A while ago David Malpass, financial writer and chief economist at Bear Stearns, (and I do mean that Bear Stearns) argued that US savings are under reported because they exclude "cash flow improvements from realized gains on equities, houses, and mortgage refinancing." Now I am not referring to Malpass as a means to take a swipe at Bear Stearns and the quality of its advisors: that's the market's job. What Malpass did was to inadvertently draw attention to the confusion that reigns among the economic commentariat with respect to the nature of saving and its critical importance for economic welfare.

Most economists define savings as deferred consumption. But this is a very misleading definition that confuses the demand to hold cash with savings. To the Austrian school of economics savings is a process that defers present consumption in favour of greater future consumption by expanding the capital structure and by doing so increases future output. This definition clearly excludes cash balances. Using the Austrian definition we see that "cash flow improvements from realized gains on equities" cannot in themselves be defined as savings. To be savings they must be invested.

Housing is a consumption good, not "a form of savings" as so many economists would argue. The fundamental difference between a capital good (future good) and a consumption good (present good) is that the services of a capital good are indirectly consumed while the services of a consumer good are directly consumed. Menger, the founder of the Austrian school, not only treated capital goods as something concrete rather than abstract he also explained that these goods have to be arranged in a particular order so that they formed an integrated whole. He therefore stated that

The classification of goods into means of production and consumption goods (goods of higher order and goods of first order) is scientifically justified . . . (Carl Menger, Principles of Economics, Libertarian Press, Inc., 1994, p. 303).

It follows that the fundamental difference economic difference between a hamburger and a house is not durability but time. In the hands of consumers they become consumer goods. While the direct services of a house can be consumed over many years, the services of a hamburger are consumed in minutes. On the other hand, capital goods are used to directly and indirectly produce consumer goods. Another defining feature of capital goods is that they are reproducible, i.e., land is not capital. Some Austrians disagree on the point of capital and durability. Hayek considered houses to be capital goods "so far as they are non-permanent". Additionally,

we have to replace them by something if we want to keep our income stream at a given level... (Frederich von Hayek, The Pure Theory of Capital, The University of Chicago Press, 1975, pp. 77-78).

The problem here is that if durability becomes a defining factor what is to stop anyone from classifying vintage cars, televisions, books, furniture, cutlery, wedding rings, etc., as capital? The result is that capital would lose its true meaning. We can now see that the misunderstanding stems from confusing durability with capital goods. Durability is incidental and in no way can define a capital good.

It therefore follows that the US Commerce Department is perfectly correct in defining "money used to pay down a mortgage into the same basket as money used for everyday consumption". Are pension funds savings? Well what Americans call 401(k) deposits are savings but only to the extent that they fit the Austrian definition of investment. Where any 401(k) deposits are "invested" in consumption goods they become 'dissavings'.

As evidence that Americans are saving it has been noted by some commentators that the Forbes 400 have increased their net worth by an enormous amount during the last several years . So what? Considering the amount of credit the Fed has poured into the US economy over the last few years much of this wealth might turnout out to be largely illusionary. One only has to be reminded of the recent collapse of Bear Stearns to realise just how quickly paper wealth can be wiped out.

Unfortunately, the idea that home ownership should be included in any measure of savings is a fallacy that just won't die. Treating this type of equity as saving leads to the absurd view that because the United States has the highest rate of home ownership in its history Americans cannot therefore be spendthrifts. But as I have already explained, houses are consumption goods. Any genuine investments liquidated in favour of housing are dissavings.

For example, if some investors sell their shares in order to buy much larger houses they are clearly dissaving. Whether their actions would result in a fall in total savings depends entirely on whether others in the market place increase their savings by at least the same amount. The fact that their houses are assets doesn't change this situation any more than if they spent their money on vintage cars. To state what should be a truism: while all savings are assets, not all assets are savings.

Although entrepreneurship is what drives an economy it is savings that fuel it. Without savings an economy will eventually regress and living standards will fall. So are Americans putting enough away to satisfy their future material aspirations? I honestly don't know. However, the lesson that Asians understand and many Americans now need to relearn is that savings and not consumption underpin living standards. And this is why the Democrats' proposed tax increase could sink the US economy.

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According to Irwin M. Stelzer: "The era of free-market, no-government-intervention purists is over, if indeed it ever existed". (The Credit Crisis of 2008: As was the case a century ago, it's good to have a J.P. Morgan when you need one, National Review Online, 31 March 2008, Volume 013, Issue 28). Stelzer relates the case of the Knickerbocker Trust Company that capsized in 1907 when the boom bust. Fortunately for shareholders J.P. Morgan came riding to the rescue. As is usual with economic pundits, Mr Stelzer got it wrong.

At the root of the boom and the Knickerbocker collapse was a monetary expansion set in motion by the system of reserve city and central reserve city banks. When the expansion ceased a credit crunch emerged and the Knickerbocker company found that the securities it had accepted as collateral were now worthless. Once again, the real lesson has not been learnt.