Say's Law: The Antidote to Countless Economic Fallacies

This recent post by Russell Lamberti on Mises.org is simply too good not to re-post on The Supply-Side Revivalist. In a pithy blog post, Lamberti lays waste to the fraudulent school of thought that is Keynesianism.

Say's Law: The Antidote to Countless Economic Fallacies

February 14, 2017

By Russell Lamberti

To understand the principle that has been called Say’s Law, it is useful to start by thinking about what unhampered exchange is: the mutual offering of goods and services between people. Seeing exchange as a mutual offering shows demand-and-supply is not an unsolvable chicken-or-egg problem. People produce what in their best judgmentthey think others want, in the expectation that others are producing or will produce what they want. Production, in other words, is always speculative.

In small social settings, this speculation is usually not too difficult. Two people deserted on a tropical island, for example, can discuss beforehand what each one will make and offer to the other. In larger social settings this speculation is harder, so a money system develops to help people judge what others want using market prices as a signal of consumer preferences. But the essence does not change: people produce what they judge others want in expectation that others will provide what they want.

Say’s Law, then, can be described as follows: The value of goods and services anyone can purchase is equal to the market value of what they supply. Or in an aggregate, macroeconomic sense, the value of goods and services any group of people can purchase in aggregate is equal to the market value of what they supply in aggregate.

Economist Paul Cwik more helpfully explains that Say’s Law is simply the reality that “we produce in order to consume.”

Say’s Law is always true because it applies to the subjective conception of value. Supply into the marketplace always provides the means for the supplier to purchase other goods and services, but only to the extent of the subjective value placed by others on that supply at any given time. Even if supply failed to create any purchasing power at all for the supplier because it was considered utterly valueless in the marketplace — like say, creating holes in the middle of nowhere — this would not be a contravention of Say’s Law but merely another manifestation of it. It also distinguishes Say’s Law from the Marxists’ labor theory of value in recognizing the crucial fact that the act of production alone is insufficient to create purchasing power, but rather the act of producing something which is valued by someone else who has also produced something valued in the marketplace. In short, it’s not production that matters per se but what is produced and for whom.

We can now understand why David Ricardo said,

Men err in their productions, there is no deficiency of demand.1

Ricardo was commenting during the great "general glut" debate that had arisen in the nineteenth century between himself and Thomas Malthus on the cause and cure of economic downturns. Malthus espoused the view that became the essence of Keynesianism and the modern mainstream. Too much saving and too little spending, they argue, cause a general glut or general overproduction. Producers sit with unsold stock and declining revenues and have to lay off workers. A recession ensues. Malthus, and later, more emphatically, Keynes, advocated saving less and spending more to recover from the recession.

But the validity of Say’s Law renders the Malthusian-Keynesian view incorrect. Since demand itself is determined only by products and services that are valued in the marketplace, widespread business errors revealed in the recession must be the result of widespread errors in speculating what value the market would place on the goods and services supplied.

If men (and women) err in their productions, then recovery efforts must be focused on rearranging productive efforts to estimate and serve consumers’ needs better. This diagnosis is very different from the Keynesian one which emphasizes demand deficiency due to mysterious fluctuations in “animal spirits” to be rectified with state and household debt spending and money printing. In a Say’s-Law diagnosis, entrepreneurs need as few obstacles as possible to discovering what products and services the market wants. Since the price mechanism is the primary information signal to entrepreneurs, market price flexibility is essential to a proper recovery. Also, once resources have been misallocated and some capital wasted altogether, more not less saving is needed to tide workers and entrepreneurs over and accumulate sufficient funds to redeploy in new endeavors.2

If we concede the fallacy that virtuous individual action like saving more can lead to chaotic social outcomes without state intervention, then all manner of central planning can be justified as not only of public benefit but as fundamentally essential for civilization. But this is the very path to civilizational ruin, to which the ash heap of history attests.

Say’s Law stands as the gatekeeper of economic freedom, prosperity, and even civilization itself.

