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A New Misunderstanding of Say’s Law.

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I love Say’s Law, as much as Keynes hated it, and for the same reason. If you accept the validity of Say’s Law, all of Keynes’ work can be tossed in the garbage. Which is why he worked so hard, albeit fruitlessly, to refute it.

One Steve Horwitz wrote an article infusing his own controversial [and in my opinion, incorrect] views and making believe they follow from Say’s Law. Once again, Smiling Dave to the rescue.

What is Say’s Law?

Put simply, Say’s Law says something everyone has to agree with. One doesn’t have money to spend unless one worked to make the money in the first place. It’s that simple. Say made it even simpler, taking money out of the scheme. You cannot trade with someone and have him agree to give you his cow, for example, unless you offer him something in exchange for the cow. And you cannot offer something in exchange, for example a chair or some apples, unless you have first been productive and actually made a chair or grown those apples.

In other words, the ability to buy stuff comes from being productive. Without being productive, you will get nowhere. Say drew the obvious conclusion from this, which Keynes hated:

The same principle leads to the conclusion, that the encouragement of mere consumption is no benefit to commerce; for the difficulty lies in supplying the means, not in stimulating the desire of consumption; and we have seen that production alone, furnishes those means. Thus, it is the aim of good government to stimulate production, of bad government to encourage consumption.

We have written many times about Say’s Law in our humble blog. Among other things, we discussed how Keynes both perverted the meaning of the law and tried to avoid the above inevitable conclusion. In fact, the previous article addresses the latter point.

In this article we will discuss what Steve Horwitz thinks Say’s Law implies, and why he is wrong. Lest I be accused of taking him out of context, I’ll quote at length, with the usual snarky comments. As always, all quotes are in italics, all regular font is me speaking.

Horwitz writes:

Because all movements between supplying and demanding have to take place through the medium of money, it is somewhat oversimplified to say that production is the source of demand.

That is the first thread of the tangled web of misunderstanding Horwitz is about to weave.

First of all, no movement HAS to take place through the medium of money. There is such a thing as barter.

Second, what he writes is like saying that because LeBron James’s movements between jumping high in the air with the basketball and throwing it down for a slam dunk have to take place through the medium of wearing a T-shirt, it is somewhat oversimplified to say that jumping high in the air is the source of a slam dunk. Let’s not forget the T-shirt.

Actually demanding products requires the possession of money, which in turn requires a previous act of supply.

Again, the simple act of barter refutes him. No money needed.

We sell assets or labor services for money, which we then use to demand. Money is an intermediate good that enables us to buy the things we ultimately desire.

Not quite. Money does not enable us to buy things. It makes it easier to buy things. Horwitz is making a big deal out of money, giving it bloated importance.

However, we have to be careful to remember that what enables us to purchase is not the possession of money, per se, but the possession of productive assets that can fetch a money’s worth on the market. When we sell that asset (or our labor services) we receive wealth in the form of money. As we spend that money, we demand from the wealth our production created. 

Here he backtracks. It’s not oversimplified at all to say that production is what gives us purchasing power. But one wonders. Is this the calm before the storm? Will this be followed by a whopper?

However, because we do not spend all of our wealth that we temporarily store as money, but choose to continue to hold some of it in the monetary form, the demand for current goods and services will not precisely match the value of what has been produced, as some money remains in the producers’ possession.

Sure enough, there it is. The whopper. Actually, it’s the whopper junior. The demand for current goods and services will not precisely match the value of what has been produced, thanks to money. In a barter economy, where there is no money, implies Horwitz, everything is precise down to the last decimal point. What is produced is matched precisely by demand. Nature knows precisely how many potatoes people want. The tailor knows precisely how many wedding dresses to make this year. Nobody makes any mistakes whatsoever. It’s the existence of money that ruins this atomic clock level of precision, is what Horwitz seems to be saying.

I’m not buying it, for the following reasons.

First, supply does not have to precisely match demand for an economy to thrive. As long as there are profits even after the losses from imprecision are accounted for, all is well.

Second, there are imprecisions in the matchup between supply and demand for many, many reasons. Why pick on money as the scapegoat?

Third, let’s see a little praxeological reasoning, or some research, to prove that imprecisions from money hoarding are non trivial. We are talking about an economy of trillions of dollars, 90% of which only exists in the form of digital money in bank accounts, which is of course not hoarded at all, but used by banks. Of the ten percent which is cash, how much of it is hoarded under a mattress? A billionth of a percent? Less? Henry Hazlitt claimed that the amount is trivial, and provided research to prove it.

Thus it looks as though, given the existence and use of money, Say’s Law, even rightly understood, leaves open the possibility that aggregate demand is insufficient to purchase what has been supplied.

Thank you for repeating your mistake. Because even without the existence of money, there is the possibility, nay the almost certainty, that aggregate demand is insufficient to precisely purchase what is supplied, as we just explained. The word precisely is left out this time around. First, we are told demand does not precisely match supply in a money economy. Then we are told demand is insufficient to match supply, subtly implying a big fat insufficiency. But that’s only hinted at for now.

However, if the monetary wealth is stored in the form of bank-created money, such as a checking account (but not Federal Reserve Notes), then that withheld consumption power will be transferred to those who borrow money from the bank that created it.

Here he is agreeing with the point we made earlier, that nobody hides money under their mattress anymore. They put it in a bank, where it is moved around until somebody spends it.

