Thoughts on Say's Law

Much of the disagreement in macroeconomics boils down to whether or not a person believes in Say's Law. Jean-Baptiste Say claimed that under-investment/production is impossible - in a free market, there will never be unused resources. This is in direct conflict with Keynes' and his descendants' argument that monetary/fiscal stimuli are able to bolster economic activity by draining away excess reserves and putting them to productive use. In other words, Keynesians believe that there is no (or very little) opportunity cost for the resources expended by expansionary monetary or fiscal policies, because if they are not spent by the government or central bank, they will simply be hoarded by the private sector.

Taken at face value, I think most people would consider Say's Law to be observably false. After all, most people have a savings account with "unused resources" at this very moment. In that sense, I would agree that Say's Law appears to be incorrect. There are constantly resources being held and not being put to immediate use in neither production nor consumption. However, I don't believe that's what Say was trying to say (pun intended).

Yes, at any given time an individual or a business may hold resources in reserve. But those resources are not held arbitrarily - they are being accounted for and being put to a use other than production or consumption. Consider a business holding capital in reserve. Why might they do this? There are a few possible explanations, but one of the more obvious responses is that they are holding them as a safeguard. The business is likely using up other resources in production or investment. The resources held in reserve function to diminish the risk associated with undertaking such production or investment projects. Without those reserves, those projects may well become too risky for the business to undertake. So, while the reserves are not being used in a physical sense, they are still serving and important function. 

When you think of it like this, Say's Law doesn't seem so wacky after all - in fact, it seems like common sense. The point is, all resources are appointed certain roles for very good reasons. It is certainly plausible that one of those roles could be functioning as held reserves, hedging against risk. Re-applying this understanding of how resources are used creates a gigantic problem for proponents of fiscal or monetary stimuli. Depleting reserves may appear to cause no harm to the private sector, but it would necessarily change the way businesses and individuals use their other resources - it now becomes more costly (due to risk) to use the remaining resources. No matter how many resources are held in reserve by people or businesses, taking those resources will divert the economy away from the decisions made by individuals and make it more costly for the private sector to produce and consume. Neither monetary nor fiscal stimuli are free from opportunity costs. 

Surprise, Surprise: Marxist Blames "Capitalism"

I was watching the lecture titled "Advanced and Applied Marxian Economics" by Richard Wolff, and this stood out to me:

"Every leader who's ever intervened has made that promise [that we will get out of the crisis and prevent future crises] and every leader has been unable to fulfill that promise... Capitalism and cyclical instability in prices are twins... What we have is an endless series of efforts to contain and limit and control prices, without getting rid of capitalism."

Hmm... so, we're left capitalism as the cause of our woes. The only difference is our version of capitalism includes the government steering the economy and limits/controls on prices. Wait, that sounds a lot like... NOT capitalism. 

Maybe Wolff has a different definition of capitalism than I do. But I decided to look up the Merriam-Webster definition:

An economic and political system in which a country's trade and industry are controlled by private owners for profit.

Even by this standard definition, when prices are controlled by the government (i.e., trade is no longer controlled by private owners), the essence of capitalism has been violated.

Is Wolff completely oblivious to the meaning of capitalism, or is he being intentionally misleading? Wolff is a renowned Marxist economist. This sort of thing is why it's so hard for me to take Marxists seriously.

Natural vs. Unnatural Monetary Expansion: Cantillon Effects

A major underpinning of Austrian Business Cycle Theory is the concept of Cantillon effects. You see, a few hundred years ago, Richard Cantillon observed that when new money enters the economy, the money is not spread out equally (i.e., not every person will receive the same share of the new money). Instead, money tends to enter the economy at particular points. When this money expansion is coming from a government or central bank, it's reasonable to believe that the first to receive the new money will be those with political pull. Those that receive the money first are excused from the inflation that will soon follow.

Now, this may seem unfair. A select few benefit from free money, while the rest suffer from inflation. Indeed, it is unfair, but that's not really the point. ABCT suggests that this new money is spent by the select industries lucky enough to receive the new money, which props up the production of input goods for that industry.  At this point, the economy becomes skewed toward those industries. Overproduction of these input goods is what Austrians call "malinvestment," and will eventually lead to an economic crisis.

Enter some Keynesian or Modern Monetary Theorist.

