Home » Keynes » Where Will the Money Come From to Replace All That Hoarded Money?

Where Will the Money Come From to Replace All That Hoarded Money?

We’ve written about how How Mises Dismissed that Whole Keynesian Thing with a Decisive One Liner.

In that article, astute readers will have noted, the theme was that what happens to the money is not important to the state of an economy. The only question that counts is, “Was there increased net production, or not?”

This article continues where that article left off. We stand by everything written there, but to cross all the t’s and dot all the i’s, we are here going to discuss Keynes’s argument that what happens to the money is terribly important. We’ll present his seemingly flawless argument, then show the flaws in it.

Keynes [see Chapter 3 of his work, or do a search on this humble site for Keynes] thought hoarding was a big problem, in fact, The Problem, the one that caused all recessions. His thinking was that a business is constantly expending money by paying salaries and other expenses, and of course needs money coming in to keep on functioning. Normally, it gets the money it needs from the sale of its products, and from investments people make in the business.

But if people start hoarding their money in large amounts, instead of buying products or investing, the business will have no money coming in. It will not be able to function. Multiply this for all businesses in an economy, and you have a recession.

Austrians disagree and claim that hoarding is not a problem at all. [Human Action, end of chapter 18, or have a look here. But why not? Isn’t Keynes raising a valid issue? Don’t businesses indeed need money coming in to function? And if money is hoarded, doesn’t that mean the money won’t be coming in? How can Austrians deny such a rock solid demonstration as the one Keynes presented?

The answer is very simple. A business does not need money per se, it needs purchasing power. Money coming in is just a means of having that purchasing power. But any way at all that a business can get purchasing power will be just as good as getting money.

Now that we realize that the goal is not money, but purchasing power, let’s see what happens when people hoard on a large scale. Say they hoard X dollars. That means they reduced the supply of money by X dollars. By the laws of supply and demand, reduced supply means increased price. The “price” of money is, of course, its purchasing power. So by hoarding money, they increase the purchasing power of the unhoarded money.

In other words, when X dollars are hoarded and held back from businesses, it increases the purchasing power of the money in the hands of the businesses or their non hoarding customers by X dollars. Every hoarded dollar, by the very act of being hoarded, creates a dollar of extra purchasing power. Bottom line: the business has no problem whatsoever functioning. The money may not be coming in, but the purchasing power is.

Devil’s Advocate: Dave, you are being simplistic. Sure, hoarding increases the purchasing power of the unhoarded money. But who says it’s a dollar for dollar ratio?

Smiling Dave: You mean the non hoarders might actually get richer? They might get a dollar and a half of increased purchasing power from every dollar hoarded?

DA: I’m saying they might get less.

SD: And you know this how?

DA: I can’t really say for certain. But neither can you.

SD: So what we have is an unproven assertion by Keynes, with no backup, that hoarding decreases purchasing power.

DA: I’m not saying that. For all I know, Keynes didn’t even think about the fact that hoarding increases everyones purchasing power.

SD: Nothing like an unproven assertion to turn economics on its head and determine govt policy.

DA: Smiling Dave, I know you aren’t that smart. You didn’t think this up by yourself. So let’s see some quotes, please.

SD: Oh, alright. Here’s Rothbard in his History of Economic Though, Vol 2:

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.

Again:

Bentham reached the acme of inflationism in his ‘The True Alarm (1801). In this unpublished work, Bentham not only continued the full-employment motif, but also grumbled about the allegedly dire effects of hoarding, of money saved from consumption that went into hoards instead of investment. In that case, disaster: a fall in prices, profits and production. Nowhere does Bentham recognize that hoarding and a general fall in prices also means a fall in costs, and no necessary reduction in investment or production.

DA: Keep up the good work, Dave.


8 Comments

  1. Anonymous says:

    Hey Dave. Good post as always. I’ve got to say that I’ve read about 90% of this blog and it’s not more than 3 weeks had I discovered it. Keep up with good work!

