Category Archives: Law of Markets

Say’s Law goes to the movies

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A while back I posted Say’s Law as Literature about a book of the name Waffle Street written by James Adams. The book is now being turned into a movie, and the story is now out in the open as they have now signed Danny Glover to play the lead role of Edward Collins. This is from the press release:

Legendary actor Danny Glover (Lethal Weapon 1-4, The Color Purple, Dreamgirls) has signed on to star in the upcoming feature film, Waffle Street. The drama-comedy tells the story of James Adams, a VP of a $30 billion hedge fund who lost his job in the recent market crash and wound up working as a waiter in a waffle shop. Amid the greasy madness of the 24-hour diner, Adams befriends ex-con grill master Edward Collins (played by Glover), who serves up hard lessons about finance, life, and grits.

Waffle Streets riches-to-rags tale is an adaptation of James Adams 2010 memoir of the same name (published by Sourced Media Books), which chronicles the financiers foray into the food industry. After being laid off at the hedge fund where he worked, and further jaded by his culpability in the crisis, Adams chose to work at a popular 24-hour diner where he claims most of his financial knowledge has been gleaned. Offering a fresh take on the fallout of corporate greed, Adams is a tale of the redemption and unlikely friendship found under the tutelage of Glover’s character Edward, the best short-order cook in town.

The story is a story of redemption for both the author, James Adams and for Edward Collins, who has found himself in productive work. How this relates to Say’s Law is through the “lessons about finance, life and grits” which includes experiencing the core understanding of economic life that the law of markets provides. This is from the review of the book by the President of the Mises Institute, Doug French:

But Adams does scrap with John Maynard Keynes in the pages of Waffle Street, lamenting, “How far we’ve fallen” in the area of economics education. Pointing out that Say’s Treatise was once the top economics textbook in America, he explains that now, “Instead of learning sound doctrine, today’s undergraduates are inundated with principles that will not bear the scrutiny of common sense and experience.”

I am still waiting to hear who will play Jimmy and then his wife. An amazing story. I’ve never been to a Hollywood premier before, but this is one I do not intend to miss. Meanwhile, you should read the book.

US GDP contracts at a rate of 2.9%

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Not exactly news but quite incredible all the same:

The Commerce Department said on Wednesday gross domestic product fell at a 2.9 percent annual rate, the economy’s worst performance in five years, instead of the 1.0 percent pace it had reported last month.

I especially like the bit about the worst in five years. It has now contracted during a supposed recovery at the same rate as it did at the height of the GFC. And for those few remaining fans of a demand stimulus, let me just add this:

Consumer spending, which accounts for more than two-thirds of U.S. economic activity, increased at a 1.0 percent rate.

Usual Keynesian ignorance about the two-thirds of economic activity. But however much it contributes, the economy went backwards even though consumption grew.

Getting Say’s Law exactly right

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It is so rare for anyone to get Say’s Law exactly right that you must forgive me if I quote at length, specially since he quotes me. This is from an article by Steve H. Hanke, Professor of Applied Economics at the Johns Hopkins University in Baltimore, and titled, “GO: J.M. Keynes versus J.-B. Say”. It is found in the publication, Global Asia:

The French economist J.-B. Say (1767-1832) was a highly regarded member of the Classical School. To this day, he is best known for Say’s Law of markets. In the popular lexicon – courtesy of John Maynard Keynes – this law simply states that “supply creates its own demand.” But, according to Steven Kates, one of the world’s leading experts on Say, Keynes’ rendition of Say’s Law distorts its true meaning and leaves its main message on the cutting room floor.

Say’s message was clear: a demand failure could not cause an economic slump. This message was accepted by virtually every major economist, prior to the publication of Keynes’ General Theory in 1936. So, before the General Theory, even though most economists thought business cycles were in the cards, demand failure was not listed as one of the causes of an economic downturn.

All this was overturned by Keynes. Kates argues convincingly that Keynes had to set Say up as a sort of straw man so that he could remove Say’s ideas from the economists’ discourse and the public’s thinking. Keynes had to do this because his entire theory was based on the analysis of demand failure, and his prescription for putting life back into aggregate demand – namely, a fiscal stimulus (read: lower taxes and/or higher government spending).

