So, my understanding of the economic theory is that burying the money under a mattress should create capital that grows at the rate of GDP growth, whereas investing it should create capital that grows at the (faster) rate of the stock market. However, this doesn’t answer the question I was trying to address in this post, which is how much should we trust the economic theory? My intuition is that the better causal models we can come up with to explain why the theory works, the more we should trust it, as long as those causal models don’t predict that the theory is likely to break down when you apply it to reality. I don’t really see anything that I would call a causal model in your comment.
I’m not quite sure how you’re defining “causal model” here, but the bit about “get paid to build a factory, which then produces goods, meanwhile you don’t consume the goods you were paid” seems causal to me. By not consuming the proceeds of your work, you have caused society to have more capital than otherwise. Heck, the paragraph beginning “But suppose…” is also describing a series of causes and effects, although it glosses over exactly how removing money from circulation drives up the value of money (that’s just basic microecon, though, I’m assuming you already understand that).
The rate of GDP growth isn’t really the right thing to use (GDP is the total value of all transactions in the economy, which is fundamentally a meaningless number and is certainly irrelevant here). Burying the money creates capital that grows at the rate of return on capital. Investing the money does the exact same thing. The only difference is to whom the interest is paid.
Actually, on re-reading your post, I see another sign of confusion where you talk about “real value” and claim that trades can’t create it. Value is a two-argument function; when you buy the stock, it’s because the stock (or rather, the future consumption-opportunity it represents) is worth more to you than the present consumption you could buy with it. Meanwhile, the seller values present consumption (or whatever else he buys with the money today, which may even be just the security of having larger reserves of liquid currency as opposed to holding less-liquid, potentially risky shares of stock) more than the future consumption the stock represents. Value has been created, not by creating ‘stuff’, but by moving existing stuff to higher-valued uses.
Similarly, when you defer consumption into the future, you are moving current stuff from consumption to capital uses (because at least some of the resources you are no longer consuming will end up as capital formation (though not all of it because the price of consumption goods will fall slightly relative to the price of capital goods, but it can only do so because the equilibrium quantities shift)), and simultaneously moving future stuff (some of which is created by the capital uses of the current stuff) to consumption uses. As long as the rate of return on capital × your value ratio of future to present consumption is greater than 1, the combined effect is an increase in value. If you invest the money saved, then you capture the value thereby created (you’re trading your future consumption against your current consumption); if you bury it, you don’t: you’re trading society’s future consumption against your current consumption, but if you’re a selfless utilitarian that’s irrelevant.
When I wrote about trades not creating real value, I just meant that any value created in the trade is incidental and not the main thing we are talking about. Like, economic theory says we should expect $1000 of value to have been created even if our trade didn’t create any value (perhaps because both buyer and seller were indifferent to whether or not to trade). Of course I understand the point about moving existing stuff to higher-valued uses.
The idea that burying money is as good as investing it seems to contradict Paul Christiano’s explanation of why investing it creates real value, which I found fairly convincing. I’m not sure what to make of the claim that GDP is a meaningless number. Again, Paul Christiano seems to think there are two different levels of growth that one can meaningfully measure, and he seems like he knows what he is talking about. And intuitively it seems to me like most people will spend their money on things that don’t grow as fast as investments. Though perhaps I will just have to let you two argue about it.
I’m not sure if I can explain why what you wrote doesn’t feel like a causal model to me, but maybe it is because it seems to gloss over too many details. Like, the main detail I was interested in was “how does there arise a connection between investment and factory-building?” although Paul Christiano’s comment may have mostly answered that. In your comment, maybe what I want to know is if you perform a service, how does the value of that service end up getting compounded at the same rate regardless of what the service was? This seems a little odd to me… Also, according to your theory, if we perform a service but then don’t accept money for it, is that the same as performing a service and then burying the money? (My understanding of economic theory is that these are basically the same, but my understanding is also that they are different from investing the money.)
