The Cobden Centre » Economics

It’s hard to account for flaws in the rule-book

Anthony J. Evans — Wed, 08 Feb 2012 09:30:11 +0000

In my latest City AM column I discuss Gordon Kerr’s recent book, which points to the role of accounting regulations in the obfuscation of the price system that contributed to the financial crisis:

When economists talk about the efficiency of the profit and loss system, we tend to take for granted that the profit and loss we observe matches with reality. But government interventions are liable to disrupt these signals – inefficient taxes, arbitrary subsidies, and monetary debasement all separate prices from the underlying conditions of demand and supply. Another source of noise is faulty accounting standards – as Gordon Kerr has pointed out in his fascinating new book The Law of Opposites: Illusory profits and the financial sector.

What the classical economists knew and the moderns have forgotten – part 3

Toby Baxendale — Tue, 07 Feb 2012 11:00:32 +0000

Today we reproduce a wonderful essay written by Ludwig von Mises for the Oct 30^th 1950 edition of The Freeman, and subsequently published in his book Planning for Freedom (1952).

Like Hazlitt in my previous post, Mises draws to our attention to the fact that Adam Smith and J B Say had already dealt with all suggestions that recessions were manifestations of shortages of money. Keynes certainly had not refuted their views. Instead, he expounded the views of the most notorious money cranks. Sadly, most economists today hold those same cranky views. It is important that we, in our own small way, do our bit to refute them. You can download the full book here.

Lord Keynes’s main contribution did not lie in the development of new ideas but “in escaping from the old ones,” as he himself declared at the end of the Preface to his “General Theory.” The Keynesians tell us that his immortal achievement consists in the entire refutation of what has come to be known as Say’s Law of Markets. The rejection of this law, they declare, is the gist of all Keynes’s teachings; all other propositions of his doctrine follow with logical necessity from this fundamental insight and must collapse if the futility of his attack on Say’s Law can be demonstrated.[1]

Now it is important to realize that what is called Say’s Law was in the first instance designed as a refutation of doctrines popularly held in the ages preceding the development of economics as a branch of human knowledge. It was not an integral part of the new science of economics as taught by the Classical economists. It was rather a preliminary—the exposure and removal of garbled and untenable ideas which dimmed people’s minds and were a serious obstacle to a reasonable analysis of conditions.

Whenever business turned bad, the average merchant had two explanations at hand: the evil was caused by a scarcity of money and by general overproduction. Adam Smith, in a famous passage in “The Wealth of Nations,” exploded the first of these myths. Say devoted himself predominantly to a thorough refutation of the second.

As long as a definite thing is still an economic good and not a “free good,” its supply is not, of course, absolutely abundant. There are still unsatisfied needs which a larger supply of the good concerned could satisfy. There are still people who would be glad to get more of this good than they are really getting. With regard to economic goods there can never be absolute overproduction. (And economics deals only with economic goods, not with free goods such as air which are no object of purposive human action, are therefore not produced, and with regard to which the employment of terms like underproduction and overproduction is simply nonsensical.)

With regard to economic goods there can be only relative overproduction. While the consumers are asking for definite quantities of shirts and of shoes, business has produced, say, a larger quantity of shoes and a smaller quantity of shirts. This is not general overproduction of all commodities. To the overproduction of shoes corresponds an underproduction of shirts. Consequently the result can not be a general depression of all branches of business. The outcome is a change in the exchange ratio between shoes and shirts. If, for instance, previously one pair of shoes could buy four shirts, it now buys only three shirts. While business is bad for the shoemakers, it is good for the shirtmakers. The attempts to explain the general depression of trade by referring to an allegedly general overproduction are therefore fallacious.

Commodities, says Say, are ultimately paid for not by money, but by other commodities. Money is merely the commonly used medium of exchange; it plays only an intermediary role. What the seller wants ultimately to receive in exchange for the commodities sold is other commodities.

Every commodity produced is therefore a price, as it were, for other commodities produced. The situation of the producer of any commodity is improved by any increase in the production of other commodities. What may hurt the interests of the producer of a definite commodity is his failure to anticipate correctly the state of the market. He has overrated the public’s demand for his commodity and underrated its demand for other commodities. Consumers have no use for such a bungling entrepreneur; they buy his products only at prices which make him incur losses, and they force him, if he does not in time correct his mistakes, to go out of business. On the other hand, those entrepreneurs who have better succeeded in anticipating the public demand earn profits and are in a position to expand their business activities. This, says Say, is the truth behind the confused assertions of businessmen that the main difficulty is not in producing but in selling. It would be more appropriate to declare that the first and main problem of business is to produce in the best and cheapest way those commodities which will satisfy the most urgent of the not yet satisfied needs of the public.

Thus Smith and Say demolished the oldest and most naive explanation of the trade cycle as provided by the popular effusions of inefficient traders. True, their achievement was merely negative. They exploded the belief that the recurrence of periods of bad business was caused by a scarcity of money and by a general overproduction. But they did not give us an elaborated theory of the trade cycle. The first explanation of this phenomenon was provided much later by the British Currency School.

The important contributions of Smith and Say were not entirely new and original. The history of economic thought can trace back some essential points of their reasoning to older authors. This in no way detracts from the merits of Smith and Say. They were the first to deal with the issue in a systematic way and to apply their conclusions to the problem of economic depressions. They were therefore also the first against whom the supporters of the spurious popular doctrine directed their violent attacks. Sismondi and Malthus chose Say as the target of passionate volleys when they tried—in vain—to salvage the discredited popular prejudices.

II

Say emerged victoriously from his polemics with Malthus and Sismondi. He proved his case, while his adversaries could not prove theirs. Henceforth, during the whole rest of the nineteenth century, the acknowledgment of the truth contained in Say’s Law was the distinctive mark of an economist. Those authors and politicians who made the alleged scarcity of money responsible for all ills and advocated inflation as the panacea were no longer considered economists but “monetary cranks.”

The struggle between the champions of sound money and the inflationists went on for many decades. But it was no longer considered a controversy between various schools of economists. It was viewed as a conflict between economists and anti-economists, between reasonable men and ignorant zealots. When all civilized countries had adopted the gold standard or the gold-exchange standard, the cause of inflation seemed to be lost forever.

Economics did not content itself with what Smith and Say had taught about the problems involved. It developed an integrated system of theorems which cogently demonstrated the absurdity of the inflationist sophisms. It depicted in detail the inevitable consequences of an increase in the quantity of money in circulation and of credit expansion. It elaborated the monetary or circulation credit theory of the business cycle which clearly showed how the recurrence of depressions of trade is caused by the repeated attempts to “stimulate” business through credit expansion. Thus it conclusively proved that the slump, whose appearance the inflationists attributed to an insufficiency of the supply of money, is on the contrary the necessary outcome of attempts to remove such an alleged scarcity of money through credit expansion.

The economists did not contest the fact that a credit expansion in its initial stage makes business boom. But they pointed out how such a contrived boom must inevitably collapse after a while and produce a general depression. This demonstration could appeal to statesmen intent on promoting the enduring well-being of their nation. It could not influence demagogues who care for nothing but success in the impending election campaign and are not in the least troubled about what will happen the day after tomorrow. But it is precisely such people who have become supreme in the political life of this age of wars and revolutions. In defiance of all the teachings of the economists, inflation and credit expansion have been elevated to the dignity of the first principle of economic policy. Nearly all governments are now committed to reckless spending, and finance their deficits by issuing additional quantities of unredeemable paper money and by boundless credit expansion.

The great economists were harbingers of new ideas. The economic policies they recommended were at variance with the policies practiced by contemporary governments and political parties. As a rule many years, even decades, passed before public opinion accepted the new ideas as propagated by the economists, and before the required corresponding changes in policies were effected.

It was different with the “new economics” of Lord Keynes. The policies he advocated were precisely those which almost all governments, including the British, had already adopted many years before his “General Theory” was published. Keynes was not an innovator and champion of new methods of managing economic affairs. His contribution consisted rather in providing an apparent justification for the policies which were popular with those in power in spite of the fact that all economists viewed them as disastrous. His achievement was a rationalization of the policies already practiced. He was not a “revolutionary,” as some of his adepts called him. The “Keynesian revolution” took place long before Keynes approved of it and fabricated a pseudo-scientific justification for it. What he really did was to write an apology for the prevailing policies of governments.

This explains the quick success of his book. It was greeted enthusiastically by the governments and the ruling political parties. Especially enraptured were a new type of intellectual, the “government economists.” They had had a bad conscience. They were aware of the fact that they were carrying out policies which all economists condemned as contrary to purpose and disastrous. Now they felt relieved. The “new economics” reestablished their moral equilibrium. Today they are no longer ashamed of being the handymen of bad policies. They glorify themselves. They are the prophets of the new creed.

III

The exuberant epithets which these admirers have bestowed upon his work cannot obscure the fact that Keynes did not refute Say’s Law. He rejected it emotionally, but he did not advance a single tenable argument to invalidate its rationale.

Neither did Keynes try to refute by discursive reasoning the teachings of modern economics. He chose to ignore them, that was all. He never found any word of serious criticism against the theorem that increasing the quantity of money cannot effect anything else than, on the one hand, to favor some groups at the expense of other groups, and, on the other hand, to foster capital malinvestment and capital decumulation. He was at a complete loss when it came to advancing any sound argument to demolish the monetary theory of the trade cycle. All he did was to revive the self-contradictory dogmas of the various sects of inflationism. He did not add anything to the empty presumptions of his predecessors, from the old Birmingham School of Little Shilling Men down to Silvio Gesell. He merely translated their sophisms—a hundred times refuted—into the questionable language of mathematical economics. He passed over in silence all the objections which such men as Jevons, Walras and Wicksell— to name only a few—opposed to the effusions of the inflationists.

It is the same with his disciples. They think that calling “those who fail to be moved to admiration of Keynes’s genius” such names as “dullard” or “narrow-minded fanatic”[2] is a substitute for sound economic reasoning. They believe that they have proved their case by dismissing their adversaries as “orthodox” or “neo-classical.” They reveal the utmost ignorance in thinking that their doctrine is correct because it is new.

In fact, inflationism is the oldest of all fallacies. It was very popular long before the days of Smith, Say and Ricardo, against whose teachings the Keynesians cannot advance any other objection than that they are old.

IV

The unprecedented success of Keynesianism is due to the fact that it provides an apparent justification for the “deficit spending” policies of contemporary governments. It is the pseudo-philosophy of those who can think of nothing else than to dissipate the capital accumulated by previous generations.