• 1.Credit to economist and classical scholar Steve Kates for this insight. Steven Kates, "Why Keynesian Concepts Cannot Be Used to Explain Pre-Keynesian Economic Thought: A Reader’s Guide to Classical Economic Theory," Quarterly Journal of Austrian Economics 17, no. 3 (Fall 2014): 313–326.
• 2.Paul Cwik, “Austrian Business Cycle Theory: A Corporate Finance Point of View,” Quarterly Journal of Austrian Economics 11, no. 1 (2008): 60–68.

Trump's Most Important Decision

The news media is currently abuzz with rumors of possible Trump Administration cabinet-level nominees.

However, no appointment Donald Trump will make is more critical to his Administration’s initial success than his pick for Secretary of the Treasury.

Trump has signaled that he will pursue comprehensive tax reform that will result in significant reductions to personal and corporate marginal rates. He is also looking to roll back onerous regulations that have burdened business in recent years, including major changes to the abominations known as Dodd-Frank and Obamacare. The bad news, however, is Trump has consistently favored a mercantilist trade policy which could lead to meaningful tariff increases and a trade war. Of course, tariffs are simply another form of tax. This has the potential to offset much of the positives on the domestic tax and regulatory front. But I am hopeful that cooler heads will prevail and the trade policies Trump is able to implement do not come close to matching his belligerent campaign rhetoric.

Any pro-growth policies will quite simply lose their potency unless the Treasury is able to deliver a strong and stable dollar to the marketplace. A stable currency will ensure that pro-growth fiscal reforms deliver the intended effects.

The value of the U.S. dollar, as measured by the fall in the price of gold, has strengthened since the election on November 8 as markets price in expectations that many of Trump’s policies will be dollar-bullish. It is not unreasonable to expect gold to retest the lows of earlier this year below $1,100/oz. However, excessive currency strength is undesirable due to the havoc that deflationary pressures can impart to debtors, commodity-producing sectors, and many emerging markets.

The country has been without a Treasury secretary that has a solid grasp of its role as caretaker of the dollar. The last person was Robert Rubin during the Clinton Administration. A relatively stable currency during that era helped create an environment that rewarded work effort, savings and investment. This resulted in immense prosperity during the mid- to latter-part of that decade.

I can think of no better selection for this key role than Steve Forbes, who has reportedly served as an informal economic advisor to the Trump campaign. Arguably no prominent public figure knows more about the importance of sound money than Forbes. He is an enthusiastic proponent of returning to a gold standard system. Other worthy candidates include Jeb Hensarling, John Allison, and Kevin Brady.

Too many economists and commentators focus on the importance of the Federal Reserve in setting monetary policy. The Fed’s control over the value of the dollar is greatly exaggerated. When the decision was made to leave the Bretton Woods Agreement in 1971, it was the U.S. Treasury that led the way. The Fed Chairman at the time, Arthur Burns, wanted nothing to do with it. As the mouthpiece for the dollar, if the Treasury secretary stresses that the Administration desires a strong and stable currency, preferably tied to gold, the market will deliver just that.

Trump will have the opportunity to name a number of members to the Federal Reserve Board. He should choose pro-sound dollar candidates such as Judy Shelton, David Malpass, or Jim Grant to name a few. They can work to bring sanity to the Fed by helping thwart its attempt to manipulate markets via interest-rate targeting and foisting overbearing regulation on the banking industry.

Trump has a grand opportunity to finally fix a highly dysfunctional U.S. monetary system. The right Treasury Secretary could also lead a global currency reform initiative that would stabilize currency values and actually promote trade and capital flows by helping eliminate “beggar-thy-neighbor” devaluations.

My fingers are crossed.  

I wish a blessed Thanksgiving Day to all of my readers!

Say's Law

If you studied economics at the college level, there is a pretty good chance that you've never heard of John-Baptiste Say. John Maynard Kenyes, definitely. Milton Friedman, highly likely. Adam Smith, maybe. David Ricardo, perhaps. But it would not be a stretch to say that J.B. Say is the most important political economist who has ever lived.