But he doesn’t let it go at that. He inserts a remark that if the money in the bank is actual Federal Reserve Notes, AKA paper dollar bills, then that’s bad. Then the money won’t be spent. It may as well be under the mattress, because every time you give a bank cash, it is hoarded in the vaults, never to be seen again. The banks never, ever, give anyone cash for any reason, is the implication, even if they have it right there in the teller’s drawer.

But banks hand out cash all the time, every single day. Even when the bank is closed the ATM machines are working non stop. In theory, cash and checks are identical.

Now maybe he means that the banks are required by law n the United States to keep a certain amount of cash in reserve, and that’s why he considers cash in a bank as hoarded.

But if he means that, he is refuted by simple arithmetic. By law, for every paper dollar you put in a bank, the banks are allowed to spend nine new dollars of imaginary money. Far from decreasing demand when you put paper money in a bank, you increase it nine fold.

There is another huge problem with this paragraph, and that is the implied acceptance of theft as economic policy. He talks about “bank created money” as if it is some neutral concept. More, he is implying that it’s a good thing, since it increases demand. But in reality when a bank “creates” money, it is stealing money.

I mean, why can banks “create” money, but you and I cannot, and it’s called counterfeiting? What is the magic difference? The answer is, of course, that there is no difference. When anyone [including the govt] “creates” money, they are increasing their purchasing power, obviously. Meaning they can outcompete you and me and everyone else for scarce goods and services, with money they did not work for. They just “created” it. I call it theft, plain and simple, because that’s what it is. To understand this more deeply, have a look at my humble article here. [I talk about the govt printing money there, but the idea is the same when banks “create” money].

The money I leave sitting in my checking account is the basis for my bank’s ability to lend to others.

Since he is talking about “bank created money”, meaning money stolen by the banks, as above, here too he is implying that it’s a wonderful thing, the “basis” for the ability to lend to others. Imagine if he had written that the Mafia’s protection rackets and murders are the basis for their ability to lend to to others, and that it creates demand. Yes, if a criminal steals money, he can lend it to people. But is that good for the economy, or for anyone, allowing thieves to run free taking what they wish?

By the way, the money “created” by the banks does not increase demand one iota. Because the banks increased purchasing power comes at the price of reducing everyone else’s purchasing power. It’s called inflation, and we have seen how it works. The banks can outbid us for things with the money they created for themselves, leaving us with less to consume. By the laws of supply and demand, the price of what’s left over from what they gobbled up will increase for us. It’s that simple, and don’t be fooled by any claims otherwise.

Let’s move on.

The power to consume that I choose not to utilize by leaving my production-generated wealth as money is transferred to the borrower. When she spends her loan, her addition to aggregate demand fills in for the missing consumption demand resulting from my decision to hold money. There is, therefore, no excess or deficiency in aggregate demand, as long as the banking system is free to perform this process of turning the saving of depositors into the spending of borrowers.

This is all true, of course, if we are talking about money not “created” by the banks, but if they lend out to someone the same money I put in there. It’s exactly what we talked about earlier, how the fact that people put their money in the bank means it will indeed be spent.

But note the subtle writing style Steve has used here. The banks have to be “free” to “perform a process”. When has anyone tried to stop a bank from lending money? Why does he call the simple act of lending money the “process” of “turning” savings into spending? And why this watchdog atitude, warning us that the banks have to be “free” to perform this “process”?

I suspect he is trying to tell us that the banks must be free not only to lend money deposited with them, but to “create” money, meaning steal money, as above. And indeed, Horwitz is a well known advocate of this kind of theft. He loves it. He thinks it is what will save America. Let the banks steal as much as they want, and we will all be rich and prosperous, is his declared stance.

Which is fine. If you think so, you are entitled to your sell-out opinion, however foolish and misinformed. But at least don’t taint the pure teachings of J. B. Say with such ideas. Look what he says next:

Say’s Law of Markets cannot be fully appreciated unless one understands the working of the banking system and its role in intertemporal coordination.[7]

That bit about intertemporal coordination is just a bit of doublespeak. Stealing is not stealing, it is intertemporal coordination. [That this what he means is clear from the citations in footnote 7, all of them apologetics for letting banks be “free” to steal]. And you cannot understand Say’s Law of Markets if you don’t let the banks steal your money. Thank you, Steve Horwitz.

In the next article, we quote J. B. Say writing explicitly that he formulated his famous Law in the first place to refute Steve Horwitz. Click the link and read on.



  1. RichF says:

    Geez I think you are looking for a fight where there is none. Horwitz is obviously writing about an advanced economy in which barter is a tiny fraction of the transactions and banking is pervasive. I doubt he would disagree with your points on your much beloved barter.


  2. sdavesblog says:

    I’m not looking for a fight. I’m pointing out the flaws in his argument, using barter as a counterexample for his claims. If he is presupposing an advanced economy and agrees with me, I’m glad to hear he agrees with me, at least with what I wrote at the beginning of my analysis of his argument.

    The conclusions he draws, that banks must be free to write checks for money that doesn’t exist, are still refuted by what I wrote, advanced economy or no, and whether banking is pervasive or not.

    My much beloved barter is beloved as a counterexample to his much beloved claims at the start of his article. Barter is not much beloved by me as what we should be doing in practice. I hope the distinction is clear.

    To help you out, I’ll give an example. Say some economist wrote that all transfers of money are voluntary, and I wrote that muggings are a counterexample. I hope no one would make the error of thinking muggings are much beloved by me.


  3. […] Dave A New Misunderstanding of Say’s Law which is a critique of the above article. This is he heading for the blogsite, or at least for this […]


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