Yet no effusions of authors however brilliant and sophisticated can alter the perennial economic laws. They are and work and take care of themselves. Notwithstanding all the passionate fulminations of the spokesmen of governments, the inevitable consequences of inflationism and expansionism as depicted by the “orthodox” economists are coming to pass. And then, very late indeed, even simple people will discover that Keynes did not teach us how to perform the “miracle … of turning a stone into bread,”[3] but the not at all miraculous procedure of eating the seed corn.

Footnotes

[1] P. M. Sweezy in The New Economics, Ed. by S. E. Harris, New York, 1947, p. 105.

[2] Professor G. Haberler, Opus cit., p. 161.

[3] Keynes, Opus cit., p. 332.

What does a credit rating mean?

David Howden — Tue, 07 Feb 2012 09:00:10 +0000

Credit ratings agencies have come under fire for not being proactive enough in recognizing bad sovereign risks. Even if the ratings agencies were a little quicker with the downgrades, the result would not be significantly different for investors. This is because there are two paths to default.

Credit ratings agencies exist to measure one thing – the risk that an entity will explicitly default on its obligations. In this regard, ratings agencies by-and-large do fairly well. What they do not do well (nor is it their job), is to assess the risk of the other default, the one by inflation.

Charles Goodhart argues that we can see the distinction if we compare the plights of two countries. England has high debt to GDP levels, yet has retained its rating through the recent downward revisions. France, by comparison, has lower debt levels and was recently downgraded. What gives?

Some would argue, as the ratings agencies do, that France is threatened because she cannot inflate her worries away. The Euro blocks this option, as Paris must succumb to Frankfurt on monetary affairs. England faces no such constraint, or at least, not an insurmountable one. The Bank of England might be nominally independent from Her Majesty’s Government. Yet what the crown gives it can take away. The BoE can be a direct policy arm of parliament if need be. When faced with insolvency, such a course of action is foreseeable.

Inflation (both measured and expected) is already higher in the UK than in France. While the investor buying French debt worries about a small chance at not getting his money back, the buyer of British bonds faces the fact that the bond’s nominal value is continually eroded at a faster rate than his French counterpart.

For the investor, it makes no difference which default occurs. Whether explicitly at a moment through insolvency or slowly through inflation, the effect is the same. Long drawn out tortures can be just as effective as swift death sentences (sometimes more so).

Investors fixated on credit ratings are cognizant of only half the story. Given this, one wonders if the official ratings mean anything at all.

Take the United States, for example. Its recent downgrade brought into question Washington’s ability to pay off its national debt (among other obligations). But that was just making explicit what was already implicit for decades. As inflation ate away at the nominal value of the debt, the country was slowly defaulting by another means.

Some may look at the low interest rates on US Treasuries right now, and argue that the risk of default is low. These investors would likely be correct. One could also argue that interest rates are low because the Fed has been purchasing large quantities of them, and without this intervention rates would signal a much different story. This story is also likely correct. But the latter story is just removing the explicit default risk from the Treasury and giving it to the Fed. The Fed will just buy more bonds from the Treasury to finance the payoff of the existing ones if the threat of default nears. This amounts to default not at the hands of Treasury, not explicitly anyhow. This becomes a Fed-orchestrated default, through the process of inflation.

Rating agencies do investors a great favour by pointing out the explicit default risk of different debt securities. Investors would do well to recognize the limited relevance of these ratings, especially in light of the continual implicit defaults we are exposed to through inflation.

2012 outlook

Sean Corrigan — Mon, 06 Feb 2012 08:00:12 +0000

This time last year, while still bullish out of regard for the effects of the Fed’s latest burst of monetary pharmacology, we had begun to warn that the latter part of 2011 was unlikely to be anywhere near as benign for either market participants or those struggling, far beyond the Bloomberg screens and VaR reports, to make a living in the real world of industry and commerce.

As regular readers will no doubt recall, ever since the cracks started appearing in the last Boom, our guiding theme has been that policy would be driven by a convergence of political expediency, faulty economic reasoning, and a misapprehension of the historical record. This, we said, would inevitably preclude the application of any swift and effective remedy for our ills in favour of a long, drawn-out programme of partial fixes, inappropriate treatments, and mounting shots of stimulus, each more short-lived than the last in its effect on growth and employment; each more rapidly dissolving into an unedifying chorus of complaint as the malign side effects of the inflation affected already-pressured household budgets. As we put it some years back, the imperative to avoid the disaster of 1931-3 would first get us into a mess from which the equally ardent desire not to replicate the ‘mistakes’ of 1937 would make it almost impossible to extract ourselves.

And so it is today, where – almost five years after the first warning tremblors began to shake our debt-mortared Tower of Babel – we are still beset with calls for yet more government borrowing, yet more central bank activism, the better to suppress the natural healing process of thrift in favour of a ruinous policy of enforced speculation and capital exhaustion.

Twelve months ago, it was clear that those emerging market nations whose financial architecture was not too obviously endangered by our Occidental folly, whose fiscal burdens were far less crushing than ours, and whose current accounts were typically in a comfortable surplus – and hence whose reliance on the forbearance of external creditors was minimal – had already pushed the envelope too far. Yes, they had been the engines of growth going into the crisis; yes, their initial, trade-driven slump had been swiftly surmounted on a wave of easy money and state-directed spending; yes, the impetus was such as to power them on to new highs of output and resource use, but the boost had not surprisingly served to raise the cost of living to the point where social unrest was threatened.

Thus, from a programme of full-bore pump-priming, the pendulum had swung toward restraint in China, in Brazil, in India and several other key contributors to global growth. As a result, real M1 (our preferred indicator) went from an incredible 37.5% yoy in China (five full sigmas over the 1996-2009 mean) to barely 2.8% (2.5 sigmas below it) in the space of 20 months. For Brazil, the story was similar: from 15.3% ( 0.8 sigmas over the 14-year, post-hyperinflation mean) to minus 6% (1.8 sigmas under it) in a year. India, too, saw a heavy-footed switch from the gas to the brake, as a 12.6% increase (1 sigma over a 25-year, stationary mean) gave way to an 8% decrease (almost 3 sigmas below it).

Making the transition even more painful in the first of these, was the inevitable bifurcation by which the brunt of the impact was felt by those arguably more entrepreneurial, smaller scale businesses who have to strive to maintain themselves in their niche, largely absent the cosseting of cheap finance and subsidised inputs which their larger, more predatory, State-Owned competitors routinely enjoy.

Nor was the situation eased by the fact that so much credit was being made available – both within and without the putative regulatory framework. As a consequence it appeared much more simple to turn a fast buck by grabbing what funding one could (especially when borrowed via a fake commodity purchase in what appeared to be a perennially depreciating dollar) in order to participate in the ballooning real estate mania, than it did to face the hard grind of safeguarding revenues and preserving profitability in a world of dubious export prospects, laggardly internal demand, and steeply rising costs.

Compounding all this was the great externality which arose firstly from the so-called ‘Arab Spring’, then from the summer’s sponsored insurgence against the Libyan regime, and lastly from the threatened Iranian (nuclear) Winter – namely, the persistently elevated price of oil which, for, say the Germans, has spent the last twelve months at a real level higher than that endured at the peak of the second oil shock and also 12% above 2008′s worst, like-period reading. The estimable Jim Walker of Asianomics refers to this as the GCT – the Global Consumption Tax – a jump in the price of a vital input which therefore constitutes at least a short-term drain on discretionary spending (and, of course, on capital formation) in all those not lucky enough to be wallowing in petrodollars or able easily to borrow them back in these times of straitened credit, in order to make up the budgetary shortfall.

Meanwhile, in Europe, the Pelion upon Ossa of adding the Keynesian burden of counter-cyclical profligacy to the chronic, boomtime self-indulgence of the all bar a few member states finally revealed the hopelessness of what we have previously characterised as the vacuous circle of ailing banks being propped up by overstretched governments who must then borrow the very same rescue funds back from the banks whose future they were supposedly securing.

As the money markets froze and the doors of the foreign exchange market almost clanged shut in their faces, such banks were no longer able to contribute to the sustenance of a rate of real money expansion which had hit what was at least a 30-year high (12.6% yoy; +2.1 sigmas) in the triumphal autumn of 2009 when this newest of New Deals was seemingly proving its worth in forestalling a slip into a slough of prolonged economic despond.

Alas! Since then, it has been a descent from surfeit into dearth. With nominal growth scarcely positive for much of last year – and with prices rising as a consequence of the earlier, near-universal laxity of fiscal and monetary settings around the globe – the score for the past few quarters has been in the negative column (-2%-plus; -1.6 sigmas) and the hopes of escaping with only a light penance in absolution of the sins of the Noughties have crumbled, turning much of the Continent into drear shadowland filled with weeping and wailing and gnashing of teeth.

At the height of the sugar-rush asset markets of last Spring, it was widely assumed that risks would be minimal. Not only did the Herd presume that the Fed stood ready to relight the blue touchpaper the minute the US economy sputtered, but the all-seeing Chinese mandarins were well on the way to engineering that most fabulous of economic happenings, the Soft Landing, too. Greece was meanwhile NOT going to trigger any CDS-inspired chaos and, besides, Portugal had just been approved for its bailout and the EU commissariat had proposed an expansion of the EFSF’s capabilities to no less than €440 billion (albeit over the dead bodies of certain Finnish and Slovak politicians, not to mention the impending professional hara-kiri of one or two Bundesbankers).

Sad to relate, this was just about the point when the metaphorical rats which carried the latter-day Black Death to sovereign Europe repeated the course of their historical antecedents and jumped the Aegean-hailing ship to swim ashore at Genoa. As Italy’s finances came under closer scrutiny, all manner of chaos was unleashed – euro-dollar basis swaps plunged to negative triple figures; OIS-Libor and vanilla swap spreads began to climb; risk reversals plummeted; the floor fell out from beneath the equity market, and the euro itself spun out to an 8-year low.

Meanwhile, the intra-Eurozone TARGET2 balances which record transfers being conducted between the system’s national central banks – who, by extension, are thus acting to provide an intermediating ‘credit wrap’ between those commercial banks of net surplus and net deficit countries who will no longer deal with each other directly – began to soar, with Germany and the Netherlands seeing their combined net creditor position mount €260 billion in the second half of 2011, while Spain and Italy’s combined net debt increased by €310 billion.

In Asia, meanwhile, the PBOC stuck to its guns, forcing banks to consolidate many of their ‘shadow’, reg-arb loans back on to their balance sheets where they would become subject to all of a heightened reserve requirement, a stricter enforcement of loan:deposit ratio ceilings, and to capital adequacy provisions. Backed up with other, bureaucratic restrictions imposed on the property market – as well as a severe cutback in other forms of infrastructure spending, such as that undertaken by the heavily-indebted and widely-criticised Railway Ministry, the China bears were soon having what looked like a well-deserved field day, as trade flows and industrial output around the entire global boiler-room began to slacken.