My friend Richard Salsman of Intermarket Forecasting Inc. has graciously allowed me to publish a wonderful essay he wrote back in 2003 commemorating the bicentennial of Say's A Treatise on Political Economy (1803).

Other great resources on Say's Law include books by William H. Hutt (A Rehabilitation of Say's Law), Steven Kates (Say's Law and the Keynesian Revolution: How Macroeconomics Lost Its Way), and Thomas Sowell (Say's Law: An Historical Analysis).


The Capitalist Advisor
December 31, 2003

A Great Debate on Fractional Reserve Banking

John Tamny did an admirable job defending his positions on fractional reserve banking and Austrian Business Cycle Theory (ABCT) in a great debate with Jeff Herbener of Grove City College on a recent episode of The Tom Woods Show.

http://tomwoods.com/podcast/ep-757-debate-is-fractional-reserve-banking-economically-benign/

Another Missed Opportunity

I didn't watch any live television coverage of the recent Republican National Convention. I couldn't stomach it. That said, I was disappointed to learn that the Donald Trump and the GOP let a golden opportunity slip by. 

After 7+ years of failed Keynesian fiscal policies and seat-of-your-pants experimental monetary policies, an optimistic message of growth would certainly resonate with the electorate in 2016. Talk about low-hanging fruit.

The corrupt and highly-likely criminal behavior of Hillary Clinton should be a major issue in this campaign and Donald Trump has rightly focused on "Crooked Hillary." But that is simply not enough. The populace is hungry for a more hopeful message of renewed prosperity. One that identifies the crushing burdens being placed on the private sector in the forms of unsound money, stifling regulation, wasteful government spending, high taxes on income and capital, and growing aversion to free trade.

Both Investors Business Daily and The Wall Street Journal editorial boards took notice of Trump's focus instead on a dour populist message of national decline. This approach is not a way to win in November.

Trump needs to pivot from his anti-trade message and fooling around with talk of higher minimum wages and focus on policies that encourage vibrant economic growth.

Will he take advantage? Does he even see the opportunity? Who is advising this guy?



Gaping Hole at the GOP Convention: Jobs and Growth

Investors Business Daily
July 20, 2016

2016 Elections: Anyone who'd hoped to get a sense from the Republican National Convention about how Donald Trump would get the economy moving again after eight years of Obama-led stagnation has so far been sorely disappointed. The topic has barely been mentioned. 

Trump and the convention organizers cleverly labeled each night of the convention. Tuesday's was supposed to be about "Making America Work Again." You'd think Trump would have plenty of say about this, and would be able to line up an array of top-flight speakers who could explain what' wrong with the economy and how he's going to go about fixing it. 

There's plenty of material to work with. Under President Obama, wages have flatlined, economic optimism is still under water, the poverty rate is up, and millions have given up looking for work and have become newly dependent on federal programs.
Now Obama is arguing that this is the best we can expect out of the U.S. economy -- forecasting GDP growth barely above 2% a year as far as the eye can see. You can bet that his fellow Democrats will devote enormous time and resources at their convention next week describing how they plan to redistribute this pie -- by making college free, raising the minimum wage, handing out more government goodies and getting the "top 1%" to pay for it all. You can also be sure that they will paint Trump and the GOP as cold, heartless bastards who are just looking out for their wealthy friends. 

So what is Trump's counter to this? What's his plan to grow the economy faster than a measly 2%? To help businesses feel that it's safe and affordable to add to their workforce? To fix the tax code? To revive the economy's hibernating prosperity? Nobody has said anything yet. 

Instead, as IBD pointed out, for the most part the only business people on the stage during the convention's first two nights have been either those who had nothing to say at all, or who owe everything to Trump himself. 

In fact, it wasn't until the last speaker on Tuesday night when anyone meaningfully brought up the struggles of running a small business against an increasingly imperious central government. Kimberlin Brown, a former soap opera star and now a small-business owner, talked about how "out-of-control unreasonable government regulations ... needlessly add costs to doing business and tie us up in red tape" and made the case that it will take someone like Trump to get the country out of the doldrums. 