    I’ve got a question reagarding one aspect of hoarding. What about subjective expectations of entreprenuers? It’s also an argument raised by Keynesians regarding loanable funds theory. To put it simply: in order for investments to rise you need entreprenuers to expect profits. What happens when they aren’t? In such a case even lower interest rate might not induce them to invest and recession might appear.

    Best luck from Poland and thanks for a reply!

    Like

  2. Smiling Dave says:

    Thank you for your kind words, Anonymous from Poland.

    In principle, they are certainly right. If entrepreneurs don’t expect profits, they won’t invest.
    Austrians point out that one reason the great Depression lasted so long in the USA in the 1930’s was for this reason. FDR had the business community terrified. He had made so many crazy new laws they were afraid to invest in their businesses, lest he make yet another law that will make their investment unprofitable. Better to hold in to the money and hope for the best.

    However, the Keynesians assume that in any every free market economy, even if the govt does not interfere at all, there will come a time when there will be no more investments. Like some scientists in 1890 who believed everything to invent had been invented, Keynesians think that every economy reaches a stage where everything to invest in has been invested in already.

    What can I say? I think time has proven their assumption ridiculous. Also, what proof do they have for such a bold assertion? Answer: None.

    BTW, how did you find my blog? Who told you about it?

    Like

  3. Anonymous from Poland says:

    I think I found your blog after following a link on Bob Murphy’s site. I am not sure, though.

    To clarify the aformentioned issue:

    I perfectly understand incorrectness of Keynesian argument about lack of investment perspectives. You’ve made a good comparison with scientists who thought that everything has already been invented. Human needs are never satisfied so there always be things which one might invest in. The problem of subjective expectations is a little bit different at least in my understanding. It states (as you say) that there always are things to invest in and entrepreunuers know that. The problem is that they perceive economy as stagnant and don’t expect people to buy this things (they might think they don’t have money to consume or so). In that case even if interest rate falls down there might be not more investment. What do you think?

    Best regards

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  4. Smiling Dave says:

    I don’t know. I guess you’ll have to ask someone more knowledgeable than I am.

    Like

  5. alberto says:

    Hey Dave nice article i just have a few critiques; First off your answer to hoarding money is strictly dogmatic and rejects pragmatic reason. For instance if me and you are going to make an exchange, we can’t possibly know at that moment know how much money is in supply or whether money is being hoarded or not, so we’d just be trading on yesterday’s prices and our contemporary subjective value scales. Now in the long run I see how your argument can be valid but in the short run how are people going to possibly know what the supply of money is at.

    Like

  6. Smiling Dave says:

    Thank you for your comment, alberto.
    It’s a good point you raise, how do people know whether money is being hoarded or not.

    For instance if me and you are going to make an exchange, we can’t possibly know at that moment know how much money is in supply or whether money is being hoarded or not, so we’d just be trading on yesterday’s prices and our contemporary subjective value scales. Now in the long run I see how your argument can be valid but in the short run how are people going to possibly know what the supply of money is at.
    I am not sure why this is not also a question to ask the Keynesians.
    So would you say they are also being strictly dogmatic and rejecting pragmatic reasoning?

    At any rate, both the Keynesians and I will answer the question in the same way, which is that a merchant need not know at all whether money is being hoarded or not.
    [If the hoarding does not affect him, then of course the problem the Keynesians are posing does not exist for him.]
    Some merchants feel the hoarding without necessarily knowing what it is, because they see people buying less of their wares than they anticipated.
    Keynes said the inevitable consequence is that they will lay people off. I quoted Rothbard who said that need not be the case at all, since if there is hoarding on such a massive scale as to affect the whole economy, prices of everything will go down, raising the purchasing power of the money, etc., as I wrote in the article.

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  7. A rather confused lay-economist says:

    I’m sorry to be a bother, but I still don’t understand the essence of your argument.