The stock market, for one, reacted by shedding a third of its value to home in on three-year lows and to stand briefly no higher than it did way back in early 2007 – another harsh reminder that the generation of even the most impressive series of GDP reports says little or nothing about returns on capital, much less the level of the equity prices which supposedly reflect them.

We are on record as being highly sceptical of the Chinese ‘miracle’ – how could an Austrian not look askance at this highly corrupted, semi-command economy, with its dysfunctional markets for goods, resources, capital, and currency? But we are also realistic – or resigned – enough to understand that ‘there is a lot of ruin in a country’ and to warn our fellow pessimists that, at least while the capital account remains largely closed off, China has a great deal of room to move losses from one balance sheet to another, and to seek out new media through which to direct the wealth and energy of its people in the wasteful pursuit of gigantism and in the false worship of the Keynesian cargo-cult of consumption at any price.

Given the vast sums at stake, it could even be that China moves to avert a nasty, decidedly non-linear episode in the wake of its imploding property bubble by seeking to reinflate that same excess directly. However, in light of the decidedly adverse political calculus associated with such a move – not to mention the perilous reinforcement of moral hazard it would entail – we would rather bet on them finding some other vehicle through which to enact any coming ‘stimulus’ – a windmill for every household, a horizontal gas rig for every acre of scrubland, and a domestic appliance voucher boondoggle for every SOE, perhaps.

Here again, the room for reversal is greater than it was last year when the land resounded to the anger of those who felt cheated by the system and who chafed at the ubiquitous evidence of Party-generated self-enrichment and privilege, an inequity whose contrast was even more strongly drawn by the experience of their own dwindling standards of living. The subsequent easing of price pressures has given the authorities a certain leeway within which to tack, when they so require – and that sea-room may be even more enlarged if the economic correction takes on a momentum of its own, as we suspect it yet might. Moreover, if the next wave of handouts takes the form of personal tax breaks, greater welfare spending, a higher SOE payroll outlay, and a programme of subsidies aimed at individuals and not at the behemoth producers, as before, public outrage may be sufficiently mollified to ensure a relatively calm hand over of power, later in the year.

Easing, then, may not be as promiscuous nor as swiftly undertaken as the Bulls might wish, nor will the interregnum between the new bubble and the old be entirely without drama for China and her satellites, but we doubt the ruling elite is yet ready to relinquish the Mandate of Heaven and the forced expansion which they deem essential to its maintenance.

Though far from clairvoyant last year, our analysis turned out largely for the best, not least in our estimation that while the notorious ‘Bernanke Put’ had not been cancelled, it did lie a great deal further out of the money than the Pollyannas had been expecting. Under assault from both left and right – pincered between the ‘Occupy’ movement and the Tea Party – the Fed could no longer fend off criticism that it was only enriching the plutocratic Few at the expense of the make-ends-meet masses of plumbers and plasterers.

Having dissipated a good deal of its credibility through its laughable attempts to pretend that it had had nothing to do with the rising price of everyday goods and services – or, conversely, that rising energy prices constituted a veritable economic boon by dint of their role in reducing real interest rates – it was then left thoroughly red-faced when the NY Fed’s latest in a long line of well-heeled, reverse-amakudari, William Dudley, tried to defend the institution’s record with a failed attempt at emulating Marie Antoinette, only to be told dismissively that no-one can eat an iPad, no matter how hedonically cheapened it might have become at the hands of the BLS statistical manipulators.

Thus, though he has long been itching to do more, the Fed Chairman has spent much of the past six months hemmed in by opposition emanating from both within and without his committee rooms, to the point where all he could do in the interim was pledge to keep near-zero rates for some unconscionable time hence while messing about with the maturity of his vast portfolio of securities in the hope of shaving a few extra basis points off the long end.

Ironically, however, his own forced inaction seems to have coincided with the first signs for some good while of a monetary inflation not being fuelled by the central bank itself. After a brief pause in the late summer, the past few months have seen a marked reacceleration of the aggregates in the US. This has come about to the accompaniment of a partial utilisation of some of that mountain of excess reserves of which the banks dispose with the result that there has been a more ready extension of credit to business and a greater take up of its paper, as well as of that of the GSEs. Domestic banks in America – if not, understandably their foreign-domiciled competitors – seem to have been doing Blackhawk Ben’s work for him in recent months, even as Corporate America has been restocking and taking a last-minute advantage of the tax breaks temporarily afforded to those making below-the-line outlays on plant and equipment.

However we look at this, with CPI no longer rising steeply, these past few months, and with the YOY comparison about to made with a quarter which saw the third fastest burst in a decade, our noble Chairman – and his packed council of Ueber-doves – will have a good deal more room for manoeuvre should the economy stutter this time, especially since he has been careful to trail the idea that any prospective easing would be aimed at relieving the sufferings of those still trapped in a moribund residential property market on Main Street rather than those fretting on a bonus on Wall Street. Nor would the present occupant of 1600 Pennsylvania Avenue be likely to raise too many objections were an injection made around the vernal equinox come to produce the maximum feelgood factor by the time the autumnal one arrived.

All this leads us to believe that though the US economy is arguably the one least in need of any further monetary amphetamine at present, its central bank stands far more ready, willing, and – critically – able to provide one than at any time since the Fall of 2010. Phrased another way, the ‘Bernanke Put’ whose activation proved so disappointingly absent during last year’s retreat, may lie a good deal closer to the money now than it did when things turned sour last year.

In Europe, too, there is a sense that headline fatigue has set in – that the only sort of surprise from Greece that has not long since been discounted is a good one. Thus, on the somewhat incautious proviso that no new outbreak of financial Ebola occurs, the market may persist awhile in its willingness to sieve through a still-growing, mountainous ore of despair, in search of the few gleaming nuggets of hope it contains.

Moreover, there is some chance that the scale of the last LTRO – coupled with the alleviation afforded by the Fed’s $100 billion-odd of dollar swaps – was finally sufficient to overcome the attrition felt earlier in the year when many of the ECB’s actions were simply substitutional – i.e., when its intercession via TARGET, its government bond purchases, and its repo finance were more about sticking fingers in the leaking dyke of interbank credit than they were about channelling a new flood of employable liquidity between the levees.

We will not know for sure until we see the data for January, but the fact that most of the stress indicators we mentioned above have backed off appreciably (and have not yet, as we write, been too aggravated by the renewed focus on Portugal), together with the fact that European yield curves have undergone a bullish steepening, certainly points in that direction.

Moreover, one suspects that the seeming apotheosis of Hausfrau Merkel’s starkly uncomplicated version of haute finance might just turn out to be a Pyrrhic victory as far as the continent’s fast-dwindling band of hard money men is concerned in that the immediate and tangible inflationary quid for the delayed and highly-contingent pro quo of budgetary rectitude might well be a successfully renewed push for more overt ECB involvement as a monetary counterweight to the theoretical fiscal austerity to come. What our German friends hope one day to gain on the swings may well turn out to have long since been lost on the intervening swirl of the roundabout.

The last few days of February will be critical to this assessment, since we will then receive the first hard evidence of just what it was that the first massive LTRO actually achieved, with this clarification arriving not too far in advance of the implementation of a follow-up operation already subject to a good deal of hyperbole about exactly how gargantuan in scale it might be turn out to be.

The upshot of all this is that we stand uneasily at something of a watershed: the economic data seem to be worsening everywhere bar the US as an inescapable consequence of the lesser degree of monetary ease which has prevailed of late in most of the major centres, but, despite this, we are all trying to whistle bravely past this particular graveyard of deterioration in the hope of the inflationary resurrection we believe will shortly come.

For now, the same people who were shaken rudely out of the bullish complacency of the front half of 2011 and into the stomach-churning round of long liquidation of the back half seem eager to be back in the game. After all, it is doubly hard to justify being on the sidelines when markets rally and when the returns to either prudence or pusillanimity (depending upon your vantage point) are zero nominal, negative real.

Not only are equity and bond markets responding to this stirring, with more participants being pulled in on each tick higher, but commodities, too, are rising despite the arrival of the annual purdah of fundamental news associated with the Lunar New Year. New positions are being built in metals; stale, largely geopolitical longs in energy are happy to cling on awhile; gold is responding once more to an inflationary thrust of policy which has seen as many dollars added to the balance sheets of the Big Five central banks in three years as would serve to pay for seven-tenths of all the bullion mined in the past three millennia.

To the extent that we have little positive to say about the prospects for genuine economic healing and recovery we can argue that this is already premature, but to the greater extent that such anaemia will only induce the quack doctors to administer a further, larger does of intravenous monetary poison, we could conversely argue that the party may have only just begun.

Having been up and down this roller-coaster of stop-go, stimulus-stasis three times already since the Fed’s first discount rate cut in 2007, it is difficult to ignore the presentiment that we are about to embark upon a fourth. Nor, being of the Austrian persuasion, is it hard to imagine that this next burst of treating symptoms and ignoring causes will prove similarly unavailing in terms of providing a final resolution of our self-inflicted ills.

If we additionally concede that even the most mule-headed Blue Skyer is susceptible of a little Pavlovian conditioning (even if we doubt his ability to draw the correct conclusion by any less painful means), we must also expect that this coming round will deliver less short-term growth, at a higher cost in price inflation, more quickly after its inception. One must follow this reasoning through to the prognosis that the rush for the exits when the next local maximum is deemed to have arrived will be equally less reluctantly embarked upon and hence that the inevitable downleg beyond it will be potentially even more violent that the one from which we have only recently emerged. Wash, rinse, repeat – und so weiter und so fort.

Hysteresis is the watchword, then, so enjoy the boomlet while it lasts but be ever ready to try to preserve what fleeting gains you can when the euphoria gives way to a funk, once more. Remember, too, that such a stagflationary trajectory is a meat-grinder for the guardians of capital and a spirit-sapper for the entrepreneurs on whom they and we ultimately rely. Only those who best serve Leviathan are likely to prosper in this Vale of Tears until the day dawns when we at last steel ourselves to break free from a repeated round of economic error and political poltroonery which has got us precisely nowhere, for all the plaintive bleatings of the biens pensants who insist that no possible alternative exists.

Gold and silver price shakeout

Alasdair Macleod — Sun, 05 Feb 2012 12:15:28 +0000

The consolidation of gold’s bull phase from October 2008 to the peak last September was a classic three-leg correction: an initial slide, rally, and final sell-off. Silver followed a similar but more violent pattern. The psychology was there too, with the final sell-off convincing many investors the game was finally over.