There are a few more business leaders scheduled to talk at during the GOP convention's final two days. But if the contentless trend continues, it will be a huge lost opportunity for Republicans to articulate a vision for robust economic growth at a time when millions are tuning in. 

The GOP should be talking about how strong growth is possible, but only by lifting the shackles of government. The party should be explaining why tax reform is vital to unleashing the economy's potential, and bring businesses and jobs back to the U.S. And they should be making the case for why voters, if they want to see a return to prosperity, must reject the big-government promises that Democrats will be making next week and up to the November elections. 

Plenty of speakers in Cleveland have talked about the stakes of this election. But so far they haven't given voters a clear reason to choose Republican economic policies over the Democrats'.

The Dark Knight

The Wall Street Journal
July 22, 2016

Say this much for Donald Trump’s Republican acceptance speech Thursday night: He stayed true to the campaign he has run from the start. The outsider stuck to his dark, populist themes of an America under siege by crime, terrorism, corruption and illegal immigration. He offered himself and his business success, more than any coherent set of ideas, as the revival medicine. 

The speech was aimed at mobilizing an angry electorate to join him in storming the ramparts of Washington. It was a polarizing speech for a polarized era. President Obama has mobilized his two-term progressive majority by pitting secular against religious, minorities against police, young against old, middle class against the affluent, and even women against men. Mr. Trump is bidding to build a mirror-image majority by tapping the voters left out of Mr. Obama’s favored coalition.  

In that sense Mr. Trump’s best moments were his call to speak for “the forgotten men and women,” the “people who work hard but no longer have a voice.” This is an echo of Richard Nixon’s “silent majority” that played well in another angry era, the late 1960s.
He ignored or downplayed traditional Republican themes and constituencies to appeal to “laid-off factory workers”—a direct pitch to Bernie Sanders voters and union members. He spoke the blunt truth that too many African-American children are living in poverty and too many black young people aren’t working, and he said the poor should have the same “choice” of schools as affluent Americans. These are constituencies that recent GOP nominees haven’t spoken to, and they should.  

Mr. Trump also offered a nod to gay Americans, albeit in the context of the terror attack on a gay club in Orlando. Peter Thiel, the Silicon Valley billionaire, made a brave and inspiring appearance by admitting to be a “proud” gay Republican. He was cheered for it. Democrats aren’t likely to have a proud anti-abortion Christian on the stage in Philadelphia next week. And if they did, she would be booed.Yet Mr. Trump’s speech had too little of that political outreach as it offered up a grim portrait of the late Obama years—sometimes to inaccurate excess. Many American cities are seeing murders increase, and one reason is the progressive political assault on police and “broken-windows” policing. But we are a long way from 1968, and some voters may wonder what country he is talking about.

Mr. Trump’s focus on the terror threat is more grounded in reality, and he will no doubt win adherents with his promise that “we are going to defeat the barbarians of ISIS.” We hope he means it.  

But his program for doing so consisted only of “the best intelligence-gathering” in the world, a parroting of Hillary Clinton; no more “nation-building and regime change” in the Middle East, an echo of Mr. Obama; and suspending immigration from any nation “compromised by terrorism until such time as proven vetting mechanisms have been put in place.”  

Better border control won’t defeat ISIS in its safe havens abroad, but Mr. Trump the populist doesn’t want to tell Americans, any more than Mr. Obama does, that a greater U.S. military commitment overseas will be needed.  

Mr. Trump’s biggest lost opportunity was focusing too little on solutions to revive economic growth. The bulk of his economic message blamed low incomes on illegal immigration and “bad trade agreements,” but neither one explains the failures of the Obama economy. 

Illegal immigration was far greater during the 1980s and 1990s when the U.S. economy was booming, and there is little evidence that it has reduced American wages. As for trade, the truth is that the U.S. typically has smaller trade deficits with nations with which we have struck bilateral or multilateral deals. Reducing immigration and trade would hurt the economy and reduce incomes, the opposite of what Mr. Trump is promising. 

