"Most people are in arrested development and cannot use logic." Jacob.
"Competition and capitalism are hated to-day because of their tendency to destroy poverty and privilege." William Hutt
"America is unique in that our economy is totally dependent on global charity." Peter Schiff

Thursday, August 18, 2011

Myth of Aggregate Demand, Part Two

As a public service, Smiling Dave will clue you in on the gist of Part One.

We quoted the Keynesians, who, like ants at a picnic, can be found everywhere. Just open any article on current economic events. They all argue that we are in a recession because there is a lack of aggregate demand.

We pointed out that demand means you want something, and equally importantly, can pay for it.

We pointed out that the Keynesians cannot mean that the problem is that people can afford whatever they want, but just have stopped wanting things. Because then the solution is advertising, not handing out money.

So they must mean that people still want what is being offered for sale, but they cannot afford it. It is just too expensive. Thus the solution, say the Keynesians, is crystal clear: give everyone more money.

We pointed out that money doesn't grow on trees; that if we are talking about the aggregate, meaning everyone in the economy, there is no way to increase the amount of money, meaning purchasing power, for everyone in any of the classical Keynesian methods. We showed that all their silly solutions, especially printing money [whether paper or digital], merely reshuffle existing purchasing power around, but do not create new purchasing power.

Which led to the question, in that case Smiling Dave, what would you do to increase aggregate demand? How would you make everyone wealthier at the same time?

Fortunately, our man Henry Hazlitt came through yet again. Here's a quote that says it all:

"Economic growth," higher real wages and living standards, are possible only through new capital formation.

He means we have to make more and better machinery, that can make more and better stuff at the same or lesser price.

Might as well quote another line that drives this idea home:
And the rate of true "economic growth" is in effect the rate of capital formation.

At this point, I wish to introduce my good friend, Mr Devil's Advocate [=DA]. I give him the floor, and we will start a dialogue.

DA: OK, we got it. Build more machines. But where is the money going to come from to do that? Everybody's broke, remember? That was the problem in the first place.

SD: Let me quote Bohm-Bawerk on that:

"To complete the act of forming capital it is of course
necessary to complement the negative factor of saving with
the positive factor of devoting the thing saved to a produc-
tive service. . . . [But] saving is an indispensable condition
to the formation of capital."

DA: Sorry Dave, you won't be able to mumble your way out of this one.

SD: What he's saying is very simple. If you need money, tighten your belt and save up. You will have to underconsume for a while, putting your nickels and dimes in the piggy bank, until you have enough saved up to buy those new machines.

DA: Now wait just a minute. That's treasonous. You're saying that the way to get rich, to end a recession, is to not spend as much?

SD: You got it.

DA: But that's just the opposite of what everyone else is saying. They all are talking about how we have to spend more. You are saying we have to spend less.

SD: Not spend less, consume less. Saving is really a form of spending, spending on capital formation. The idea is, buy one less hamburger today, put the money in the bank. The bank will lend the money to some clever business man, who will use it build a better, cheaper, mousetrap.

DA: But that's ridiculous. If we consume less, the stores will obviously not make as much profits. They will buy less from the factories. The factories will have to stop making as much, meaning they will have to fire people. You are advocating that we increase unemployment.

SD: Do we have any choice? Stuff is being made we cannot afford. Obviously we have to stop making it for a while, because no one will buy it.

DA: But you are creating a downward spiral of unemployment and poverty. And you think that's how we will get rich again?

SD: Actually, the idea is not to have unemployment, but to move the workforce from one part of the economy to another. Instead of working at Walmarts, they will find jobs where the money is now supposed to be going. They will be hired by that clever businessman who borrowed the money from the bank to improve his business.

DA: I get it, sort of. We are poor, and have to do all the responsible adult things that we hate to hear about to climb out of it. But there's one piece of the puzzle that eludes me. How does the guy making a better mousetrap make us all richer? I see how he personally might get rich, but how will that help li'l ole me?

SD: He provides jobs, and he provides better, cheaper, mousetraps.

Bottom line, the problem never was lack of demand in general, meaning not enough money to go round. It was malinvestment, meaning the wrong things being made. More on this next blog.

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