The rest of the article deals with the new statistic that has just been released by the Bureau of Economic Analysis in the United States which has largely been undertaken because at the instigation of the great Austrian economist, Mark Skousen. The notion that consumption drives an economy is so nonsensical since consumer demand is the end of all forms of production, from mining coal to generating electricity and so to focus on consumer demand is focusing on nothing at all other than the end of the production process. But if we are looking at value added, as we ought to be, only about 5% of economic activity is directed at selling directly to consumers. The new supply side statistic that has been developed, which at long last gets this balance right, will make a great difference in how the economy is perceived, which should also make a difference in how it is managed, or at least it is to be hoped. Let me finish with one further quote from Professor Hanke:

Even though the always clever Keynes temporarily buried J.-B. Say, the great Say is back. With that, the relative importance of consumption and government expenditures withers away. And, yes, the alleged importance of fiscal policy withers away, too.

Contrary to what the standard textbooks have taught us and what that pundits repeat ad nauseam, consumption is not the big elephant in the room. The elephant is business expenditures.

If you really want to stimulate the economy, it is business at every stage of production you have to go through and not the consumer. How different that kind of economic policy would need to be, but at least it will have the merit of actually producing positive results.

HET Montreal 2014

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The History of Economic Thought conference in Montreal has just ended and, as always, it was wall-to-wall interesting. I have already given a background report on the paper I gave before it was given and I can now report how nicely it went. Even in HET where historical change is our line of work, there is that dreamworld notion that everything stays as it is without effort so my warning that the history of economics has enemies who would drive it as far as they can from economic theory seems remote and incomprehensible. But the people who would move it are still in executive positions, but now it’s for a new generation to deal with.

The most remarkable aspect of the conference was that there was not a single paper on Keynes. Two, three, four years ago, such conferences were crawling with “Keynes, return of the master” sorts of things. Now, not a one. It’s not that the Keynesians have gone anywhere since it is still impossible to think about macro without aggregate demand. Instead, there is confusion and uncertainty about how to go forward, but try to find a textbook that talks about the national economy without mention of C+I+G. It can’t go away unless economists begin to understand Say’s Law and that’s not happening soon. So it is a sullen quiet resentment that hovers over economics with the vultures ready to pick at the bones of economies that fail to recover due to perceived failures of the various austerity programs. I think the Chinese are more likely to try a market-based solution before the Americans but that really means no one is likely to try one any time soon.

And as a bonus, Montreal is lovely, more similar to Melbourne, as I’d been previously told, than it is to Sydney. But the many “a louer” signs everywhere shows a city down on its luck. But aside from six months of winter with ten foot snow drifts, this seems a very liveable place to be.

Disproving Keynesian economics once and for all

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I don’t allow comments on this blog mainly because I am not up to policing what other people say. But I read them and this today, from Rob, was stunning. Referring to my little rant on the uselessness of economic theory today, he wrote:

But at least it has advanced enough to tell us that for more growth, we need …. more broken windows:

The Lack of Major Wars May Be Hurting Economic Growth

Tyler Cowen is a professor of economics at George Mason University

I mean, what would a dead white male like Frederic Bastiat know anyway?

Tyler Cowen is, of course, a live white male, but given there are such things as negative knowledge – things that if you believe them make you dumber than if you knew nothing at all – it is possible for him to know less than Frederic Bastiat, dead though he may be. Let me quote from the opening of that column:

The continuing slowness of economic growth in high-income economies has prompted soul-searching among economists. They have looked to weak demand, rising inequality, Chinese competition, over-regulation, inadequate infrastructure and an exhaustion of new technological ideas as possible culprits.

An additional explanation of slow growth is now receiving attention, however. It is the persistence and expectation of peace.

Let me put it this way. There is bad economics, there is unbelievably stupid economics, and there is the belief that growth has slowed because there are no wars.

It is neither here nor there that there’s not all that much peace around anyway. But let me remind you of the greatest disproof of Keynesian economic policy in history. Everyone always points out that one Keynesian data point which is the so-called boom that came at the start of World War II. Not a boom at all since what most people remember about the home front was rationing and controls of every kind, and if you are thinking about the labour shortages, merely recall that around half the labour force under thirty was drafted into the army. But that’s not that point either, although it should put quite a dent into such Keynesian thought.

It is the coming of peace in 1945 that is the grand refutation of Keynesian economics. At the end of the war, within a year millions who had been overseas fighting, or had been part of the war effort at home, were suddenly in the labour market looking for work. Many women who had taken jobs while the men were overseas also remained in the workforce. The Keynesians were continually badgering Truman to maintain war-time deficits since, they said, if he did not the US would go straight back into the depression. Truman, however, having had a business background, hated deficits and the US virtually balanced its budget in a single year. No deficits, no stimulus, no nothing. The US slashed its expenditures and in so doing set off the greatest economic boom in world history, a boom that lasted straight through until ground into the dust by the war on poverty, and dare I say it, the unfunded, deficit-financed war in Vietnam.