"Ah, but a Cantillon effect is not solely a central banking phenomenon. Suppose a business writes a promissory note. The receiver of the note will then use it to purchase input goods, and this will produce the same Cantillon effect as monetary expansion by a central bank. So, should we outlaw all forms of credit?"

Well, "some Keynesian or Modern Monetary Theorist" (if that is your real name), you have completely missed the point. Cantillon effects are not intrinsically harmful to the economy, they are simply the method through which malinvestment is achieved.

The reason the Cantillon effects stemming from money printing are bad is because there is no real wealth to back up the money. The money has been created "out of thin air." When the economy is eventually skewed toward the industries where the new, false money resides, we have begun investing in industries based on false information.

In contrast, if a business issues a promissory note, they do so with the ability to (or expectation of the ability to) pay the note. The note will be paid off with profit generated by the business - meaning real wealth is being created by this business. There is absolutely nothing wrong with real wealth transforming the economy. In fact, it is a magnificent and necessary consequence of a growing economy. The real wealth is being transferred to the input goods of this profitable businesses, allowing investments to flow to the factors of production of a profitable businesses.

Maybe Austrians need to be more clear on this issues. Cantillon effects can be positive in an unhampered market economy. The problem only arises when false wealth is created.

5 Reasons I Am Not Voting For Mitt

1. Military Spending - From the Romney campaign:

As Commander-in-Chief, Mitt Romney will keep faith with the men and women who defend us just as he will ensure that our military capabilities are matched to the interests we need to protect. He will put our Navy on the path to increase its shipbuilding rate from nine per year to approximately fifteen per year, which will include three submarines per year. He will also modernize and replace the aging inventories of the Air Force, Army, and Marines, and selectively strengthen our force structure. And he will fully commit to a robust, multi-layered national ballistic-missile defense system to deter and defend against nuclear attacks on our homeland and our allies.

This will not be a cost-free process. We cannot rebuild our military strength without paying for it. Mitt Romney will begin by reversing Obama-era defense cuts and return to the budget baseline established by Secretary Robert Gates in 2010, with the goal of setting core defense spending—meaning funds devoted to the fundamental military components of personnel, operations and maintenance, procurement, and research and development—at a floor of 4 percent of GDP. 

Currently, U.S. military spending accounts for 41 percent of total world military spending, making its military budget the largest in the world. The second largest is China, with only 8.2%. Apparently, this is not good enough for Mitt Romney.

The current level of U.S. government spending is both economically detrimental and unsustainable. If our president refuses to make cuts on spending that goes directly toward violence and destruction, how could he possibly justify cuts in social spending?

2. Inconsistency - During his political career, Romney has found himself on both sides of many issues, including:

- Abortion

- Gun control

- Bank bailouts

- Coporate bailouts

- Government mandates

- Climate change

When a candidate flip-flops on so many major issues, it is difficult to count on him to stand with the promises and principles of his platform throughout his entire term. The fact is, we have no way of knowing what Romney truly stands for.


3. Keynesianism - From Romney's nomination acceptance speech:

His [Obama's] trillion dollar cuts to our military will eliminate hundreds of thousands of jobs, and also put our security at greater risk;

His $716 billion cut to Medicare to finance Obamacare will both hurt today’s seniors, and depress innovation – and jobs – in medicine. 

Here, Romney demonstrates a belief in the popular fallacy that government spending drives economic prosperity, an important tenet of Keynesianism. The late economist, Henry Hazlitt, identified this as the "Broken Window Fallacy." The logic is as follows:

A child throws a rock and breaks his neighbors window. The neighbor is then forced to pay to have his window replaced. While common sense dictates that this is a negative occurrence, a Keynesian says, to the contrary, that the broken window initiates a chain of events that lead to greater economic prosperity. The neighbor pays the window repairman. The repairman then spends the money on something he needs at a local store. The store owner then buys goods from a producer. And so forth.

However, this analysis neglects "the unseen." The neighbor has lost wealth. He would have preferred to use elsewhere (somewhere that better satisfied his needs or wants), the money that he was forced to spend on the window repair. Meaning, the money would have been spent in an area that is more economically beneficial, then went through a similar cycle.

Much like the broken window example, Romney fails to see "the unseen." He sees the money generated by government spending on military and healthcare. But, he neglects the money taken from the economy through taxes, which would have been spent by individuals in a manner that best suited their preferences. The government has effectively forced wealth into the industry that it prefers, while disregarding the choices of millions of individuals. This is what Romney calls economic prosperity.