Those who sold will most probably be kicking themselves. Consolidations that break established trends, such as 200-day moving averages, shake out weak holders who will buy again higher up when they are more confident. The big traders in the futures market know this: your losses are simply their gains. And as a result both gold and silver are on a far sounder footing with these weak holders out of the way. It is lethal for your savings to play this game. Instead it is more sensible to understand what is happening in simple economic terms. To do this you must turn your normal thinking upside down, and realise that what is happening to precious metals prices is only a reflection of what is actually happening to paper money.

Put simply, governments all over the world are debasing their paper monies at an accelerating rate. Printing euros to rescue the banks has been in the headlines, but this process has only just begun. America, which has to be the focus of monetary attention, is committed to zero interest rates for the next three years, which is unprecedented. The result is that the price of gold has been left behind by exceptional monetary events. You can see this clearly in the chart below.

This chart shows US dollar True Money Supply (cash, instant deposits and checking accounts plus a few other minor cash balances) expressed in official gold reserves held at the US Treasury. This has soared over the years, and we can expect it to accelerate further from December’s figure of $31,600 per ounce of gold. Meanwhile, the percentage of TMS actually backed by gold stood at 4.8% at the year-end, and this is shown by the blue line.

The chart clearly shows that while gold has risen dramatically over the last decade in nominal dollar terms, adjusted for the extra money in the system it has only risen 150%. Amazingly, the price of gold measured in these TMS terms has only risen to where it was in late 1991, when the nominal price was $360. Gold’s valuation is therefore still at exceptionally low levels.

The sense of perspective charts like this imparts is vital for understanding the dangers from the tsunami of paper money and debt. Conventional portfolio managers have missed this point entirely, being hampered by the legacies of portfolio management theory and Keynesian economics. But there is a growing band of private individuals around the world who do get it and are accumulating physical gold and silver. They are beginning to understand that paper money is falling rather than gold and silver rising.

The message is if you think like an investor, you will probably lose your investment. Be aware of what is happening to paper money and you probably won’t.

This article was previously published at GoldMoney.com.

Aggregate nonsense

Detlev Schlichter — Sat, 04 Feb 2012 11:00:59 +0000

The economic policy debate is dominated by wishful thinking and fallacies of the most dangerous kind, propagated no less by the high and mighty in the policy bureaucracy and the alleged experts in the media.

Here is my point, and every clear-thinking person already knows it: That economic growth, and thus recovery from the crisis, will come about through the actions of governments is complete and utter nonsense. It is an illusion to assume that running budget deficits and printing lots of money and manipulating prices will make the economy better. Nevertheless, this fantasy is being reflexively regurgitated ad nauseam in countless reports and ‘analyses’ in the media so that nobody really bothers thinking about it anymore. A large part of the public seems to have been numbed into passively accepting it as the truth.

Since 2007, various governments have been engaged in Keynesian deficit spending and Monetarist money printing of unprecedented proportions. If the stupid ‘theories’ behind these policies had any merit, the world economy would be booming right now. It isn’t. Go figure!

Thank you, government, for all the growth!

Earlier this week the Wall Street Journal Europe had this to report about the Eurozone debt crisis:

“Some analysts also say the [fiscal consolidation] pact biases the euro zone toward recession. Not only does it limit governments’ ability to use budgetary policy to avert an economic downturn, but the long-term requirement to lower government debt would make it harder for nations with high debts, such as Italy, to grow their way out of their problems.”

[In fairness to the WSJE, the authors of the article may not share these views. But the ‘analysts’ who hold these views certainly exist, we know who they are, and they are actually quite numerous.]

So, here we have it. Public spending and deficits help the economy grow faster. By allowing our governments to constantly spend money they don’t have we all get more prosperous. — But how does that work? What is the evidence for this? Countries with massive government spending, big deficits and lots of debt are hardly booming, are they? In fact, these are the basket case economies. Is their problem maybe that they have not run large enough deficits in the past to stimulate their economies more?

The following statement is so absurd that it deserves repeating:

“The long-term requirement to lower government debt would make it harder for nations with high debts, such as Italy, to grow their way out of their problems.”

Italy has a debt problem. But if Italy was only allowed/encouraged/enabled to run even larger deficits, the deficits would then create growth, and this growth would automatically raise tax receipts and this would pay for the extra debt-load taken on to create the growth. Wonderful. Government deficits are obviously self-financing. They create growth that then pays off the debt, and not only the new debt but also the old debt, because only then would you “grow out of your problem”. The only question is how these governments could have piled up all this debt in the first place if their deficit spending was self-funding?

The idiocy behind these ideas knows no bounds, and the newspapers are full of such hogwash. That is why it is so refreshing when you occasionally get a chance to speak to sensible people.

The other day, I was discussing the economic crisis during a cab ride with the taxi driver. “I don’t get this,” he volunteered on the topic of the government saving us, without much prompting on my part, “so the government hires someone at £70,000 a year and is collecting £30,000 in taxes from him. Who pays the difference? How does that help the economy?”

To give credit to my cabdriver it has to be said that he probably has not undergone the extensive economic education that our economic experts have benefitted from. He had not had his common sense sapped out him by learning about magical multipliers, doing economic equations, and running complex econometric regression analyses. He is a practicing capitalist who is independent, has kept an independent mind, and who knows a thing or two about balancing the books, serving the paying public and running a business.

“Of course,” our economic experts will say, “this is all so very different, once you transport it into the complexity of the modern economy.”

No, it isn’t.

Fiscal death trap

Let’s look at a large and complex economy. The US economy is by far the largest in the world. The US Treasury and the US Federal Reserve hardly ever come under criticism from the Keynesian commentariat. Why? Because the US is conducting one gigantic Keynesian ‘stimulus’ experiment that is positively Krugmanesque in its dimensions. For years on end, the US government has been spending money like a drunken sailor, and the Fed is widely known, correctly me thinks, as a passionate QEer. In short, there is a lot of pro-growth policy going on in Washington.

Here is a very rough back-of-the envelope calculation: Economic growth in the US was 1.6% for the year 2011, when measured quarter over quarter (i.e. Q4/2011 versus Q4/2010). In a roughly $15 trillion p.a. economy that means an extra $240 billion in goods and services were produced by US companies and US individuals in 2011 compared to 2010. That is the extra growth, the extra economic activity.

Over the same time, the US government ran a budget deficit of $1,500 billion, and the Fed printed money to the tune of $600 billion, a growth-rate in the monetary base of almost 30 percent.

The US government is running 10% of GDP deficits to ‘stimulate’ 1.6% of growth. This is not only absurd it is certainly not self-financing. Debt is accumulating much faster than the economy is growing.

Is this how the ‘analysts’ imagine a country “grows its way out of problems”? Is this what Italy, Spain and Greece should do? (As an aside, as a percent of GDP, the Greek deficit and the US deficit are almost identical.)

The reality is that the US government is piling ever more problems onto its economy with these policies. The U.S. government is a hindrance to wealth and prosperity.

And for those who still believe the old folklore that it was exactly this type of policy that got us out of the Great Depression, consider this quote from FDR’s Treasury of the Secretary, Henry Morgenthau, spoken in the early 1940s:

“We have tried spending money. We are spending more than we have ever spent before and it does not work. . . . After eight years of this administration we have just as much unemployment as when we started . . . and an enormous debt to boot!”

Without the recent binge-spending the official statistics may well have shown an economic contraction in 2011. So what? At least that would have provided a realistic picture of what is going on on the ground in the US economy rather than provide some pathetic charade that is supposed to fool the public into believing we are in a recovery.

If the state stepped out of the way and allowed the liquidation of the accumulated imbalances, and allowed the private sector to get on with rebuilding the economy, we would already be in better shape. Present policies pile more debt on an already debt-laden economy; they obstruct the cleansing of the economy of misallocated capital and fictitious ‘wealth’, and introduce new misallocations of resources.

Aggregate demand, baby, aggregate demand!

All this nonsense is conducted in the name of “aggregate demand”. This concept itself is a coarse trivialization of economic reality. The economy is not about aggregate demand but always about specific demand, and the specific activities that are needed to satisfy that demand.

The economy is a tool. It is a tool for all of us who participate in it to improve our provision with material things by mixing our labour with that of countless other people in an extensive division-of-labour economy and with the accumulated capital stock in that economy. We get wealthier by combining our efforts with others in precisely the way that produces exactly the goods we want at the prices we are willing to pay for them, and we earn the income to afford these goods by participating in their production. If that sounds complex, it does because it is.

For this process to work, it requires an undisturbed market and free price formation (and that includes interest rates!), and it needs entrepreneurs and capitalists who constantly look out for new opportunities to combine capital and labour in new ways. Everything about this is specific.

But to those who keep babbling on about “aggregate demand” such complexities count for nothing. The economy can, in their view, be conveniently squeezed into a number of statistical aggregates, which can then be manipulated by government intervention. In a way, they consider the economy to be like a receptacle that can contain and should contain a certain amount of ‘economic activity’ at each moment in time, and if some ‘activity’ drops out of that bucket (because the private sector, at least momentarily, discontinues this activity) then the difference has to be made up by government activity of some sort.

In this concept, one activity is as good as any other. The drop in activity in the housing market (because a bubble, which had been inflated by state fiat money, finally burst) can be offset with the activity of the government building another road or spending more money on a war. It all neatly goes into GDP statistics – whether it is what people really want or not. It is the aggregate that matters.

Bad advice

In the meantime, over at the IMF, the Keynesian policy road show continues. The joy of constant debt accumulation and monetary debasement must be spread to every corner of the global economy. Asian growth, so says the IMF, has been resilient but with the international bureaucracy and the central banks already working hard at intensifying and prolonging the crisis, it is only a question of time until Asia will wobble, too. What, then? – More pro-growth policy of course:

“In the event of a further slowdown in the global economy, our sense is that most economies in Asia have room for a strong policy response,” said Anoop Singh, director of the IMF’s Asia and Pacific Department.

China and many export-dependent economies in the region could loosen fiscal policy, while Japan’s central bank could boost its asset purchases, he said, adding that efforts to trim external surpluses would reduce exposure to outside risks and support global growth.”

Thanks, Anoop, great advice. More debt and more paper money – prosperity through government policy knows no limits!

The IMF should, of course, be dissolved immediately. As a friend of mine, who worked for that institution for a number of years, observed: “The IMF only serves one group of people: those who work for it.”

And if you want to discuss the economy, you better do it with a London cabdriver than with anyone from the IMF.

In the meantime, the debasement of paper money continues.