Thinking about economic issues from the demand side is the single biggest mistake anyone can make in economics. In fact, if you do think that way, you aren’t even an economist since Say’s Law was once considered the best test of a sound economist. Not many of them around any more, I fear.

Here is the message. An economy is driven only by real value adding supply. Nothing else. This is the message of Say’s Law, supposedly discredited by Keynes but as accurate a statement of economic principle as there has ever been.

Negative interest rates in Europe specifically designed to lower saving and raise inflation!

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Just what Europe’s economies need, lower saving and higher inflation:

Mario Draghi: “Together, the measures will contribute to a return of inflation rates to levels closer to 2%”

The European Central Bank has introduced a raft of measures aimed at stimulating the eurozone economy, including negative interest rates and cheap long-term loans to banks.

It cut its deposit rate for banks from zero to -0.1%, to encourage banks to lend to businesses rather than hold on to money.

The ECB also cut its benchmark interest rate to 0.15% from 0.25%.

The ECB is the first major central bank to introduce negative interest rates.

If one set of Keynesian policies don’t seem to work there are then others they have that will fail just as well. And if -0.1% doesn’t work they can lower the number even more. And the thing is, they are clueless about why none of this will work.

Say’s Law and Austrian economics

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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.

Piketty is an economic illiterate

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I have finally put my hands on a copy of Thomas Piketty’s Capital in the Twenty-First Century. And what do I find, that this world famous book, this book that is going to set our economic world on its head, in its introductory chapter makes a fundamental error in basic economic theory I would fail any first year student for making. Forget about fraudulent data. He has confused a shift in demand (ie a movement of the demand curve) with a change in quantity demanded (the effect on the number of units bought caused by a change in the price). For an economist, you cannot be more wrong than that. Here is the passage in which, of all things, he is discussing Ricardian land rents in a section he titles, “Ricardo: the principle of scarcity”:

“To be sure, there exists in principle a quite simple economic mechanism that should restore equilibrium to the process: the mechanism of supply and demand. If the supply of any good is insufficient, and its price is too high, then demand for that good should decrease, which should lead to a decline in its price.” (p.6 – my bolding)

He has here basically stated that insufficient supply (a shortage) will lead to a fall in price which you can see from the bits in bolding. An economist should immediately see the flaw, but for those not trained in the dark arts, let me explain.

1) The phrase, “if the supply of any good is insufficient” means, suppose there is more being demanded at the price than is being supplied. That is, suppose the price is below its equilibrium level so that there is upwards pressure on the price. He doesn’t say it quite that way, but only that “its price is too high” which, in theory terms, is a nonsense statement. But since he is talking about the pressure of demand on supply, he can only mean that the increase in demand is pushing the price up which is driving some people out of the market. As economists like to put it, the demand curve has moved to the right and prices have therefore gone up.

2) But because “its price is too high,” he writes, “then demand for that good should decrease.” Big, big mistake. He has shifted his meaning of “demand” from representing a movement of the entire demand curve to a movement along the demand curve. Higher prices, he is saying, cause the quantity demanded to fall. The demand curve stays put but with a higher price some people are leaving the market. That is why demand curves are downward sloping.

3) Then he writes that “demand for that good should decrease, which should lead to a decline in its price”. He has now mistaken a fall in quantity demanded, a movement along the curve, for a fall in demand, a movement of the entire curve to the left. He has confused a fall in the quantity demanded caused by a rising price with a fall in the level of demand, which is a shift of the entire curve.

This is one of the things I harangue my students about to stop them from making such elementary mistakes. Compare what Piketty wrote with the text of my Free Market Economics where I warn my students against making this absurd but common enough error, at least common enough amongst economic illiterates. From page 100:

Demand versus Quantity Demanded

People often do talk about demand as if it is a specific amount and it is therefore important to make sure that when someone is talking about “demand”, that one is aware of which meaning they have in mind.

Compare these two statements:

(1) if the price goes up demand goes down (and who would deny this is so?)

(2) if demand goes down the price goes down (and similarly, who would deny this?)

This becomes the following conclusion if the two statements are run together:

(3) if the price goes up [demand goes down; if demand goes down] the price goes down.

That is, if the price goes up the price goes down. A higher price is the cause of a lower price. Obvious nonsense, but it comes from using the word “demand” in its two different meanings.

In (1), this is using the word demand to mean a movement along the demand curve when the price happens to rise. In (2), this is using the word demand to mean a shift of the entire demand curve when one of the underlying factors has changed.

It is therefore essential to always make sure which meaning of demand is intended. You can usually tell from the context of what is being said, but the words here are slippery and can lead you into trouble.

