Home » Uncategorized » Reply to an Article that Supposedly Proves There can be a Money Shortage.

Reply to an Article that Supposedly Proves There can be a Money Shortage.

Loyal readers of Smiling Dave’s blog have already enjoyed my article proving there can be no money shortage. Someone replied with a blog to explain how there can be a money shgrtage, he thinks. He didn’t actually refute my chain of reasoning [since that’s not possible]. Rather he resorted to two charts.

In those two charts and their accompanying explanation, he totally refuted, he thinks, what Mises wrote about money. Mises thought that “The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do”. With those two charts, said blogger placed himself firmly in the camp of those that Mises called “monetary cranks”, people who think they have found “a method for making everybody prosperous by monetary measures.”

But hey, we are not dogmatists here. Maybe this fellow is right, and Mises is wrong. Let’s hear his case. As always, all quotes from others in italics, my stuff in normal font. Anything in bold was emphasized by me, even in the blogger’s writing.

The blogger first hits us with these two charts:

monetary disequilibrium adjustment as-ad

He goes on to explain:

I apologize if the above two graphs are not as clear as they should be, but the leftward shift in the demand curve, ceteris paribus, implies a reduction in output (O), from Ō (“optimal” output, associated with “full” employment) to, say, Ot. If we equate output with exchange, then we’d think about it in terms of a reduction in the total volume of trade. What is the causal process which leads to this decline in trade?

In other words, he is about to show that “not enough money” will lead to a recession.

The money supply is defined as the sum of all individual cash balances: ΣM = Md1 + Md2 + Md3…; for our purposes, ΣM = x. Suppose that a sufficient number of individuals increase their demand for cash balances, given current prices, such that the total demand for money rises to y. In order to do this, they acquire money by trading their own output, but it means that they themselves won’t trade that money for other individuals’ output.

Exactly what Keynes said would happen when people got too rich for their own good. But this blogger says what happens is that, for reasons we need not care about, people suddenly decide to salt away huge amounts of their money under the mattress. Note that if they put the money in a bank, like everybody does nowadays, that will not be a problem, even by the blogger’s way of seeing things. The bank will just up and lend the money right back out to someone who will spend it.

So we are talking about many many people having an Uncle Scrooge-like pile of cash that they are just sitting on. They don’t spend it, they don’t put in a bank, nothing. And there are so many people doing this that it effects the whole country, throwing it into recession. Has this ever happened, historically? Of course not. Henry Hazlitt pointed this out in his book, Economics in One Lesson . Here’s Hazlitt:

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
consumption.

“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.

In the USA, it is physically impossible to hoard more than 10% of the money supply, because 90% of the dollars out there are digital, meaning they only exist as electric impulses inside some bank’s computer. How are you going to withdraw digital money and hoard it? It has to be in some institution, and they are going to spend it or lend it, as Hazlitt pointed out.

Hazlitt goes on to add that historically, never has there been the situation the blogger describes. Sure people hoard money now and then, but always in trivial amounts that cannot possibly affect an economy. So our blogger isn’t talking about anything that has actually happened in the modern world, but rather about some hypothetical Bizzaro World situation.

But hey, even theoretical situations have to be investigated. Mises seemed to be saying that there is never such a thing as “not enough money”. Maybe in the blogger’s hypothetical case, he will be shown wrong. Let’s see what the blogger has to say about it.

As a result, these others won’t be able to fulfill their own cash balance preference — thus, the justification for the term “shortage of money” (represented arithmetically by y – x).

In other words, just to keep things simple to calculate, say there are 500 million dollars in existence, and 500 million people. If everyone decides at the same time, “I want to pad my mattress with moolah, and I mean a hundred dollars,” there just isn’t enough money in the world for everyone to be able to do that.

Given the nature of how money is acquired — you must trade for it —, it also follows that there will be a reduction in the volume of exchange.

This is the key to his whole argument. Sadly, it’s a non sequitor. If money is acquired by trade, and everyone wants money, what is going to happen? Obviously, people are going to trade like there is no tomorrow, to get their hands on that shiny ole money.

Furthermore, saying money is acquired by trade is like saying Obama became president by taking the oath of office. A lot more goes into it than just the final little step. Money is acquired by first being productive, then trading for for money with what you produced. If you don’t produce, you have nothing to trade with. So all these people who want money are going to start being more productive, not less. They will try to trade more, not less.

Now had he written that the way to keep your money is by not spending it, he would have a case, one might think. Since money is held onto by not buying stuff, people will buy less. But that line of reasoning, too, is fallacious.

If people are trading less, that means, by definition, that there is a decrease in demand. Demand has two components, the desire to buy, and the ability to buy. I think we can all agree that the desire to buy things does not diminish just because people want to save their money. Assume you wanted a yacht yesterday. Today you want a lot of money under your mattress. If you could keep your money under the mattress, plus get a yacht, would you say, “Sorry, I don’t want a yacht anymore. I have become a monk. All I want is to sleep on a bed of cash. I used to want yachts, but things have changed.” Clearly the notion is absurd. A desire to hoard does not imply a desire for less of the good life.

So much for the first component of demand. How about the second one, the ability to buy things. If people hoard all their cash money , they will have 10% less to spend [= the amount of cash, as opposed to digital money, in existence, as above]. Sound like they should buy 10% less, right? Wrong.

It all goes back to Say’s Law, the simple observation that ultimately products are bought by products, with money serving as a humble middle man. Since products are bought by products, then there cannot be a money shortage which will decrease trade, for the following simple reason.

If Mr A produces wine, say, and he and his tailor both agree that ten bottles of wine is worth a new suit, Mr A will be able to buy that suit by trading it for ten bottles of wine. The money will follow along, adjusting prices until the price of wine and the price of a suit are the same. This follows from the subjective theory of value. The price of a thing is determined by how people value it. If everyone agrees that the suit and the ten bottles are fair trades for each other, they must have the same price. This will be true no matter how much money is in the system.

Mr A produced. He will get his suit. No money shortage can stop that. Even if money totally disappears, he will get his suit by barter. Mr A’s ability to demand is there, created by his production.

All the rest of that blog is built on the quicksand of his non sequitor, so no need to go into it.

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