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Wednesday, June 22, 2011

Layer 2 of the Cake

Welcome back. For those of you following the blog, we are defending Say's Law from one LK

LK quoted Thomas Sowell [a good guy] as saying that the classical version of Say's Law assumed or asserted six things. The first was James Mill's version of the Law, that whatever is produced in an economy is exactly enough to buy what is sold in an economy. Last post, we explained this with the homely parable of twenty children sitting in a circle, trading toys.

We move on to the next of the six propositions Sowell stated as being part of Say's Law, what we are calling Layer Two of the cake. Without further ado:

(2) There is no loss of purchasing power anywhere in the economy. People save only to the extent of their desire to invest and do not hold money beyond their transactions need during the current period [James Mill and Adam Smith].

Just to make sure we are all on the same page, the second sentence is intended as a reason for the first.

LK claims that this assumption is essential for Mill's version of Say's Law, the first layer of the cake, to be true. And to the superficial mind, he looks right. Going back to the twenty kids in a circle trading toys, LK is saying that we forgot to introduce money into the picture.

OK, let's do that. We'll make the children's party more realistic, and now it will be twenty children standing in two rows facing each other, ten children to a row. All the children are trying to sell their current toy and buy a different one, and each has a five dollar bill. Not all goes well. The children in the left row all sell their toys to some child in the right row. So at this stage the kids on the left have 10 dollars each, five that they came to the party with and five from selling a toy, and the kids on the right have two toys and no money. Before the kids on the right have a chance to sell their toys, Mommy comes in and says the party is over for now, but they are all invited back tomorrow.

The next day, the two rows form up. The kids on the right bring their old toy, but keep the toy they bought yesterday at home. After all, they just bought it, they like it, they don't intend to sell it. They only bring their ten old toys, one per child, to the party. Their plan is to sell the old toy, and go home with five bucks apiece, just like they started with before the parties began.

They line up in two rows, and then the disaster comes to light. None of the kids on the left have brought any money. They ended yesterday with ten dollars each, but they brought zero of it today.

"What happened? Where's the money? Aren't you going to buy our toys?"
"We decided to keep our money under the mattress."
"But didn't you read Mill in Commerce Defended, page 83? Don't you know that every individual in the nation uniformly makes purchases, or does what is equivalent to making purchases, with every farthing's worth which accrues to him? And that the whole annual produce of the country, therefore, is employed in making purchases?"
"Meh, we're into hoarding."

As LK explains, some people will hoard because...
In a fundamentally uncertain world, you have the problem of facing a possible lack of liquidity in the future (i.e., lack of money). This is why many people like to hold onto money, and precisely why money has utility – and in fact often has a great deal of utility.

He quotes Keynes to inform us that money does not grow on trees, so that if people want more money to hoard they cannot hire someone to grow it for them. And money is mostly not replaceable with something else to hoard instead. So when hoarding fever strikes, for whatever reason, those last ten kiddies on theright row will be stuck with their old toys, and no one will buy them.

If we now change our point of view to the real world, what he is saying is that producers in all industries may innocently produce normal quantities of stuff, same as last year and the year before that, but this year people get mattress disease and want to hoard their money and not buy anything. Unsold stuff means recession, because workers have to be laid off.

Thus has LK lopped off two layers of Sowell's cake in one blow. The second layer is wrong. People do hoard. And so the first layer is wrong too. There might not be enough money to buy all that is produced, because the requisite cash is under a mattress somewhere.

Truth be told, we have seen how Hazlitt and Rothbard dealt with this in an earlier post. In short, Hazlitt points out that historically people do not hide money under a mattress, but put it in a bank. He explains how that places the money right back into circulation.

Rothbard comes at it form a different angle. If people really did hide money under a mattress to a significant extent, the cash in their wallets would gain in value [by the law of supply and demand applied to money], so the purchasing power to buy all that is produced would still be there.

For a guy who has a bibliography of over 25 books for that article, including major Austrian works, you'd think he'd bother to present the well known Austrian refutations of his line of reasoning, if he had something to say about them.

Break time.

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