to revive a moribund economy.

Keynes’ theory has, unfortunately, held sway ever since–despite being contrary to what had been believed up until that time and the plentiful criticism of it since.

An individual’s income can be distributed in one of three ways: it can be spent, saved, or held in cash. If individuals do not spend and decide to save more of their income, it will have no negative economic impact. In fact, the increased savings will expand the capital base, which will provide the vital means necessary for lengthier periods of production, a situation that will eventually generate more and cheaper goods – granted there is no artificial increase in the money supply.

If income is kept in cash (checking accounts, bills, coins, stuffed in mattresses), money is taken out of “circulation,” so to speak, which will eventually lead to an increase in the purchasing power of the monetary unit. This is a scenario rarely seen in the modern era, but one that would be of tremendous benefit to just about everyone–especially retirees and those on fixed incomes.

The manner in which individuals divert their income, therefore, has little if any effect on output. Historically, this ratio has remained relatively stable with only gradual change over time.

Furthermore, consumption always takes place as long as there is life. One “consumes” without even walking out of the house – turning on lights, running water, eating, etc., are all consumption activities. If there was a sudden drop-off in purchases, it would not lead to a recession. Some retail sectors would likely suffer; however, it would only be for a short period until entrepreneurs adjust to the new saving and consumption patterns.

Instead of consumer spending, there are more accurate ways to “measure” economic performance.

First, the trend of overall prices: are prices falling or rising? If prices continually rise, it is the result of money creation (inflation) by the central bank – in America’s case, the Federal Reserve.

Second, the tax burden – what percentage of income is taken by the state? There are many pernicious effects of high taxes; the most damaging is that they sap an economy of the capital necessary for production and employment.

The personal savings rate is often overlooked as a barometer of economic well being. A low or negative rate of savings indicates, among other factors, that income levels are not sufficient enough for individuals to save. The individual savings rate in most Western nations is abysmally low–and under current monetary and economic policies will remain so.

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This post originally appeared on Western Journalism – Informing And Equipping Americans Who Love Freedom