So, my understanding of the economic theory is that burying the money under a mattress should create capital that grows at the rate of GDP growth, whereas investing it should create capital that grows at the (faster) rate of the stock market. However, this doesn’t answer the question I was trying to address in this post, which is how much should we trust the economic theory? My intuition is that the better causal models we can come up with to explain why the theory works, the more we should trust it, as long as those causal models don’t predict that the theory is likely to break down when you apply it to reality. I don’t really see anything that I would call a causal model in your comment.
I’m not quite sure how you’re defining “causal model” here, but the bit about “get paid to build a factory, which then produces goods, meanwhile you don’t consume the goods you were paid” seems causal to me. By not consuming the proceeds of your work, you have caused society to have more capital than otherwise. Heck, the paragraph beginning “But suppose…” is also describing a series of causes and effects, although it glosses over exactly how removing money from circulation drives up the value of money (that’s just basic microecon, though, I’m assuming you already understand that).
The rate of GDP growth isn’t really the right thing to use (GDP is the total value of all transactions in the economy, which is fundamentally a meaningless number and is certainly irrelevant here). Burying the money creates capital that grows at the rate of return on capital. Investing the money does the exact same thing. The only difference is to whom the interest is paid.
Actually, on re-reading your post, I see another sign of confusion where you talk about “real value” and claim that trades can’t create it. Value is a two-argument function; when you buy the stock, it’s because the stock (or rather, the future consumption-opportunity it represents) is worth more to you than the present consumption you could buy with it. Meanwhile, the seller values present consumption (or whatever else he buys with the money today, which may even be just the security of having larger reserves of liquid currency as opposed to holding less-liquid, potentially risky shares of stock) more than the future consumption the stock represents. Value has been created, not by creating ‘stuff’, but by moving existing stuff to higher-valued uses.
Similarly, when you defer consumption into the future, you are moving current stuff from consumption to capital uses (because at least some of the resources you are no longer consuming will end up as capital formation (though not all of it because the price of consumption goods will fall slightly relative to the price of capital goods, but it can only do so because the equilibrium quantities shift)), and simultaneously moving future stuff (some of which is created by the capital uses of the current stuff) to consumption uses. As long as the rate of return on capital × your value ratio of future to present consumption is greater than 1, the combined effect is an increase in value. If you invest the money saved, then you capture the value thereby created (you’re trading your future consumption against your current consumption); if you bury it, you don’t: you’re trading society’s future consumption against your current consumption, but if you’re a selfless utilitarian that’s irrelevant.
When I wrote about trades not creating real value, I just meant that any value created in the trade is incidental and not the main thing we are talking about. Like, economic theory says we should expect $1000 of value to have been created even if our trade didn’t create any value (perhaps because both buyer and seller were indifferent to whether or not to trade). Of course I understand the point about moving existing stuff to higher-valued uses.
The idea that burying money is as good as investing it seems to contradict Paul Christiano’s explanation of why investing it creates real value, which I found fairly convincing. I’m not sure what to make of the claim that GDP is a meaningless number. Again, Paul Christiano seems to think there are two different levels of growth that one can meaningfully measure, and he seems like he knows what he is talking about. And intuitively it seems to me like most people will spend their money on things that don’t grow as fast as investments. Though perhaps I will just have to let you two argue about it.
I’m not sure if I can explain why what you wrote doesn’t feel like a causal model to me, but maybe it is because it seems to gloss over too many details. Like, the main detail I was interested in was “how does there arise a connection between investment and factory-building?” although Paul Christiano’s comment may have mostly answered that. In your comment, maybe what I want to know is if you perform a service, how does the value of that service end up getting compounded at the same rate regardless of what the service was? This seems a little odd to me… Also, according to your theory, if we perform a service but then don’t accept money for it, is that the same as performing a service and then burying the money? (My understanding of economic theory is that these are basically the same, but my understanding is also that they are different from investing the money.)