The real reason for slower growth is the Obama agenda of high taxes, multiplying regulations across the economy, and government allocation of credit. Mr. Trump did get to those problems, albeit more than an hour into his speech and then as something of a laundry list. Perhaps he feels these ideas won’t appeal to the working-class voters he is targeting in November, but they are the proposals he will have to implement if he wins.
Then again, Mr. Trump’s biggest idea is himself. His politics is personal, not ideological, and his main pitch to Americans is that he can be the agent of the change they want, details to be filled in later. “I am your voice,” he said, in the speech’s signature line. The messenger is his message. This has the virtue of being truth in advertising, but it also means that Democrats next week will do whatever they can to tarnish the Trump brand—business and personal. 

With his anti-trade and anti-immigration populism, Mr. Trump is taking the GOP back to what it was before Ronald Reagan. His message is closer to Richard Nixon’s or the Republican protectionism of the 1920s. Predictions are foolish in this year of so many surprises, and perhaps Mr. Trump’s non-ideological populism can find a majority. Republicans have placed their hopes for revival on the Dark Knight. 

Tom Woods on Why Profit is Crucial

Bernie Sanders and other leftist-types despise the concept of business profit. In their minds, profit is a sign that a business is ripping someone off. In episode 697 of his eponymous podcast, Tom Woods deftly addresses the left's cluelessness regarding the importance of profit to a well-functioning market economy.

If this is your first time listening to The Tom Woods Show, I highly encourage you to subscribe via iTunes or Stitcher and become a regular listener.

http://tomwoods.com/podcast/ep-697-profits-arent-evil/

Book Review: Who Needs The Fed? by John Tamny

"Credit equals resource access." p. 2

In a triumphant sequel to his essential book Popular Economics, John Tamny has written a treatise on money and credit entitled Who Needs the Fed? What Taylor Swift, Uber, and Robots Tell Us About Money, Credit, and Why We Should Abolish America's Central Bank (Encounter Books).

Ever the original thinker, Tamny offers a view of credit that is a clear challenge to the conventional wisdom. Tamny states emphatically that credit is simply access to real economic resources, such as tractors, computers, airplanes, and labor. Credit cannot be created out of thin air by central banks or governments. The latter point may make heads explode on both the left and the right.

In Part One, Tamny focuses on his view of credit in a most effective way by offering numerous interesting examples from the world of popular culture (Taylor Swift, Hollywood), sports (college football coaches), and politics (Hillary Clinton, Donald Trump). His method is unique in that he has made explaining economics this way a feature of his writing. Using no higher math or statistics, it's what made Popular Economics a classic in the image of Henry Hazlitt's Economics in One Lesson. And this style is what animates his regular commentary on Forbes Opinion and Real Clear Markets.

These examples provide the reader with easy to understand narratives of how credit is actually created in the real world.

Tamny rightfully mocks the Federal Reserve's attempt to deem credit cheap by manipulating interest rates. The Fed ignores the fact that by setting interest rates at an artificially low level, fewer savers will offer up their surplus resources to be lent to those in need of funds for immediate consumptive needs. The end result is not an abundance of credit, but rather its scarcity.

Like the manipulation of other prices by government such as wages or apartment rents, bureaucrats believe they can divine proper prices in a dynamic marketplace where supply and demand conditions are shifting constantly. The hubris is staggering.

Supply-siders do not escape criticism in Chapter 7. Although he considers himself a supply-sider, Tamny believes it's time to ditch the Laffer Curve and focus on finding the income tax rate that actually results in less revenues for the government to raise and then subsequently waste. The reason is simple. The government has no resources of its own. It must extract those resources from the private sector. There is simply no way a politician or bureaucrat, undisciplined by the market, can invest better than someone in the accountable private sector.

Part Two of the book deals with banking and contains the most fascinating chapter of the entire book. In Chapter 11, Tamny takes on the Austrian School's belief in fractional-reserve banking and the notion that money can be "multiplied". This requires the reader to keep an open mind and think through the author's logic and the examples provided. It may take awhile for many to come around to his viewpoint, if at all, but it cannot be denied that Tamny has thought through these issues methodically and logically.