This is trouble, all right. I find it absurd that Piketty cannot tell the difference between a shift of the demand curve and a movement along the demand curve.

To trust anyone’s economic judgment on serious economic matters who makes such a fundamental error would be ridiculous. He has 650 pages of stats and data but almost literally doesn’t know the first thing about economic theory?

The sentiment of a large majority of the active business community

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Reading classical economics for me is to be in the company of economists who understood how economies worked. I have of late been reading Simon Newcomb’s “The Problem of Economic Education” which was published in The Quarterly Journal of Economics in July 1893. And what he does is go through the kinds of economic illiteracy that was all too common in the general population of his time, with a decidedly pessimistic view of whether these ideas can ever be eradicated amongst the population in general. And this was even though there was then universal understanding amongst economists about how fallacious these fallacious ideas were. An example:

From the economic point of view, the value of an industry is measured by the utility and cheapness of its products. From the popular point of view, utility is nearly lost sight of. . . . The benefit is supposed to be measured by the number of laborers and the sum total of wages which can be gained by pursuing the industry. . . . Here legislation only reflects the sentiment of a large majority of the active business community. A man’s economic usefulness to society is supposed to be measured by his expenditure of money and consumption of goods. He who spends freely is pointed out as a benefactor; while the miser, who invests his income, is looked upon as a selfish being, mindful only of his own aggrandizement. (p. 7)

Well, that was in 1893 for goodness sake. Who today would think spending is good and saving bad? From The Australian today:

CLIVE Palmer wants the age at which Australians can access their superannuation lowered, saying it will boost domestic demand for goods and services and increase economic growth. . . .

“I think we should be allowing people to access their super at 50 if they want to.

“It’s up to them, it’s their savings … we want to get that money released from the super funds.”

On this, Newcomb wasn’t even close to being pessimistic enough. Now, and since 1936, even economists think saving is a bad thing and spending is good.

A policy experiment in the South Pacific

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Apparently we ran an experiment in economic policy here in the South Pacific which is described here:

[New Zealand] Treasurer Bill English said last week that he would cut public spending as a share of gross domestic product by more than twice as much as the Abbott government has announced.

In fact, without a minerals boom to line government coffers and despite a huge repair bill from two devastating earthquakes, New Zealand’s budget will be back in surplus by $NZ400 million ($370m) next financial year, rising to $NZ3.5bn by 2018.

English, now in his sixth year as New Zealand’s Treasurer, commendably chose not to emulate the world’s greatest treasurer Wayne Swan and kept a tight leash on public spending before and after the global financial crisis, preferring to cut income taxes and lift consumption tax. The Key government, facing election again later this year, is now reaping the rewards.

It wasn’t just our Wayne who took this road to ruin. Virtually everywhere was the same, with the US leading the way into an economic darkness it is impossible to see ending any time soon. But try to tell someone that Y=C+I+G is an economic death trap. But if you doubt it, look at the comparison with Australia.

The culmination of almost two decades of mainly populist budgets, the Abbott government will spend $6200 a person on cash welfare next year, over 25 per cent more than New Zealand’s government will on each of its citizens (converting all amounts to Australian dollars).

Education spending, at $2900 a person, is 10 per cent more generous in Australia but health expenditure is torrential by comparison: Australian state and federal governments will lavish more than $4600 a person to keep Australians alive and healthy, almost 50 per cent more than is spent in New Zealand. No methodological quibble could bridge such stark differences.

The relative splurge extends to hiring, too. Australia’s population of 23.5 million is about 5.2 times New Zealand’s, but as of June last year we had 8.4 times as many public servants: 1.89 million across our state, federal and local governments compared with New Zealand’s 226,000. . . .

Apart from a bloated public sector and a wellspring of whingeing, what does Australia get for its vastly more indulgent public spending? Much higher taxes, for one thing. The marginal income rate most Australians will pay from July — 34.5 per cent — will be higher even than New Zealand’s top 33 per cent rate, which makes a mockery of our 49 per cent top rate, which will be higher than China’s and France’s.

Undisciplined government spending will pull an economy into the dust. Such spending is a disaster both economically and then politically as governments try to pull things right.

And then there is also the delusion that low interest rates will propel an economy upwards, yet another Keynesian bequest.

Even rising interest rates have been unable to dent record high confidence levels among New Zealand households and businesses.

There is no “even” about it. High interest rates, or at least high enough to shut non-productive borrowers out of the money market, are a major factor in keeping an economy on track and growing. Economic theory today is comparable to the theories Adam Smith was writing about criticising in 1776 if not actually worse.