What the classical economists knew and the moderns have forgotten – part 2

Toby Baxendale — Fri, 03 Feb 2012 11:00:00 +0000

On Wednesday, I talked about the forgotten wisdom embodied in Say’s Law. Today, we reprint the chapter called “Keynes vs. Say’s Law” from Henry Hazlitt’s The Failure of the “New Economics” which is a quick read and sheds more light on what the classical economists did and did not think with regards to Say’s law, whilst exposing some very poor scholarship from Keynes and revealing a startling contradiction in his work.

This is very relevant to today, when we have shops and factories stuffed full of goods that they can’t sell. This is a situation generally called a recession whose cure, according to conventional wisdom, is more Keynesian style spending, be it by way of deficit spending, increased taxation and spending, or the minting up of new money and spending.

A full copy of Hazlitt’s book can be downloaded here (with thanks to our friends at Mises.org).

KEYNES vs. SAY’S LAW

1. Keynes’s “Greatest Achievement”

We come now to Keynes’s famous ”refutation” of Say’s Law of Markets. All that it is necessary to say about this ”refutation” has already been said by Benjamin M. Anderson, Jr.,[1] and Ludwig von Mises.[2] Keynes himself takes the matter so cavalierly that all he requires to “refute” Say’s Law to his own satisfaction is less than four pages.

Yet some of his admirers regard this as alone securing his title to fame:

Historians fifty years from now may record that Keynes’ greatest achievement was the liberation of Anglo-American economics from a tyrannical dogma, and they may even conclude that this was essentially a work of negation unmatched by comparable positive achievements. Even, however, if Keynes were to receive credit for nothing else . . . his title to fame would be secure .. . [Yet] the Keynesian attacks, though they appear to be directed against a variety of specific theories, all fall to the ground if the validity of Say’s Law is assumed.[3]

I think I am justified, therefore, in devoting a special chapter to the subject.

It is important to realize, to begin with, as Mises [4] has pointed out, that what is called Say’s Law was not originally designed as an integral part of classical economics but as a preliminary—as a refutation of a fallacy that long preceded the development of economics as a recognized special branch of knowledge. Whenever business was bad, the average merchant had two explanations at hand: the evil was caused by a scarcity of money and by general overproduction. Adam Smith, in a famous passage in The Wealth of Nations [5] exploded the first of these myths. Say devoted himself to a refutation of the second.

For a modern statement of Say’s Law, I turn to B. M. Anderson:

“The central theoretical issue involved in the problem of postwar economic adjustment, and in the problem of full employment in the postwar period, is the issue between the equilibrium doctrine and the purchasing power doctrine.

Those who advocate vast governmental expenditures and deficit financing after the war as the only means of getting full employment, separate production and purchasing power sharply. Purchasing power must be kept above production if production is to expand, in their view. If purchasing power falls off, production will fall off.

The prevailing view among economists, on the other hand, has long been that purchasing power grows out of production. The great producing countries are the great consuming countries. The twentieth-century world consumes vastly more than the eighteenth-century world because it produces vastly more. Supply of wheat gives rise to demand for automobiles, silks, shoes, cotton goods, and other things that the wheat producer wants. Supply of shoes gives rise to demand for wheat, for silks, for automobiles, and for other things that the shoe producer wants. Supply and demand in the aggregate are thus not merely equal, but they are identical, since every commodity may be looked upon either as supply of its own kind or as demand for other things. But this doctrine is subject to the great qualification that the proportions must be right; that there must be equilibrium.” [6]

Keynes’s “refutation” of Say’s Law consists in simply ignoring this qualification.

He takes as his first target a passage from John Stuart Mill:

“What constitutes the means of payment for commodities is simply commodities. Each person’s means of paying for the production of other people consist of those which he himself possesses. All sellers are inevitably, and by the meaning of the word, buyers. Could we suddenly double the productive powers of the country, we should double the supply of commodities in every market; but we should, by the same stroke, double the purchasing power. Everybody would bring a double demand as well as supply; everybody would be able to buy twice as much, because every one would have twice as much to offer in exchange.” [7]

By itself, this passage from Mill, as B. M. Anderson [8] has pointed out, does not present the essentials of the modern version of Say’s Law:

“If we doubled the productive power of the country, we should not double the supply of commodities in every market, and if we did, we should not clear the markets of the double supply in every market. If we doubled the supply in the salt market, for example, we should have an appalling glut of salt. The great increases would come in the items where demand is elastic. We should change very radically the proportions in which we produced commodities.”

But as Anderson goes on to point out, it is unfair to Mill to take this brief passage out of its context and present it as if it were the heart of Say’s Law. If Keynes had quoted only the three sentences immediately following, he would have introduced us to the conception of balance and proportion and equilibrium which is the heart of the doctrine—a conception which Keynes nowhere considers in his General Theory.

Mill’s next few lines, immediately following the passage torn from its context, quoted above, are as follows:

“It is probable, indeed, that there would now be a superfluity of certain things. Although the community would willingly double its aggregate consumption, it may already have as much as it desires of some commodities, and it may prefer to do more than double its consumption of others, or to exercise its increased purchasing power on some new thing. If so, the supply will adapt itself accordingly, and the values of things will continue to conform to their cost of production.”

The doctrine that supply creates its own demand, in other words, is based on the assumption that a proper equilibrium exists among the different kinds of production, and among prices of different products and services. And it of course assumes proper relationships between prices and costs, between prices and wage-rates. It assumes the existence of competition and free and fluid markets by which these proportions, price relations, and other equilibria will be brought about.

No important economist, to my knowledge, ever made the absurd assumption (of which Keynes by implication accuses the whole classical school) that thanks to Say’s Law depressions and unemployment were impossible, and that everything produced would automatically find a ready market at a profitable price. Say’s Law, to repeat, was, contrary to the assertions of the Keynesians, not the cornerstone on which the great edifice of the positive doctrines of the classical economists was based. It was itself merely a refutation of an absurd belief prevailing prior to its formulation.

To resume the quotation from Mill:

“At any rate, it is a sheer absurdity that all things should fall in value, and that all producers should, in consequence, be insufficiently remunerated. If values remain the same, what becomes of prices is immaterial, since the remuneration of producers does not depend on how much money, but on how much of consumable articles, they obtain for their goods. Besides, money is a commodity; and if all commodities are supposed to be doubled in quantity, we must suppose money to be doubled too, and then prices would no more fall than values would.”

In sum, Say’s Law was merely the denial of the possibility of a general overproduction of all goods and services.

If you had presented the classical economists with “the Keynesian case”—if you had asked them, in other words, what they thought would happen in the event of a fall in the price of commodities, if money wage-rates, as a result of union monopoly protected and insured by law, remained rigid or rising—they would have undoubtedly replied that sufficient markets could not be found for goods produced at such economically unjustified costs of production and that great and prolonged unemployment would result. Certainly this is what any modern subjective-value theorist would reply.

2. Ricardo’s Statement

We might rest the case here. But such a hullabaloo has been raised about Keynes’s alleged “refutation” of Say’s Law that it seems desirable to pursue the subject further. One writer [9] has distinguished “the four essential meanings of Say’s Law, as developed by Say and, more fully, by [James] Mill and Ricardo.” It may be profitable to take her formulation as a basis of discussion. The four meanings as she phrases them are:

(1) Supply creates its own demand; hence, aggregate overproduction or a ”general glut” is impossible.

(2) Since goods exchange against goods, money is but a “veil” and plays no independent role.

(3) In the case of partial overproduction, which necessarily implies a balancing underproduction elsewhere, equilibrium is restored by competition, that is, by the price mechanism and the mobility of capital.

(4) Because aggregate demand and supply are necessarily equal, and because of the equilibrating mechanism, output can be increased indefinitely and the accumulation of capital proceed without limit.

I shall contend that of these four versions, 1, 3 and 4 are correct, properly interpreted and understood; that only version 2 is false as stated, and that even this is capable of being stated in a form that is correct.

Now Ricardo clearly stated the doctrine in versions 1, 3, and 4; and though he implied it also in version 2, his statement even of this can be interpreted in a sense that would be correct:

“M. Say has . . . most satisfactorily shown that there is no amount of capital which may not be employed in a country, because a demand is only limited by production. No man produces but with a view to consume or sell, and he never sells but with an intention to purchase some other commodity, which may be immediately useful to him, or which may contribute to future production. By producing, then, he necessarily becomes either the consumer of his own goods, or the purchaser and consumer of the goods of some other person. It is not to be supposed that he should, for any length of time, be ill-informed of the commodities which he can most advantageously produce, to attain the object which he has in view, namely, the possession of other goods; and, therefore, it is not probable that he will continually produce a commodity for which there is no demand.

There cannot, then, be accumulated in a country any amount of capital which cannot be employed productively until wages rise so high in consequence of the rise of necessaries, and so little consequently remains for the profits of stock, that the motive for accumulation ceases. While the profits of stock are high, men will have a motive to accumulate. Whilst a man has any wished-for gratification unsupplied, he will have a demand for more commodities; and it will be an effectual demand while he has any new value to offer in exchange for them. . . .

Productions are always bought by productions, or by services; money is only the medium by which the exchange is effected. Too much of a particular commodity may be produced, of which there may be such a glut in the market as not to repay the capital expended on it; but this cannot be the case with respect to all commodities.” [10]

The italics above are my own, intended to bring out the fact that Ricardo by no means denied the possibility of gluts, but merely of their indefinite prolongation.[11] In his Notes on Malthus, in fact, Ricardo wrote:

“Mistakes may be made, and commodities not suited to the demand may be produced—of these there may be a glut; they may not sell at their usual price; but then this is owing to the mistake, and not to the want of demand for productions.” [12]

The whole of Ricardo’s comment on this phase of Malthus’s thought will repay study. “I have been thus particular in examining this question [Say's Law]/’ wrote Ricardo, “as it forms by far the most important topic of discussion in Mr. Malthus’ work.” [13] i.e., Malthus’s Principles of Political Economy.

It was Malthus who, in 1820, more than a century before Keynes, set himself to “refuting” Say’s Law. Ricardo’s answer (most of which was not discovered or available until recent years) is devastating. If it had been earlier available in full, it would have buried Malthus’s fallacious “refutation” forever. Even as it was, it prevented its exhumation until Keynes’s time.

Ricardo’s answer was, it is true, weak or incomplete at certain points. Thus he did not address himself to the problem of what happens in a crisis of confidence, when for a time even the commodities that are relatively underproduced may not sell at existing price levels, because consumers, even though they have the purchasing power and the desire to buy those commodities, do not trust existing prices and expect them to go still lower. But the basic truth of Say’s Law (and Say’s Law was only intended as a basic or ultimate truth) is not invalidated but merely concealed by a temporary abnormal situation of this kind. This situation is possible only in those periods when a substantial number of consumers and businessmen remain unconvinced that “bottom” has been reached in wages and prices, or feel that their job or solvency may still be in danger. And this is likely to happen precisely when wage-rates are artificially forced or held above the equilibrium level of marginal labor productivity.