    You argue that decreasing the supply of money will increase the total value of money still in circulation by at least a 1:1 ratio. But the only way that you mention that the decreased quantity of cash in circulation will be noted is when companies notice less of their products being purchased. You say that this will force companies to respond by lowering their prices, but I don’t see why a company would _lower_ prices in response to decreased revenues, especially since I many companies already run dangerously close to 0 net profit. Surely there must be more to it than that?

    It just occurred to me that the law of supply and demand would dictate that companies would in fact lower their prices in response to reduced demand, but supply and demand also states that this would cause people to stop saving their money and go out to buy stuff, which implies only that ridiculously excessive saving of the kind that you were talking about won’t happen, although we can certainly see that it does. It does _not_ explain how a sudden shift downwards in demand (which we are saying happens here) would give companies the incentive to hire the same number of employees or produce the same number of goods.

    I guess my confusion boils down the the Classical vs. Keynesian economics fundamental split: Classical economists argue that goods produced will always be sold eventually (albeit perhaps at a reduced price), so we want suppliers to produce as much as possible, whereas Keynesian economists argue that companies won’t produce more goods if they know that there is no demand for the goods (at or near their current price).

    The former argument has always bothered me, as I know that there are some goods which no one will take for free, and I also know that this is true of anything, if it has sufficient quantity (if there are a trillion pencil sharpeners being given away, I’m still not going to take more than three–I would derive no practical, economic, or entertainment use from having more. Even if everyone in the world took 10, we still wouldn’t be rid of all of them.). On this point, I can’t see anything wrong with Keynes’s perspective (I think that I have problems with the solutions that he proposes, but I don’t really understand their details well enough to know for sure, although your summary of Keynes’ theory helped me a lot with understanding Keynes’s fundamental assumptions)

    So…what am I missing? Why would a reduction of demand (due to increased saving) not lead to a corresponding decrease in the amount of goods that companies will supply? And, while we’re here, if you could explain to me or direct me to an explanation of what precisely it is that Keynes believes that we should do about the ‘problem’ of excessive saving (and why it’s wrong, if you like. =p), I would HUGELY appreciate it.

    Like

  8. Smiling Dave says:

    0. I’m going to answer in reverse order, and very concisely. Maybe reading my articles, or free online books by Hazlitt and others Austrians, will help. Mises.org is the gold mine for material, books, articles, videos, podcasts.
    You also could ask at libertyhq.freeforums.org and I’ll try to answer you there. [The software for writing replies here is terrible, and also the forum has folk more knowledgeable than me that can chime in.]

    1.

    And, while we’re here, if you could explain to me or direct me to an explanation of what precisely it is that Keynes believes that we should do about the ‘problem’ of excessive saving (and why it’s wrong, if you like. =p), I would HUGELY appreciate it.

    Simple. Stop the saving. Only way to do that is take people’s money away, give it to the govt, and have the govt spend it. This can be done either by taxes or by the govt printing money.

    What’s wrong with it? First, it’s immoral, aka theft. Second, the problem it supposedly solves is no problem. Third, the solution [of the problem that doesn’t exist] does great damage to the economy.

    2.

    Why would a reduction of demand (due to increased saving) not lead to a corresponding decrease in the amount of goods that companies will supply?

    First, because people save money in banks. Banks lend money to people and businesses, in fact for every dollar saved they lend out ten dollars. So that increased savings merely switches around what will be demanded [=bought] by the saved money, but will not reduce the total spending.

    Second, even when money is hoarded under a mattress [which in reality is always a trivial amount], no harm is done. In fact it’s bad for the hoarder, good for everyone else. See link at top of this article. The key idea is that the companies HAVE ALREADY MADE THEIR MONEY because the hoarder worked for them. And if he won’t buy stuff, someone else will. And if prices are lowered, they are lowered for the companies, too, lowering their costs of production.

    3. Everything you wrote in the penultimate paragraph [The former argument etc.] is 100% correct. But the paragraph before is all wrong. That’s not the classical position at all, and everyone agrees with what you call the Keynesian argument.

    4. I wrote an article called Summary of Keynes’ Theory, and the More Obvious Flaws in it. May help you a bit, unless that’s the one you already read.

    Like

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