I have for the first time come across an article that invokes Say’s Law exactly right. It has come up on the Mises Daily website, is by an economist by name of Patrick Barron and titled, Why Central Bank Stimulus Cannot Bring Economic Recovery. It has surprised me to see it since even though Say’s Law is at the heart of the classical theory of the cycle, Austrian economists have tended to ignore the single most important theorem in economics, I think because it is hardly mentioned by either Mises or Hayek. It is also a principle that predates what is Austrian about Austrian economics, going back to the earliest days of economics, first having been discussed by James Mill in 1808 and definitively stated in no uncertain terms by John Stuart Mill in 1848 following the general glut debate (1820-1848). So what does Barron say is the problem with the central bank stimulus?

They are following Keynesian dogma that increasing aggregate demand will spur an increase in employment and production.

Exactly so! The number of economists across the world who understand this is infinitesimal. Aggregate demand is so ingrained it is almost ineradicable. Even Austrian economists of the most pedigreed kind get this wrong. Not this time. And what’s more, he reminds us that this error is a product of Keynes and The General Theory. Say’s Law understood correctly states demand is constituted by supply. Here Barron points out just this very thing:

Keynes tried to prove that production followed demand and not the other way around. He famously stated that governments should pay people to dig holes and then fill them back up in order to put money into the hands of the unemployed, who then would spend it and stimulate production. But notice that the hole diggers did not produce a good or service that was demanded by the market. Keynesian aggregate demand theory is nothing more than a justification for counterfeiting. It is a theory of capital consumption and ignores the irrefutable fact that production is required prior to consumption.

I only wish it were all that irrefutable. In real life, it is refuted every time a Keynesian stimulus is tried. Amongst economists it is the most immovable of dogmas. But let us continue.

Central bank credit expansion is the best example of the Keynesian disregard for the inevitable consequences of violating Say’s Law. Money certificates are cheap to produce. Book entry credit is manufactured at the click of a computer mouse and is, therefore, essentially costless. So, receivers of new money get something for nothing. The consequence of this violation of Say’s Law is capital malinvestment, the opposite of the central bank’s goal of economic stimulus. Central bank economists make the crucial error of confusing GDP spending frenzy with sustainable economic activity. They are measuring capital consumption, not production.

Highlighted here is the difference between the market rate of interest (money) and the natural rate (things). Very nineteenth century but universally accepted by economists right through to 1936. Even Keynes made it central to his Treatise on Money, but that was in 1930 before he came across Malthus. Keeping the monetary side of the economy separate from the real side is crucial to even the most rudimentary understanding of how an economy works.

We must remember that the very purpose of central bank credit expansion is to trigger an increase in lending in order to stimulate the economy to a self-sustaining recovery. But this is impossible. At any one time there is only so much real capital available in society, and real capital cannot be produced by the click of a central bank computer mouse. As my friend Robert Blumen says, a central bank can print money but it cannot print software engineers or even cups of Starbucks coffee to keep them awake and working.

Me and his friend Robert should get together. I harangue my classes holding a $5 bill in one hand and a cup of coffee in the other and ask if they can see the difference. And you would be amazed how hard it is to see the difference, not then and there, but when it counts. Economists are forever pointing out how much money various businesses have stashed away in banks as if the existence of such money stocks is equivalent to a stock of unemployed labour or capital goods available for investment.

So we come to his conclusion, where he discusses not just the wasted effort through trying to stimulate demand by printing money, but the actual wilful ruining of economies by their sensationally misguided attempts to increase the level of spending:

The governments and central banks of the world are engaged in a futile effort to stimulate economic recovery through an expansion of fiat money credit. They will fail due to their ignorance or purposeful blindness to Say’s Law that tells us that money is the agent for exchanging goods that must already exist. New fiat money cannot conjure goods out of thin air, the way central banks conjure money out of thin air. . . . In fact rather than stimulate the economy to greater output, bank credit expansion causes capital destruction and a lower standard of living in the future than would have been the case otherwise.

It’s all insane, really, but what may be more demented than anything is the refusal of the mainstream to perhaps think about this standard macroeconomic theory of theirs. You know, insanity as in doing the same thing over and over again and expecting different results. As in thinking an increase in aggregate demand will lead to an increase in anything before there has been an increase in production.

Not for the first time do I suggest that anyone interested in Say’s Law and much else should pick up a copy of my Free Market Economics, although I would hold off at the moment for a couple of months. The copyedited manuscript of the second edition arrived via email just today so I will have a very intense week in front of me in going through it with a fine tooth comb. It will be out in September when you can then pick up the new improved edition for yourself.