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Keynes and Hayek portrayed in the Fight of the Century. |
I was wondering. Should I refer to Ludwig von Mises as “von Mises”, instead of “Mises”? Should I change my name to Smiling von Dave?
We know that Keynes popularized an old blunder [one picked up by the Money Dis. crowd], one that was around for ages, the so called lack of Aggregate Demand. Say wrote his famous law to refute it, and I’m sure a little research will find it mentioned in the Stone Age cave drawings.
We’ve written many times about how wrong it is, in theory and reality. Now it’s time to see how Mises took care of it. Genius that he was, all he needed was one line to expose the key flaw in Keynes’s theory.
Unfortunately, when he wrote the one liner, he didn’t mention Keynes by name. He also wrote it in technical language, because he wasn’t addressing a lay crowd, but experienced economists. This may be why Mises’ argument is not well known. Luckily for our generation, and for mankind in general, Smiling von Dave is here to spell it all out.
What is Keynes’s argument? Over the years, the first step had to be revised constantly, but the second step is always that people hoard their money instead of spending it. That first step, the explanation why they hoard, had to be changed over and over, as every explanation offered has been exposed as true of Bizzaro World only. But that is not our concern now. We will accept that for some reason, people hoard. Massive Hoarding is also called a General Glut [of products that people aren't buying], and Lack of Aggregate Demand, and by the Monetary Dis. crowd, as Excess Demand for Money, or a Money Shortage.
So what’s so terrible if people don’t spend their money? Everything, says Keynes. It means money won’t get back to the manufacturers. Meaning they will lose money. Meaning they will fire people. Meaning even less spending, meaning a vicious circle, until we have a Depression with massive unemployment. Furthermore, there is no reason to assume people will spend ever again, so this situation may well be permanent.
Keynes goes on to propose various solutions that are even worse for the economy than the problem he raised, but that is not the topic of discussion right now.
[von] Mises claimed the problem is not a problem in the first place. Sure we have depressions, but they aren’t a result of General Glut. Kaptain Keynes has it all wrong.
To understand why, let’s imagine that a bunch of Aliens came down from Mars to Earth. They are from the Planet of War, and have admired the way mankind has been killing itself more and more bloodily for less and less reason. Out of sheer respect for our murderous ways, they volunteer to be our slaves. They go out and pick the cotton, wait on tables, and do a lot of things for us, all for free. Being Martians, they don’t eat Earthly food or consume any Earthly products.
And here comes Devil’s Advocate, again. Just when I was warming to my topic.
DA: von Dave, are you saying von Mises wrote about Martian slaves?
SD: No, von Devil, it’s me. I’m describing a thought experiment. You know, like Einstein did for physics.
DA: Oh, I see. von Einstein made this up.
SD: Whatever. Since you’re here, Devil, tell me. What effect will these Martians have on the economy?
DA: They will be great for the economy. Economists of all schools agree that if you increase production, as these loyal slaves are doing, that’s good. More goods, more capital accumulation, it’s great.
SD: What about the fact that they aren’t eating or consuming anything at all?
DA: Are you kidding? That’s what makes them so good for the economy. They produce and produce, making us all richer, and take nothing back in return.
SD: But they aren’t contributing to Aggregate Demand. Isn’t that a problem?
DA: Dave, how foolish can you be? You know what they call demand in the movies? “Another Mouth to Feed”. If those Martians start consuming, there will be less for us Earthlings.
SD: OK, Dev, thank you. You just disproved Keynes.
DA: What?
SD: Keynes is describing a situation exactly like the Martians coming here to be our slaves. He says that for some reason or other, a lot of Earthlings have decided to become Martians and work for free. They are producing but not consuming. Instead of spending their money [=consuming] they are hoarding it [= not being mouths to feed]. Just like the Martians, they are making us all richer. They produce, but don’t consume. They increase our Capital Accumulation by working, and don’t decrease it by spending.
DA: von Dave, you are losing your touch, no offense. The Martians did not eat, but they did not get money either. The Earthlings aren’t eating, but they are getting money. That’s the problem. Money is magic. It is the gasoline that makes the automobile called the Economy run smoothly. By hoarding their money, they are clogging up the works.
