Sunday, October 4, 2009

How the World Works Financially

This is a Sunday feature looking back at selected articles from the early days of this blog before readership had ramped up. Enjoy.

People can be split into two groups: 1) those who spend carefully, save money, and invest wisely, and 2) those who, to varying degrees, do not do these things well. For convenience, let’s call these two groups savers and spenders.

Some of the spenders’ wages get transferred to the savers, primarily in the form of interest on debts. Most interest paid by spenders becomes the profits of banks and other companies, which then gets distributed to shareholders who happen to be savers.

Of course, people don’t really fit into just two groups. Most people fall somewhere between the best of savers and the worst of spenders. You can think of people being lined up the side of a mountain based on how well they handle money with the worst spender at the top of the mountain. Now imagine money rolling downhill from the spenders to the savers.

Although I have called the two groups savers and spenders, limiting spending is not enough to make someone a saver. A saver must invest wisely as well. Imagine someone who never takes on any debt, but keeps all savings in a low interest bank account that fails to keep up with inflation. This will increase the bank’s profit and benefit the bank’s shareholders who are savers.

It may seem like being a saver is not much of a life, but in truth, it is only necessary to spend less than your wages for a while. Once you have some savings built up and invested wisely, the investments generate returns in the form of interest or capital gains. When these returns are large enough, they can be your new savings, and you can spend all of your wages. Later, you can begin to spend all your wages plus some of your investment returns. The best of savers can ultimately quit their jobs and live on their savings.

If you are a saver, one way to think of it is that spenders go to work to benefit you. If you are a spender, then you go to work to benefit savers, at least partially. No amount of claiming that money isn’t the most important thing in life changes the basic fact that spenders work for savers.


  1. I was just thinking about this post the other day. I remember it from the first time around. I think there's a subtle flaw in this reasoning in that it seems to presuppose that the money supply is fixed. If banks stop lending money, money vanishes (sorry, did you think the government minted our money?). The spenders can't spend, the savers don't profit, and the economy falls apart just long enough for the bankers to buy everything at rock-bottom prices using newly fabricated money and start the cycle again.

  2. Patrick: That's a pretty good summary of our recent financial troubles. In one part of the post I said "limiting spending is not enough to make someone a saver. A saver must invest wisely as well." Part of investing wisely is not selling at rock-bottom prices. Bankers can only buy from those who choose to sell. So, the savers who held on and didn't sell through the financial crisis are fine.

  3. In "The Millionaire Mind", Tom Stanley tells an anecdote about a banker talking to a business owner from the banker's high-rise office.

    The banker tells the business owner that all those businesses down there all over town are operated by the business owners for the benefit of the bank. You are running those businesses for us, he says to the business owner.