Again, it is true that Ricardo declares at one point (already quoted) that “Money is only the medium by which the exchange is effected.” If this is interpreted to mean, as Bernice Shoul interprets it, that money “plays no independent role,” then of course it is not true. But if it is interpreted to mean: “If we, for the moment, abstract from money, we can see that in the ultimate analysis goods exchange against goods,” then it is both true and methodologically valid.

Having recognized this truth, of course, we must in the solution of any dynamic problem put money back into our equation or “model” and recognize that in the modern world the exchange of goods is practically always through the medium of money, and that the interrelationship of goods and money-prices must be right for Say’s Law to be valid. But this is merely to return to the qualification of correct price relationships and equilibrium that has always been implicit in the statement of Say’s Law by the leading classical economists.

3. The Answer of Haberler

Before leaving this subject it may be important to address ourselves to some of the confusions about it, not of Keynes himself, but of the “post-Keynesians.” Prof. Gottfried Haberler has been by no means uncritical of Keynes [14], but his discussion of Keynes’s discussion of Say’s Law is peculiar. He presents part of the quotation I have already presented from Ricardo (on pp. 37-38) but does so in truncated form, and ends with the sentence: “Money is only the medium by which the exchange is effected.” He then declares: “The meaning of this original formulation of this law seems to me quite clear: It states that income received is always spent on consumption or investment; in other words, money is never hoarded. . . .” [15]

Now the meaning of Ricardo’s formulation of Say’s Law is already quite clear, particularly when it is given in full. It does not require any exegesis by Haberler or anyone else, and certainly no paraphrase that quite changes its meaning. Not only did Ricardo never explicitly assert the proposition that Haberler attributes to him; there is every reason to suppose that he would have repudiated it. At several points he actually describes what we today might call money hoarding and its effects. At many points in his Notes on Malthus he writes, regarding some view that Malthus attributes to him: “Where did I ever say this?” [16]. We may be confident that he would have written the same regarding this Haberler “interpretation.”

“Our conclusion, thus [Haberler goes on] is that there is no place and no need for Say’s Law in modern economic theory and that it has been completely abandoned by neo-classical economists in their actual theoretical and practical work on money and the business cycle. . . . Summing up, we may say that there was no need for Keynes to rid neo-classical economics of Say’s Law in the original, straightforward sense, for it had been completely abandoned long ago.” [17]

The short answer to this is that there is still need and place to assert Say’s Law whenever anybody is foolish enough to deny it. It is itself, to repeat, essentially a negative rather than a positive proposition. It is essentially a rejection of a fallacy. It states that a general overproduction of all commodities is not possible. And that is all, basically, that it is intended to assert.

Haberler is right insofar as he denies the belief of Keynes (and such disciples as Sweezy) that Say’s Law “still underlies the whole classical theory, which would collapse without it” (General Theory, p. 19). It is true that Say’s Law is not explicitly needed in the solution of specific economic problems if its truth is tacitly taken for granted. Mathematicians seldom stop to assert that two and two do not make five. They do not explicitly build elaborate solutions of complicated problems upon this negative truth. But when someone asserts that two and two make five, or that an existing depression is the result of a general overproduction of everything, it is necessary to remind him of the error.

There is still another line of attack on Say’s Law, which Haberler among others seems to adopt, and this is to assert that in the sense in which Say’s Law is true it is “mere tautology.” If it is tautological, it is so in the same sense in which basic logical and mathematical propositions are tautological: “Things that are equal to the same thing are equal to each other.” One does not need to say this as long as one does not forget it.

To sum up, Keynes’s “refutation” of Say’s Law, even if it had been successful, would not have been original: it does not go an inch beyond Malthus’s attempted refutation more than a century before him. Keynes ”refuted” Say’s Law only in a sense in which no important economist ever held it.

4. To Save Is to Spend

Risking the accusation of beating a dead horse, I should like to address myself to one more effort by Keynes to disprove Say’s Law, or what he calls “a corollary of the same doctrine” (p. 19). “It has been supposed,” he writes, “that any individual act of abstaining from consumption necessarily leads to, and amounts to the same thing as, causing the labor and commodities thus released from supplying consumption to be invested in the production of capital wealth” (p. 19). And he quotes the following passage from Alfred Marshall’s Pure Theory of Domestic Values (p. 34) in illustration:

“The whole of a man’s income is expended in the purchase of services and of commodities. It is indeed commonly said that a man spends some portion of his income and saves another. But it is a familiar economic axiom that a man purchases labor and commodities with that portion of his income which he saves just as much as he does with that he is said to spend. He is said to spend when he seeks to obtain present enjoyment from the services and commodities which he purchases. He is said to save when he causes the labor and the commodities which he purchases to be devoted to the production of wealth from which he expects to derive the means of enjoyment in the future.”

This doctrine, of course, goes much further back than Marshall. Keynes could have quoted his bête noir, Ricardo, to the same effect. “Mr. Malthus,” wrote Ricardo, “never appears to remember that to save is to spend, as surely as what he exclusively calls spending.” [18] Ricardo went much further than this, and in answering Malthus answered one of Keynes’s chief contentions in advance: “I deny that the wants of consumers generally are diminished by parsimony —they are transferred with the power to consume to another set of consumers.” [19]

And on still another occasion Ricardo wrote directly to Malthus: “We agree too that effectual demand consists of two elements, the power and the will to purchase; but I think the will is very seldom wanting where the power exists, for the desire of accumulation [i.e., saving] will occasion demand just as effectually as a desire to consume; it will only change the objects on which the demand will exercise itself.” [20]

For the present, however, it may be sufficient merely to note Keynes’s contention on this point rather than to try to analyze it in full. There will be plenty of opportunity for that later. As we shall see, Keynes himself alternates constantly between two mutually contradictory contentions: (1) that saving and investment are “necessarily equal,” and “merely different aspects of the same thing” (p. 74), and (2) that saving and investment are “two essentially different activities” without even a “nexus” (p. 21), so that saving not only can exceed investment but chronically tends to do so. The second is the view which he chooses to support at this point. We shall have occasion to analyze both views later. For the present it is sufficient merely to note the presence of this deep-seated contradiction in Keynes’s thought.[21]

Notes

1 Economics and the Public Welfare, (New York: Van Nostrand, 1949), pp. 390-393.

2 Planning for Freedom. (South Holland, 111.: Libertarian Press, 1952), pp. 64-71.

3 Paul M. Sweezy in The New Economics, ed. by Seymour E. Harris, (New York: Alfred Knopf, 1947), p. 105.

4 Op. cit., pp. 64-65.

5 Vol. I, Book IV, Chap. I, (Edwin Cannon edition, 1904), p. 404 ff. 6 Economics and the Public Welfare, p. 390.

7 Principles of Political Economy, Book III, Chap. xiv. Sect. 2.

8 Op. cit., p. 392.

9 Bernice Shoul, “Karl Marx and Say’s Law,” The Quarterly Journal of Economics, Nov., 1957, p. 615.

10 David Ricardo, The Principles of Political Economy and Taxation, (Everyman ed., New York), pp. 193-194.

11 The phrase “effectual demand,” however, was italicized merely to bring out here the fact that Keynes did not invent this phrase. Ricardo even uses the phrase “effective demand” in his Notes on Malthus (Sraffa edition, Cambridge University Press, p. 234). The term “effectual demand” was actually introduced by Adam Smith in The Wealth of Nations (Book I, Chap. 7). John Stuart Mill explains. “Writers have . . . defined [demand as] the wish to possess, combined with the power of purchasing. To distinguish demand in this technical sense, from the demand which is synonymous with desire, they call the former effectual demand.” Principles of Political Economy, 1848, Book III, Chap. II, § 3.

12 Sraffa edition, Cambridge University Press, p. 305.

13 Op. cit.} pp. 306-307.

14 Haberler’s comments on the General Theory in Chap. 8 of the third edition of his Prosperity and Depression (Geneva: League of Nations, 1941) contain many penetrating observations.

15 The New Economics, ed. by Seymour E. Harris, p. 174.

16 See, e.g., Sraffa edition, p. 424.

17 Op. cit., pp. 175-176.

18 David Ricardo, Notes on Malthus (Sraffa edition), p. 449.

19 Ibid.,p.3O9.

20 Letters of Ricardo to Malthus, ed. by Bonar (1887). Letter of Sept. 16, 1814, p. 43.

21 Supplementing the present chapter, the reader is referred to the remarkable statement and defense of Say’s Law by John Stuart Mill, quoted at length on pp. 364-371.

Mal-investments small and large

Toby Baxendale — Thu, 02 Feb 2012 12:00:05 +0000

In yesterday’s article I emphasised that it is profit that is beneficial, not revenue.

I’ve just read an excellent article (H/T Sean Corrigan) by Jerry L. Jordan, past president of the Federal Reserve Bank of Cleveland. He makes the same point, with particular reference to government “investment” and national accounting.

He opens with an analogy to warm the hearts of American readers:

It is tempting to think that the Soviets perfected negative-value-added investment — the stuff produced is worth less than the value of the resources to produce it. However, most families have experienced this first hand.

It usually surfaces with an entrepreneurial adolescent deciding it would be a good idea to sell lemonade at the curbside to passersby

Parents, wanting to encourage the idea that working and making money is a good idea, drive around to buy the lemon, sugar, designer bottled water, cups, spoons, napkins, a sign or two, and probably a paper table cloth.

Aside from time and gas, the outing adds up to something north of $10. At the opening of business the next day, the kids find business is slow to nonexistent at $1 per cup. So, they start to learn about market demand and find that business becomes so brisk at only 10 cents per cup that they are sold out by noon, having served 70 cups of lemonade and hauled in $7.

The excited lunch-time conversation is about expanding the business. A stand across the street to catch traffic going the opposite direction; maybe one around the corner for the cross-street traffic. The kids see growing revenue; the “investors” see mounting losses.

There is a strand of economics, we’ll call it the K-brand, that sees all this as worthwhile. They add together the $10 spent by the parents to back the venture and the $7 spent by the customers and conclude that an additional $17 of spending is clearly a good thing. Surely, the neighborhood economy has been stimulated.

To the family it is a loss, chalked up as a form of consumption. If this were a business enterprise it would be a write-off. In classical economics it is a “mal-investment.”

But of course the government “invests” on a much larger scale:

To K-brand economics, such “investing” is better done by the government because there never has to be a write-down for bad ideas. So, Japan spent a couple of decades “investing” in airports few people fly to, highways few people drive on and bullet trains that not enough people ride on. All the expenditures were recorded as investment and were additions to national output, never recognizing that the value of what was produced is less than the value of the resources needed to produce it — negative-value-added. Surely it is clear that Japan was made poorer by lots of bad “investments.”