SD: They aren’t clogging anything. Say the money has disappeared, never to be seen again. So what? The nation is neither richer or poorer by that. The wealth of a nation is its goods and services. Money is just a measuring stick for that.
DA: But if money disappears, then by the laws of supply and demand, the purchasing power of money will increase. Those guys who buried their money have made our money worth more.
SD: You say that like its a bad thing.
DA: But what about the fact that the earthlings who work for free aren’t buying anything? Won’t that mean that even though the nation as a whole is wealthier, because more capital has been accumulated, there will be one bad side effect? Doesn’t it mean manufacturers will lose money, because they aren’t selling to the Earthlings turned Martians?
SD: There may be an adjustment period, sure. No economy is static, anyway. What is produced, what jobs people have, has to change constantly, and does. But bottom line, there is only one thing that counts. If an economy increases its capital stock, it is richer. Its future is brighter than before. There will be more jobs, there will be higher wages, there will be a higher standard of living. That’s what capital accumulation does.
It is madness to call that a problem, and to brew some mad scheme to reduce the capital stock. If someone hoards money, that means he’s essentially working for free, and voluntarily to boot. Like the Martian, he is increasing the capital stock without being a mouth to feed who will reduce it by consumption.
DA; von Dave, you say von Mises wrote this. Show me Chapter and Verse.
SD: It’s the last section [Section 9] of Chapter 18 in Human Action. Let’s quote it in italics, with my comments in regular font:
In recent years economists have paid special attention to the role cash holding plays in the process of saving and capital accumulation. Many fallacious conclusions have been advanced about this role.
Translation: Keynesianism has taken over the world, and made a big deal about cash holding, aka hoarding.
If the individual saver employs his additional savings for increasing his cash holding because this is in his eyes the most advantageous mode of using them, he brings about a tendency toward a fall in commodity prices and a rise in the monetary unit’s purchasing power.
Translation: His hoarding does change the prices of things, of course.
If we assume that the supply of money in the market system does not change, this conduct on the part of the saver will not directly influence the accumulation of capital and its employment for an expansion of production.
Translation: But so what? The capital he created is all there. It hasn’t disappeared.
The effect of our saver’s saving, i.e., the surplus of goods produced over goods consumed, does not disappear on account of his hoarding.
Translation: Guys, this fellow is working for free. He’s a Martian who is producing and not consuming. The fact that he buried his money in the sand does not change that.
Just to make sure we get it. Mises repeats the salient point again. Hoarding changes prices. But it does not erase the capital accumulation that is a direct effect of the guy being a Martian:
The prices of capital goods do not rise to the height they would have attained in the absence of such hoarding. But the fact that more capital goods are available is not affected by the striving of a number of people to increase their cash holdings.
Knowing most people have to be told things three times before it sinks in, Mises says it yet again:
If nobody employs the goods—the nonconsumption of which brought about the additional saving—for an expansion of his consumptive spending, they remain as an increment in the amount of capital goods available, whatever their prices may be.
In other words, we owe a big thank you to this Earthling turned Martian. He has increased our capital stock by not consuming what he produced. Thank you hoarder, thank you.
Mises then points out the obvious, that the whole reason he is making us all richer is because he is not spending. He is not being a mouth to feed.
The two processes—increased cash holding [=hoarding] and increased capital accumulation [=making us all wealthier]—take place side by side.
Guys, the essential idea is so short and so simple that all Mises can do is repeat it in various ways again and again. I spotted two more times he restated it. I leave it as an exercise to the reader to find them.
DA: One last Parthian shot at you, Dave. What is the one liner?
SD: It’s the idea he keeps repeating over and over, frinstance this:
The effect of our saver’s saving, i.e., the surplus of goods produced over goods consumed, does not disappear on account of his hoarding.
DA: Curses! Zinged again!
Originally posted at Smiling Dave's Blog of Psychology, Economics, and Gentle Sarcasm. Reposted here in accordance the GNU General Public License.