In which a modern day “Lord Keynes” [yes, that’s what he calls himself, and we will grace him with the acronym “LK”] has another stab at Say’s Law. Our previous post here quoted LK’s claim that Say didn’t understand fractional reserve banking and fiat money when he wrote his law. We begged to differ.
1. LK goes on:
Say’s law appears to require a world where money is produced like any other commodity, and this is one condition for the law of markets to work. But the condition does not exist today: Say’s law is irrelevant to modern fiat money using economies, where money also has a store of value role.
He explains what he means later on, that people hoard money. He repeats this many times in different ways all through his article. We will refute it later in this post once for all.
2. LK then finds what he considers a fatal flaw in Say’s Law. Say forgot that people know how to read and write, and indeed do so every day, writing contracts and such:
The second fatal and ridiculous flaw in Say’s argument is the belief that “every producer asks for money in exchange for his products, only for the purpose of employing that money again immediately in the purchase of another product.”
In fact, it simply isn’t the case that producers of commodities (whether individuals or businesses) or the recipients of the money profits of the firm like workers or owners will always use the money they earn from the sale of commodities “only for the purpose of employing that money again immediately in the purchase of another product.” Money can be saved and it can become idle. Capitalism also has markets for real and financial assets. Money can flow into the purchasing of financial assets. If there are financial assets or real assets whose prices are rising, modern capitalists, producers and even workers might decide to start speculating on asset prices. This would take money away from the purchasing of commodities and instead tie it up in exchanges on asset markets, as money alternates between being (1) held idle before buying assets and (2) purchasing assets, and then being held idle again by the new owner of the money in preparation for further speculation.
Well, I’m a simple kind of guy. I had to look up what exactly a financial asset is. Fortunately, Investopedia.com told me:
What Does Financial Asset Mean?
An asset that derives value because of a contractual claim. Stocks, bonds, bank deposits, and the like are all examples of financial assets.
Unlike land and property–which are tangible, physical assets–financial assets do not necessarily have physical worth.
So LK is saying that people don’t rush out with all their money to buy bananas, like Say thought. They use much of it to buy stocks and bonds, and deposit it in banks. And this proves that Say’s law is fatally flawed and ridiculous.
I don’t get it. What is Say’s Law, and how has LK disproved it? Say’s law is that Mr Smith’s ability to consume comes from Smith having previously produced. To which LK retorts, yes, but some people buy assets. And I reply, so what?
Now he might mean this. A consequence of Say’s law is that recessions are not caused by a lack of cash. They are caused by a lack of production. Say seems to have held that there is no lack of cash because people will spend it right away. To which LK replies, Ah but they may not spend it. They may buy financial assets instead.
I wrote a reply filled with gentle sarcasm, but I’ll defer to Hazlitt and Rothbard on this one. First Hazlitt in Economics in One Lesson. He is talking about a fictitious frugal fellow named Benjamin:
Now let us see…what happens to the
$20,000 that he neither spends nor gives away. He does not let it pile
up in his pocketbook, his bureau drawers, or in his safe. He either
deposits it in a bank or he invests it. If he puts it either into a com-
mercial or a savings bank, the bank either lends it to going businesses
on short term for working capital, or uses it to buy securities. In other
words, Benjamin invests his money either directly or indirectly. But
when money is invested it is used to buy capital goods—houses or
office buildings or factories or ships or motor trucks or machines. Any
one of these projects puts as much money into circulation and gives
as much employment as the same amount of money spent directly on
“Saving,” in short, in the modern world, is only another form of spending. The
usual difference is that the money is turned over to someone else to
spend on means to increase production.
OK, and here’s Rothbard, History of Economic Thought:
Echoing Turgot, Say also counters the Malthus-Sismondi worry about the
leaking out of savings from vital spendings, pointing out that savings do not
remain unspent; they are simply spent on other productive (or reproductive)
factors rather than consumption. Rather than injuring consumption, saving is
invested and thereby increases future consumer spending. Historically, savings
and consumption thereby grow together. And just as there is no necessary limit
to production, so there is no limit to investment and the accumulation of
capital. ‘A produce created was a vent opened for another produce, and this is
true whether the value of it is spent’ on consumption or added to savings.
But what about hiding the money under the mattress for a hundred years? Here Rothbard says that Say did not give a satisfactory answer, but that later Austrians did. [By the way, Hazlitt points out that historically very little money gets hoarded like that. Almost all of it goes into a bank]:
Conceding that sometimes the savings might be hoarded, Say was for once
less than satisfactory. He pointed out correctly that eventually the hoard will
be spent, either on consumption or investment, since after all that is what
money is for. Yet he admitted that he too deplored hoarding. And yet, as
Turgot had hinted, hoarded cash balances that reduce spending will have the
same effect as ‘overproduction’ at too high a price: the lower demand will
reduce prices all round, real cash balances will rise, and all markets will
again be cleared. Unfortunately, Say did not grasp this point.
In other words, if a significant amount of money gets hoarded, that increases [by the law of supply and demand] the purchasing power of all the unhoarded money. There will be deflation, but not recession.
This is not the place to go into detail about why they are not the same thing, and why deflation is good. I wrote previous posts that touched on deflation a bit, here , here, and here.
3. LK goes on to mention another fatal flaw, that Say did not think money has utility, nor is it a store of value. I imagine he means that Say didn’t think people hide money under the mattress. We quoted Rothbard earlier to deal with that one.
4. Next comes the accusation that “it is clear” Say believes in neutral money. We are sent to Visser 2002 to find out what neutrality of money is. I used Wikipedia instead. Here’s how Uncle Wiki explains it:
Neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages and exchange rates, with no effect on real (inflation-adjusted) variables, like employment, real GDP, and real consumption.
Neutrality of money is an important idea in classical economics…It implies that the central bank does not affect the real economy (e.g., the number of jobs, the size of real GDP, the amount of real investment) by printing money. Instead, any increase in the supply of money would be offset by an equal rise in prices and wages. This assumption underlies some mainstream macroeconomic models…but as …Olivier Blanchard has said, there is no real evidence.
Bottom line,the whole concept of neutral money is talking about what happens when new money is printed. Say never discussed such a question. LK, you really struck out here.
Let me point out that LK may be using neutrality of money in a different sense than Wikipedia. Hazlitt in Failure of New Economics quotes a Keynesian as rephrasing Say’s Law [incorrectly] to be,
“Since goods exchange against goods, money is but a
“veil” and plays no independent role.”
LK elaborates on this later, so we leave it aside for now.
4. We are then told that “Say’s analysis also ignores the role of financial markets in affecting demand for money.”
The patient reader knows the answer to this one by now. The quotes from Hazlitt and Rothbard take care of it.
OK, time for a break.