The U.S. recorded a great amount of “residential investment spending” in the central valleys of California that added to national output, only to have the houses bulldozed because there were no buyers. Subsequently, the homebuilders incurred losses, reducing business income, thus shrinking national output.

Nevertheless, the national accounts will never be revised to reflect that the “investment spending” of a few years earlier was all “mal-investment” and should have been recorded as a form of business consumption. Such “investment” actually made us poorer.

The irony of this example is the expenditures incurred to bulldoze the vacant houses is recorded as “stimulus” to the economy. Thanks for that to K-brand economics. They now want California to “invest” in a Japanese-style bullet train that is negative-value-added economics.

I recommend the whole article.

What the classical economists knew and the moderns have forgotten

Toby Baxendale — Wed, 01 Feb 2012 09:30:57 +0000

At times of recession, like we have today, a range of dodgy economic ideas that have been refuted several times over during the last 200 years are recycled with fresh enthusiasm, requiring us to refute them once again.

Chimera 1: prosperity through stealing and spending

Our political masters follow the lead of the economists. Recently we heard this statement from our Culture Secretary, the Rt Hon. Jeremy Hunt MP,

There are people who say that doing a project like this is a massive Keynesian boost to the economy. That is definitely the case, in terms of money being spent.

The message is clear: if we spend money, we will end up getting wealthier. That’s nice and simple then. What are we waiting for? If £39bn of spending is going to create more than £39bn of wealth, we should not be shy! Why not spend £339bn? In fact, choose any number!

It is remarkable that an educated man like Hunt cannot see that if we extract £39bn in taxes from the private sector and give it to the Olympic development people to spend, we have just moved money that people would otherwise have spent on goods and services they actually want, and directed it instead to the government’s preferred expenditure? The net gain is zero, at best.

This was clear enough to Jean-Baptiste Say in 1803, when he wrote A Treatise on Political Economy:

But this advantage is to be derived from real production alone, and not from a forced circulation of products; for a value once created is not augmented in its passage from one hand to another, nor by being seized and expended by the government, instead of by an individual. The man, that lives upon the productions of other people, originates no demand for those productions; he merely puts himself in the place of the producer, to the great injury of production, as we shall presently see.

Say had a great letter exchange with his English contemporary Malthus. Like Hunt today, Malthus believed public expenditure was essential to keeping the economy going. He argued that the payroll of the state — in modern terms, the army of teachers, nurses, civil servants, and quango staff — should be maintained across the economy, for the benefit of all.

Say pointed out that if no extractions were made from the private sector, the public labour force would soon get redeployed. If the tax collector did not collect, no-one would struggle to find better ways to spend their money!

In his letters to Mr Malthus, Say reminds us that spending is only half of the equation. Value must be traded for value, and production must precede consumption:

When I advance that produce opens a vent for produce; that the means of industry, whatever they may be, when unshackled, always apply themselves to the objects most necessary to nations, and that these necessary objects create at once new populations and new enjoyments for those populations, all appearances are not against me. Let us only look back two hundred years and suppose that a trader had carried a rich cargo to the places where New York and Philadelphia now stand; could he have sold it? Let us suppose even, that he had succeeded in founding there an agricultural or manufacturing establishment; could he have there sold a single article of his produce? No, undoubtedly. He must have consumed them himself. Why do we now see the contrary? Why is the merchandize carried to, or made at Philadelphia or New York, sure to be sold at the current price? It seems to me evident that it is because the cultivators, the traders, and now even the manufacturers of New York, Philadelphia, and the adjacent provinces, create, or send there, some productions, by means of which they purchase what is brought to them from other quarters.

We produce in order to support our own demand for goods and services. We can’t produce just anything. We must be focused on producing things our fellow citizens want. This happens naturally in an unhampered market economy. If we consume without producing, we will eventually burn through all our capital and have no ability to demand anything further in the future. Spending alone is never the solution. The key is prior production.

So much for the Rt Hon. Jeremy Hunt’s plan to boost wealth by stealing and spending.

Chimera 2: prosperity through printing and spending

A more senior political master, the Chancellor, acquiesces to his Governor of the Bank of England: they will make more money units, freshly minted digital ones, specifically to create a Keynesian stimulus! The letter from the Governor to the Chancellor laying this proposition out concludes

the Committee judged that it was necessary to inject further monetary stimulus into the economy.

I have spent 22 years in devotion to satisfying consumer demands, and thus creating wealth. It is done as follows:

As an entrepreneur you look for the most urgent needs of consumers.
You work out how to fulfill those needs.
Painfully, at the beginning of your enterprise, sometimes to pay more to your staff, you go without wages yourself and refrain from consumption — in short you save.
Thus you deploy your savings or borrow the savings of others to take command over the various factors of production — land, labour and capital — and mix them into better and more capital-intensive combinations to provide the goods and services that the customers want.
More capital deployed in the right intensity creates more productivity, allowing cheaper goods and services.
This takes place over time.

More money units may create the illusion of wealth, leading to temporary euphoria, but when reality bites, you rapidly go back to square one, perhaps having made some unwise decisions along the way.

We are currently experiencing a money deflation, which the authorities are attempting to counteract by putting more money units in circulation. All stops have been pulled to prevent prices from falling into line with what consumers want. The money printers are obsessed with aggregate spending, when they should be concerned about profits.

If you had a company with £1m of capital invested in the capital structure, with revenues of £10m p.a. and profits of £250k and by dumping low-margin, loss-making work, you could move to a £1m capital intensive enterprise with £8m revenues and £500k of profit, would this not be better? The capital deployed would now be generating twice as much. I often give this analogy to people who have consumption spending fetishes, showing that it is not the top line, but the bottom line that we should all focus on.

Another analogy I give is of the salesman who reports to you that he has sold £1m of kit and does not mention at what net margin. How does he compare to the one who says he has sold £1m of kit at 10% net margin? It will almost be apodictic that the latter will have sold for more profit while the former, not concentrating on the bottom line and not even mentioning it, will have sold for less profit. Profit (in cash terms) is the only thing that matters at the end of the year.

Crudely put, the mass of Keynesians relate GDP, which measures largely the consumption side of the economy (ignoring the larger production side), as the revenue of goods and services sold for money in a particular period (usually a year). There are many problems with this, but for now note that a lowering of prices means a lowering of GDP. If prices fall thanks to productivity improvements we have the basis for a recovery, but GDP-obsessed planners will instead see disaster.

Attempts to prop up GDP by printing more money units will not increase real wealth, but they will cause further distortions to an economy that’s already out-of-sync with consumer preferences, and stoke new asset bubbles. The injections of cash will not address any of the causes of monetary deflation.

Over the last two decades, credit has been created to the extent that our money supply has tripled and asset prices have soared. These prices need to come down. When they come down, people will start to pick up bargains and start spending again. Companies will then invest to satisfy the renewed demand.

No politician will allow this painful adjustment to happen. They are in thrall to the circular flow of income fallacy.

What would Say say?

Say pointed out, as we have seen in the examples above, that it is production that allows you to trade for other goods and services. Production and consumption can’t be out of sync in an unhampered free market. Why do we have recessions like today’s, with shops and factories with too much to sell and too little demand? The only answer can only be that prices are too high. These goods and services, and indeed the factors of production that create these goods and services, are offered for too much money. Prices need to come down.

Prices were a subject of lively debate in the letters between Say and Malthus. Malthus, wedded to the erroneous Labour Theory of Value, alleged that if prices fell too low, wages would not be paid and the problem would get worse as labour would become idle, there would be less spending, and we would spiral into the abyss. This is what virtually all economists tell us today.

Here’s what Say had to say, in 1821:

Give me some just ideas on the price of things?

If you wish to form just ideas on this subject you must never confound the nominal price with the real price of things.

What do you call the nominal price of things?

The price we pay for a thing in money or in coin.

What do you call its real price?

The value we have given to obtain the money with which we purchase this thing.

Give me an example.

A potter is in want of a loaf of bread, which sells for a shilling: he is obliged, in order to obtain it, to sell a vase which is worth a shilling. If the price of the loaf should rise to two shillings; and if the potter is obliged to sell two vases in order to obtain these two shillings, which he must pay for the loaf, the dearness of the bread is real. If the potter can obtain these two shillings by the sale of a single vase, the dearness of the bread is only nominal. He has in both cases exchanged only one vase against one loaf, whatever may have been the denomination of the intermediate value. It is the value of the money which is depreciated, that of the bread has remained the same.

Is it not a real dearness to a man whose income arises from lands which are let, or from a capital lent at interest, when the loaf has risen from one to two shillings?

No: that which is real is the depreciation which has taken place in the value of the merchandise in which his income is stipulated to be paid: that is, in the fall of the money. He who pays the income, by acquiring at less expense this merchandise, gains in this case what the other loses.

You have said that if, when I am obliged to give two shillings to buy a loaf, I am able to obtain these two shillings, on the same terms that I before obtained one, the loaf has not become dearer; but if to obtain two shillings, that is, the price of one loaf, I am obliged to give two vases instead of one, then the bread will have really become dearer?

No; not if the vases as well as the money have fallen to half their value.

How can I tell whether they have fallen to half their value or not?

They have fallen if they can be obtained for half the expenses of production: that is, if means have been found to create, at the same charge of production (which consists as we know of the workmanship, interest of capital and profit) two vases instead of one.

It is then the lowering the charges of production which causes the real fall in the price of products?

Just so. Then whatever may be the value with which a product is purchased, this product, which has fallen one half, is obtained for one half less expense of production.

Explain that by an example.

If, by means of a knitting frame, I can make a pair of stockings for three shillings, instead of expending six shillings on them, he who grows wheat can obtain a pair of stockings for one half the quantity of wheat which he had before been accustomed to give for them. That is, if he was before obliged to sell thirty-six pounds of wheat in order to obtain a pair of stockings, he would now sell but eighteen. But the eighteen pounds have required on his part only one half the expenses of production which the thirty-six pounds would have required.

It is the same whatever is the production with which we are occupied. It may be said, that when an article really falls in price, not only those who produce it, but every body else, obtains it at the price of the reduced charge of production.

You have said besides that the riches of society is composed of the sum total of the values which it possesses: it appears to me to follow, that the fall of a product, stockings for example, by diminishing the sum of the values belonging to society, diminishes the mass of its riches.

The sum of the riches of society does not fall on that account. Two pairs of stockings are produced instead of one; and two pairs at three shillings are worth as much as one pair at six shillings. The income of society remains the same, for the maker gains as much on two pairs at three shillings, as he did on one pair at six shillings.

