Quantitative Easing and the Fund of Real Savings (aka the Subsistence Fund)

Pater Tenebrarum of Acting Man wrote another great post titled, “QE Forever and Ever?“. In this post, he cited one of the key insights of Austrian economics, the necessity of a fund a real savings (aka the subsistence fund) required for the completion of roundabout production processes.

To describe with a simple example what we mean, consider a very primitive island economy. Say that there are three fishermen who want to build a new boat to improve their productivity and hence increase their wealth. Building the boat takes time, during which they can no longer catch fish. They must therefore have enough food stored to see them through the boat building period – otherwise they will simply begin to starve and never be able to finish the project. If they hire additional helpers and pay them with money, then these helpers will also require food, shelter and so forth during the time it takes to build the boat. Unless someone else produces food in sufficient quantity to sell it to them, or they have a big enough store available, the project will come to grief. In other words, an adequate pool of real funding is a sine qua non if such an investment project is to succeed. It would obviously not help at all if these men increased the size of the money supply.

It is not different in a modern complex market economy – all economic activities require real funding in the end.

These concepts, roundabout production processes and the necessity of a subsistence fund, form the central theme of Richard von Strigl‘s “Capital and Production“, which I am currently reading.

Let us examine Tenebrarum’s example in more detail. We will assume that the fishermen already posses capital goods in the form of fishing rods. These capital goods increase the productivity of their labor by allowing them to catch more fish in a given period of time than by using their hands or scavenging. They realize that if they build a boat, they will no longer be relegated to the shore and will be able to go to areas where fish are more abundant. This new capital good, the boat, will thus enhance their productivity by allowing them to catch more fish per unit time. However, as Tenebrarum pointed out, the construction of a boat takes time. In fact, it will take so much time, that the fishermen will have to sacrifice time spent fishing to construct the boat. This time consuming process is known as a roundabout production process.

The problem that arises upon contemplating the construction of a boat is how will the fishermen obtain food if they have less time to fish? The solution is that they must save enough fish to feed them while they are building the boat. This can only happen if two things occur. First, they must be productive enough without the boat to catch a sufficient amount of fish. Second, they must consciously abstain from eating all their fish each day so that there are leftovers. Thus, they must engage in the act of saving. The saved fish form the subsistence fund. Without this fund, the fishermen would starve before completing construction of the boat. Note that this fund consists of real goods.

By saving real goods, the fishermen are able to embark on a roundabout production process resulting in a capital good that will enhance the productivity of their labor. At the end of the process they will be able to produce more consumer goods, fish, than they were able to produce without the new capital good. This is economic progress in a nutshell: savings -> investment -> production -> consumption.

Now we see the rationale behind one of the key Austrian critiques of quantitative easing (printing money). Producing pieces of paper with mug shots of politicians does not add one real good to the subsistence fund. Thus, such monetary shenanigans cannot produce real economic growth.

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