4. RomneyCare - Romney's state-level healthcare mandate served as a model for ObamaCare. Both plans are in conflict with individual liberty, as they limit free choice by forcing citizens to purchase a plan. These plan are also based on faulty economics, which will lead to waste and increasing costs in the the health market.


5. The Status-Quo - With over 15 trillion dollars in debt, long-lasting high unemployment levels, a depreciating currency, and never-ending military conflict, it is apparent that the U.S. needs a philosophical reformation. Yet, it is difficult to see anything that a President Romney would actually change. The following is a brief list of his status-quo entities and policies that Romney would continue:

• The Federal Reserve 
• Medicare, Medicaid, Social Security 
• The War on Drugs 
• The Food and Drug Administration 
• Military interventionism 
• The IRS/national income tax 
• Wage controls 
• Barriers to trade 
• Foreign aid 
• Corporate Welfare 
• The Patriot Act/The TSA 

The only significant change proposed by Romney, that I know of, is the repealing ObamaCare, which he has said he will replace with his own plan (surely to be another big government, bureaucratic mess).

A vote for Romney is akin to saying "America is on the right path." This is something I certainly do not believe.

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I could go on. There are plenty of reasons not to vote for Romney, but these are the big 5. Any one of these, by itself, would be enough to scare me away from checking his name.

So, go vote for Obama. (Just kidding, don't do that either)

Governing Dynamics Refutes Adam Smith?

A Beautiful Mind has been one of my favorite movies for years. However, I have a criticism to offer, after watching it again recently. Below is one of the most famous scenes from the movie:

This is the scene where John Nash finally discovers the revolutionary idea he's been searching for, Governing Dynamics (or what is now known as Nash Equilibrium). However, the movie completely misrepresents the concept.

"Adam Smith needs revision. If we all go for the blonde, we block each other - not a single one of us is going to get her... What if no one goes for the blonde? We don't get in each other's way... It's the only way we win. 

The best result will come from everyone in the group doing what's best for himself... and the group. Adam Smith was wrong."

So there we have it. The theory of the Invisible Hand has been demolished. Well, at least that's what some bloggers across the web have claimed, based on this clip.

In reality, Nash's theory of Governing Dynamics was not meant to be a critique of Adam Smith, nor was it a recommendation for social organization. It's simply a theory that can be used to predict the outcomes of certain situations.

In other words, Nash wasn't saying, "We need to consider the group, not just self-interest." Nash was saying that human action *IS* influenced by the actions of others. In the clip, it is in everyone's self interest to not go for the blonde. It has nothing to do with concern for the overall group. An individual from the group must simply take into accord the actions of the others in the group, in order to make the correct, self-interested decision.

Nash was not concerned with how society should function. His theory deals with the reality of self-interested human action.

I just needed to get that off my chest. Carry on.

In Defense of Free Banking

One area of disagreement within Austrian Economics is on the subject of the proper role of banks. Specifically, many Austrians disagree on whether or not banks should be required to maintain full reserves on savings. This divergence goes back to Mises (a defender of free banking) and Rothbard (a proponent of full reserve banking). It is important to recognize that both positions are very different from, and preferable to, the status quo. However, I believe free banking is both the most economically beneficial position, and the position that stands on free market principles.

I will attempt to simplify the issue:

Assume there exists an island on which only two people, Fred and George, make up the population. Fred  spends his time picking apples, while George spends his time on bananas. Both depend entirely upon the consumption of apples or bananas for survival. Trade exists between apples and bananas, so it is possible for  both Fred and George to consume a combination of apples and bananas, instead of relying completely on one or the other.

One day, Fred decides to leave some of his apples with George, in exchange for protection of his apple supplies while Fred goes out picking for more apples. George decides to consume the apples in order to maintain the energy levels for one day's banana picking.

Clearly, George expects to receive a higher value in banana picking for the day than the value he consumed in apples. If this were not the case, George would have not touched Fred's stock of apples. (This is assuming that George receives utility from Fred's "banking" with him. George wants Fred to continue to leave his apples with him in the future, so that he may use the apple resources to generate more bananas.) So, George wants Fred's initially banked value to be returned to him when he demands it. George is able to meet Fred's demands because his apple resources were used to generate an equal or higher value in bananas (if things go as expected).