But, when the income remains the same, and the products fall, the society is really enriched. If the same fall takes place on all products at once, which is not absolutely impossible, society by obtaining all the objects of its consumption at half price, without having lost any part of its income, would really be twice as rich as before, and could buy twice as many things.

This does not generally happen, but it has happened to a great number of products, which have fallen from the price they were formerly at, some a tenth, some a fourth, a half, three-fourths, as silver, and even in a greater proportion as silks, and probably many other articles.

To what cause is that to be attributed?

To many causes: but principally to the progress of intelligence and industry. It is to their progress that we owe, both the discovery of countries in which there is a greater abundance of products, and also a means of transporting them less hazardous and more economical. To that progress also we are indebted for processes more simple and more expeditious, the use of machinery, and in general a better adaptation of the productive faculties of nature.

Are there any products which have really become dearer?

There are some, but very few, and only those the demand for which has increased in consequence of the progress of civilization, without the means of production having increased in the same proportion. Such as butchers’ meat and poultry, and almost all the useful animals which are raised at less expense in less civilized countries.

Are there not variations in value which are not the consequence of the charges of production?

The errors, the fears or the passions of men, or unforeseen events, cause disorder and confusion in values which are merely relative: that is, when any merchandise rises or falls with respect to others, in consequence of circumstances foreign to its production. Late frosts increase the price of the last years wines, whatever may have been the charges of their production.

Does such a dearness increase the national wealth?

No: for in exchanging another product for one which has become dearer, one must give more to receive less: he who buys, loses on his merchandise, precisely as much as the seller gains on his goods.

When the wine doubles its price, he, who, to purchase a piece of wine is obliged to sell six bushels of wheat instead of three, which should have purchased a piece of wine is poorer by all that the wine merchant is richer.

Thus these kinds of variation, which sometimes overturn private fortunes, do not affect the general riches

The key thing to note is that a rise in productivity means the same goods are produced at a lower cost, and profits go up, allowing more demand to be expressed in the economy. Productivity rises can be facilitated by allowing taxpayers to retain more of their wealth. Adding more money units simply creates asset bubbles.

Over the next few days I will post copies of some of the best refutations of Keynes’s supposed refutation of Say’s Law. The wisdom of the older economists is in short supply, and we will do our bit to promote that wisdom.

Big Brother loves you!

Detlev Schlichter — Tue, 31 Jan 2012 09:00:08 +0000

“All within the state, nothing outside the state, nothing against the state.” Benito Mussolini

Those who have eyes to see and ears to hear will have noticed the accelerating trend towards interventionist policies and assertive state action all around us. This is not a conspiracy theory circulating on the internet. It is a phenomenon that is now so blatantly obvious that it makes the headlines in the highbrow pro-establishment media: The Economist and the Financial Times are talking openly about the trend towards “repression” and “national capitalism” as if it was simply the latest fashion in crisis management. A century ago, Randolph Bourne pointed out that “war is the health of the state”. It turns out that so is economic crisis.

Politicians, bureaucrats and many of their claqueurs in the media have drawn conclusions that are conveniently in their own interests: to them the crisis is evidence that things cannot be left to the markets, to consumers, to greedy bankers, and the spontaneous interaction of the public. If the state does not regulate and control everything, chaos ensues. We need more government. More control. More regulation. More oversight. Politicians and bureaucrats need more power.

Conveniently, the public believes it was greedy bankers and ‘unfettered capitalism’ that brought us down. But cheap credit through state fiat money and the systematic subsidization of the housing market are not features of the free market but of politics. The present mess is the result of decades of institutionalized monetary debasement and the accumulation of public debt. These policies have left us with bankrupt welfare states and overstretched banks, yet none of this has diminished the enthusiasm of politicians and bureaucrats to give us more of their medicine.

Let’s not forget that it was politicians and their central bankers, with the intellectual support of ambitious but misguided economists, who got rid of the gold standard. They considered the gold standard an inconvenient monetary straitjacket that was best replaced with a system of limitless fiat money under central bank control. Limitless money allowed unrestricted bank credit creation and state deficit spending. Once that system was in place, it was politicians who accumulated all that public debt and issued the deluge of unfunded and unkeepable promises that pit large sections of society against one another. And it is the central bankers who happily funded this gigantic debt bubble for decades with cheap credit.

After 40 years of fiat money the world is in a deep and deepening financial crisis. Excess levels of debt, weak and overstretched banks and distorted asset markets – all of this marks the inevitable endgame of a system based on persistent monetary debasement. But politicians and central bankers are merrily undeterred. “Nothing that cannot be papered over with more paper money!”

Authoritarianism needs ever more authorities

So the problem is not with the policy establishment but with us, the masses. We need to be controlled better. Mr. Martin Wheatley, inaugural head of the UK’s new Financial Conduct Authority, told the Financial Times last week that his agency will “step into the footprints of investors – who cannot be counted on making rational choices.” Apparently, we, the consumers and savers, cannot be trusted with our own money. We need someone to tell us what we should or should not buy. But don’t worry. Mr. Wheatley assures us that his interventions into our financial affairs are based on the latest insights of science, namely the latest research in “behavioural economics.”

Part and parcel of this trend is the global fight against cash. Authorities want to monitor and record ALL your transactions. They don’t want you to use cash. Ever more countries restrict the amount of cash you can take across borders (noticed the signs at airports?), and in Italy and Spain, proposals are being discussed to limit the amount of cash citizens can use for individual transactions. “Cash has been a problem for a long time” the UK’s top taxman, Dave Hartnett, told The Daily Telegraph last week. Hartnett wants the citizenry to stop giving cash to their cleaners, gardeners, and to small tradesmen and other potential tax cheats and economic criminals so that they can no longer avoid paying taxes. Hartnett’s vision of Britain is a society of snoops and denunciators. “Households have a duty to ensure that other people do not evade paying their share of tax. The people who are worried about it should use our whistle-blowing line to tell us. We are getting better and better at finding people who receive cash.” Nice touch. A tinge of the former GDR’s Stasi culture for the British way of life?

The beauty of a big state is apparent to Mr. Hartnett: “Tax provides the funding to run the country.” Really? No, I don’t think so. It is rather Mr. Wheatley’s irrational savers and Mr. Hartnett’s tax-avoiding cleaners, gardeners and shopkeepers who are running whatever is still functioning in this country, the productive, independent middle class, who are able to and do look after themselves and their children, but who are also forced to fund the largely parasitic class of self-deluded authoritarians with their wasteful government projects.

Decent citizens don’t use cash. Cash is used by tax-cheats, terrorists, drug-dealers and child pornographers. Once this is established it will be a short step to severely restricting or even banning the withdrawal of cash from bank accounts. As all banks will soon anyway be mere branches of the ever-expanding central bank, which prints the money to keep the nominally private banks alive, all transactions will then be just electronic bookkeeping adjustments at the state central bank. All financial transactions will then be entirely transparent to the authorities. “Irrational” behaviour can be identified early and – eliminated.

Whatever you may think of Julian Assange’s Wikileaks, it is deeply troubling how quickly and easily this organization was crippled by Visa and Mastercard cutting it off from its donors. This gives you a taste for where we are going.

Fiat money and central banking are incompatible with free banking, with a system in which banks are independent capitalist enterprises. But more than that, fiat money and central banking are incompatible with capitalism and a free society. Central banking is central planning.

Hey, who is boss?

The bureaucracy is annoyed. The public is not giving it enough credit for its excellent management of the economy. The public is still pessimistic and concerned about banks and the overall direction of the equity market. Okay. So the government just stops them from acting on that pessimism. Show them who is boss:

In France, Spain and Belgium the government has ruled that shares of financial companies cannot be shorted. In Italy you are banned from shorting any stocks. Shorts on stock indices are banned in Italy, France, Belgium and Spain. Is this arbitrary? Of course it is. But the real measure of power is if you can use it arbitrarily. Make it clear to people what you, the government, likes or dislikes. Then you ban what you don’t like.

Government is not voluntary association, contractual cooperation and trade. “Government is essentially the negation of liberty” (Ludwig von Mises). “Everything a government does rests on the use of force. No law actually is a law unless it is backed by the threat of force.” (George Reisman). And a government that is digging itself an every deeper economic hole will, in its growing desperation, apply force ever more readily. Count on it.

But what does the sovereign do, the democratic masses? Well, they obey. Like obedient sheep they stand patiently in line at airports in the UK, the USA, and elsewhere, calmly watching their six-year olds being padded down by security personnel. And they happily pay their Starbucks Coffee and the pack of cigarettes (as long as we are still allowed to smoke somewhere) at Tescos with their debit cards, or buy everything on the internet, leaving for whatever they do a perfect paper trail, a seamless record kept forever. “It is so convenient. And I have nothing to hide.”

And, naturally: “the government is here to help, so why not cooperate with the government? After all it is still a democratic state.” Every four to five years each of us has an opportunity to cast a vote of infinitesimally small importance to decide which of two gangs will get almost unlimited power over the ever growing state apparatus, and this, it seems, is to many sufficient compensation for handing over control of their lives and property to others. Stimmviehvolk is how an incredibly prescient Friedrich Nietzsche described them more than a hundred years ago: voting cattle.

Prosperity through money printing

The persistent debasement of money in the modern state fiat money system is an obstacle to the smooth operation of the market, the production of wealth and the growth in prosperity. It keeps the middle class in bondage as its efforts to save and gain financial independence are constantly undermined by the official policy of inflationism. But the central planners and central bankers and their apologists among journalists and economists tell us that it is exactly the other way round: “Prosperity through monetary debasement” is Big Brother’s slogan, and he has spokespeople with outstanding academic credentials to explain this absurdity to the masses. In November 2010, MIT and Princeton man Ben Bernanke, the U.S. government’s money-printer-in-chief, wrote this in the Washington Post when explaining to the less educated why creating $600 billion out of thin air and massaging yields on government debt down was a clever policy:

Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

Well, that was 14 months ago. As it turns out, manipulating the economy by artificially lowering rates (lowering rates not by saving but by simply printing money) has not started a virtuous circle. Such manipulations come with nasty unintended consequences, and after a few decades of such a policy the accumulated unintended consequences far outweigh whatever short–lived growth blip money debasement may have manufactured otherwise. None of this has anything to do with healthy growth and a functioning free market economy.

But it is important that those in positions of authority do not admit that they are clueless. They never make mistakes. Their policy is never wrong. They simply need to do more of the same – and then even more. As I write this, the Fed is, of course, preparing another round of quantitative easing, and so is the Bank of England. And the ‘economists’ on Wall Street and the City of London cheer them on.

The debasement of paper money certainly continues.