Chapters dealing with the declining importance of the banking industry as a source of credit and the real reason behind the housing boom during the decade of the 2000's smash conventional thinking.

Part Three deals with the Fed and how its impact on the economy is overstated. Tamny shatters the widely believed myth that the Fed controls the supply of money. Production is the source of money; it is an effect of productive economic activity. And since the Fed cannot plan production, it will never have the ability the control the money supply.

I particularly enjoyed the vivid example of Baltimore. This economically depressed city would presumably benefit from the Fed's attempts to inject money into its local banks in an effort to stimulate economic activity. But no sooner would the money arrive it would get loaned out by the banks to businesses and consumers outside of the city. As Tamny makes clear, money migrates to the productive. 

The author helpfully reminds us that economic growth and prosperity cannot come from government. Government spending isn't stimulative, simply because politicians can only spend what they extract from the real economy first. Real economic advancement results from entrepreneurial ideas being matched with savings. Economic "stimulus" provided by government is a cruel hoax.

The Fed's manipulation of interest rates is another distortion of markets that is anti-credit creation. As Tamny points out, the Fed's imposition of artificially low interest rates on the way to supposedly easy credit would have to have been one of the few instances in global economic history of price controls actually leading to abundance over scarcity. He again emphasizes that an interest rate is a price like any other. As a price, the interest rate is meant to float to whatever rate maximizes the possibility that those who have access to credit (savers) will transact with those who need access to economic resources (borrowers). So why is it assumed by so many that a handful of bureaucrats at the Fed can define what the proper level of interest rates should be?

It is also assumed by too many people that the Fed's quantitative easing (QE) scheme created a boom in the U.S. stock market. According to Tamny, the Fed wasn't "printing money" to conduct QE.  It was doing something much worse by borrowing trillions from America's banks while backed with America's credit.  His more credible claim is that the Fed helped to deprive the U.S. economy of a massive rebound that would've taken place absent the central bank and federal government presuming to allocate so many trillions of the economy's resources.

If the Fed's QE machinations were the reason for the rise in stock prices in recent years, why didn't Japan's multiple bouts of QE since the 1990s not boost the Japanese stock market? The Nikkei 225 is no where near the level it was in the late 1980s. A more plausible reason for the rebound in U.S. stocks since early 2009 can be better explained by the impressive recovery in corporate profits from the lows of the last recession.

Tamny addresses the Fed's ludicrous belief in the Phillips Curve, which posits an inverse relationship between inflation and unemployment. Essentially, the Fed believes that inflation is created by too much prosperity. Could a theory more antithetical to prosperity possibly be promulgated? It must be stressed that economic growth, if anything, leads to lower prices. Goods that are initially available only to the wealthy become available to the masses as entrepreneurs find ways to lower prices of such goods to serve a much larger market. Historical examples abound, including the automobile, the personal computer, flat-screen televisions, and cell phones. All were once available exclusively to the ultra-wealthy but soon became ubiquitous. That's the beauty of capitalism.

In the final chapter, Tamny states that robots will ultimately be the biggest job creators, because automation will free up humans to do new types of work by virtue of robots eliminating work that was once essential. It seems every major advance that improves human living standards initially creates fears that workers will be displaced. But as Tamny notes, what resources are saved on labor will redound to increased credit availability for new ideas. We "see" the jobs destroyed by advances in technology but the "unseen" is all the new forms of work that will be created.

Tamny repeats key points frequently throughout the book. Some may find that somewhat annoying, but I believe his repetition helps drive critical points home.

Readers outside of the United States may not be quite familiar with the names of the college football coaches cited in Chapter Two, but that shouldn't distract from an understanding of the points Tamny is conveying about labor as a form of credit.

Tamny has a real gift for clear writing and making sense of issues that are unnecessarily complicated by the economics profession and the media. Who Needs the Fed? is a provocative, yet highly enjoyable companion volume to his 2015 book Popular Economics.