This is precisely what is going on in a free market, fractional reserve banking system, except rather than using banked funds themselves, banks loan out the funds for others to use on investments. There is no false credit expansion as we have currency debasement. The credit expansion is real because the loanable funds are true sources of wealth that are being used to generate returns on investments. Thus, I reject the Rothbardian case for full-reserve banking as a means to prevent a Misesian boom-bust cycle.

There is an objection that may be raised. What if things do not go as expected in the world of Fred and George? What if George uses Fred's apples but fails to gain the necessary return on investment? Fred would not be able to collect his full demand.

This is certainly a concern, but hardly one that is not inherent to a market economy. Suppose instead Fred had invested his apples in George's firm, Bananas Inc. There is clearly a possibility that Bananas Inc. will fail and Fred's initial investment will not be returned. Fred implicitly accepted that risk when he invested the money.

The same is true for Fred, or any person, who puts their money in a bank. There is a natural risk (albeit small) that the banked money will not be returned in full. Fred was compensated for this risk by the security George provided in watching over his stock of apples. In our world, bank savers are compensated in a similar manner.

I seriously doubt any Austrian economist would demand an S&P 500 company maintain full reserves on money invested by a stockholder. When a company uses the unused resources of savers to invest in current and future production, we see it as the eloquent functioning of the market. But when this same activity is organized through a banking system, it is called credit manipulation or fraud.

Paul Krugman Outdoes Himself

Nobel laureate and New York Times journalist Paul Krugman has once again lived up to his legacy of being a Keynesian simpleton. His most recent blog post that has left me open-mouthed is titled What You Add Is What You Get. Krugman writes on the effects of raising taxes on the rich:


So, imagine a Romney supporter named John Q. Wheelerdealer, who works 3000 hours a year and makes $30 million. And let’s suppose that he really does contribute that much to the economy, that his marginal product per hour — the amount he adds to national income by working an extra hour — really is $10,000.

Now suppose that President Obama has reduced Mr. Wheelerdealer to despair . . . Wheelerdealer decides to go Galt. Well, actually just one-third Galt, reducing his working time to just 2000 hours a year so he can spend more time with his wife and mistress.

Wheelerdealer adds $10,000 worth of production for every hour he works, so his semi-withdrawal reduces GDP by $10 million. Bad! But what is the impact on the incomes of Americans other than Wheelerdealer? GDP is down by $10 million — but payments to Wheelerdealer are also down by $10 million. So the impact on the incomes of non-Wheelerdealer America is … zero.


Clearly, Dr. Krugman sees the economy as a simple numbers game to be manipulated at the whims of the elite. Can he truly not see that the economic consequences go beyond immediate GDP statistics? By his logic, the government could raise taxes to 100% on every single person, distribute the funds arbitrarily, and the economy would still be perfectly fine. There's still the same amount of money in the economy, right Paul?

No, something that cannot be measured in GDP is the incentive to invest in future production. Communism fails because the incentives to produce are absent. Capitalism leads to prosperity because members of the society receive a reward equal to value in what they produce. Mises eloquently sums up one of the necessary conditions for action:


A . . . condition [for human action] is required: the expectation that purposeful behavior has the power to remove or at least alleviate the felt uneasiness. In the absence of this condition, no action is feasible. Man must yield to the inevitable. He must submit to destiny.


When income is distributed, not by what an individual produces and earns, but by the determination of need according to the government, the power to affect one's own condition is lessened. Thus, individuals are incentivized to show need (or establish political pull) instead of benefiting the economy through producing goods or providing services. There is no way to manipulate GDP that will make a man productive. Krugman, being an excellent mathematician, lacks the capability to use simple economic reasoning.

Now, Krugman allows income to be equal to a person's marginal product for the purposes of this particular writing. However, he strongly implies that it is not actually so. I must agree on this. But it is not due to the flaws of the free market, as Krugman would have us believe. To the contrary, the reason that the top income earners are able to receive incomes which exceed their marginal product is that people like Krugman prop up the corporate welfare system through Keynesian bailouts and central banking. Through bailouts, large companies are able to receive benefits from the government while the market is trying to oust them. Similarly, central banks are capable of providing loans with low interest rates to companies that are going through financial difficulties.

In a free market, choices are made voluntarily. Every monetary transaction is made with the consent of both the purchaser and the provider. It is inconceivable that a consumer would purchase a good or service at a price higher than its worth to them. Thus, it is implausible that anyone, in a purely free market, could earn an income larger than their marginal product. Only through theft could such an outcome be possible.