Obama Challenges the Law of Markets

In the public mind, recessions are ascribed to insufficient consumption. Members of the public can hardly be held accountable for their erroneous thinking when we consider that every media outlet on the planet seems to regurgitate the same error, including vulgar Keynesians. However, more intelligent Keynesians will point an accusing finger at the "animal spirits" of businessmen, blaming them for investment being volatile. But this is just a flashier version of the underconsumption theory that argues that insufficient demand is what brings on recessions. If this be so then the solution is obvious: pump up demand. In plain English, increase the money supply.

This brings me to Obama's 'economic stimulus' that seems geared more towards enshrining a permanent Democratic majority and entrenching massive government spending than in promoting recovery. Nevertheless, the idea that government spending - through monetary expansion - is fundamental to achieving economic recovery is clearly one of the legs propping up Obama's 'economics'. If this were not so, then he would have been unable to garner sufficient support for his policy. Therefore the question that is debated is not whether government spending is needed but how much and on what. Unfortunately, this really is the wrong question. What needs to be debated is the theory that has it that increased government spending is necessary to lift an economy out of recession.

In my opinion there is no better place to start than with the classical economists, those intellectual pioneers who had thoroughly thrashed out this question and found that rather than promote economic growth, increasing government spending will retard it. They also understood that what was needed for recovery from a recession was not more taxes, regulations and spendthrift government but the elimination of "disproportionalities" (what the Austrians call "malinvestments") and the restoration of consumption and investment to their proper proportions.

All of this was within the framework of Say's law of markets according to which production is the source of demand and not consumption. The American Marxist economist Paul Sweezey was spot on when he wrote:

...the Keynesian attacks, though they appear to be directed against a variety of specific theories, all fall to the ground if the validity of Say's Law is assumed.

A Keynesian could snort: "So What? Everyone knows Keynes refuted Says Law". In fact Keynes did absolutely nothing of the kind. What he did was to deliberately misstate the law so that he could refute his version of it. He then tried to support his conclusion with a truncated passage from Mill. (The General Theory of Employment Interest and Money, Macmillan-St. Martin's Press, p. 18). Let us look at what Keynes deliberately ignored. Mill wrote that

which constitutes the means of payment for commodities. It is simply commodities. Each person's means of paying for the productions of other people consists of those which he himself possesses. All sellers are inevitably and ex vi termini buyers. Could we suddenly double the productive powers of the country, we should double the supply of corn modifies in every market; but we should, by the same stroke, double the purchasing power. Everybody would bring a double demand as well as supply: everybody would be able to buy twice as much, became every one would have twice as much to offer in exchange. It is probable, indeed, that there would now be a superfluity of certain things. Although the community would willingly double its aggregate consumption, it may already have as much as it desires of some commodities, and it may prefer to do more than double its consumption of others, or to exercise its increased purchasing power on some new thing. If so, the supply will adapt itself accordingly, and the values of things will continue to conform to their cost of production. At any rate, it is a sheer absurdity that all things should fall in value, and that all producers should, in consequence, be insufficiently remunerated. If values remain the same, what becomes of prices is immaterial, since the remuneration of producers does not depend on how much money, but on how much of consumable articles, they obtain for their goods. (Essays on Economics and Society University , Collected Works of John Stuart Mill, Vol. III, University of Toronto Press 1967, p. 571-72).

Mill had also written elsewhere:

Nothing is more true than that it is produce which constitutes the market for produce, and that every increase of production, if distributed without miscalculation [italics added] among all kinds of produce in the proportion which private interest would dictate, creates, or rather constitutes, its own demand. (Essays on Economics and Society University , Collected Works of John Stuart Mill, Vol. I, University of Toronto Press 1967, p. 278.)

Two things stand out. The first one being the stress on the classical insight that demand springs from production. Hence "supplies constitute demands". The second - and perhaps not so obvious point - is the recognition that disproportionalities (disequilibrium in modern jargon) do emerge and must be dealt with. And as for Obama's suggestion of reducing unemployment by raising taxes to expand the public payroll and subsidising all manner of projects, Mill scathingly observed:

The utility of a large government expenditure, for the purpose of encouraging industry, is no longer maintained. Taxes are not now esteemed to be 'like the dews of heaven, which return in prolific showers'. It is no longer supposed that you benefit the producer by taking his money, provided that you give it to him again in exchange for his goods. There is nothing which impresses a person of reflection with a stronger sense of the shallowness of the political reasoning of the last two centuries, than the general reception so long given to a doctrine which, if it proves anything, proves that the more you take from the pockets of the people to spend on your own pleasures, the richer they grow; that the man who steals money out of a shop, provided that he expends it all again at the same shop, is a public benefactor to the tradesman whom he robs, and that the same operation, repeated sufficiently often, would make the tradesman a fortune. (Ibid. p. 262-63.)

Without a doubt, the old mercantilist fallacies are back with a vengeance.

The heart of Say's Law is simple and amounts to the fact that there cannot be general overproduction. Say never claimed, neither did any other classical economist - as is made clear by Mill's writings - that depressions were impossible along with gluts of particular goods, far from it. We have already noted that Mill drew attention to proportionality or what we today call equilibrium. Hence doubling a nation's real income does not result in a doubling of demand for all goods and services.

The key to avoiding a glut in one good, which amounts to a shortage elsewhere, is equilibrium or producing them in the right proportions as demanded by consumers. The classical view that demand springs from production which in turn must be in equilibrium to avoid gluts and depressions brings us not to the current state of the American economy but to its condition in the early 1930s, with which many are now drawing a comparison.

Classical economists, including Marx, knew that depressions always started in the producer goods industries and then worked their way down to the point of consumption. Most economists in the 1930s, e.g., Dr. Benjamin M. Anderson and Joseph Stagg Lawrence, also knew where depressions first made themselves felt.

While others of the time were arguing that maintaining, or even increasing, consumer spending was necessary to restore prosperity, Lawrence pointed out that consumption was being maintained and that it was the producer goods industries that were contracting. And this is exactly what happened during 2000 and 2001 recession and this is what will happen again. If the consumptionist school were right the very opposite would have happened with the economic decline starting with a fall in consumer demand, the effects of which would have worked their way up the production structure. This reasoning leads to the conclusion that the bulk of the unemployment should have been concentrated in manufacturing. In 1934 it was calculated

that of a total of almost 14 million persons were without jobs at the peak of unemployment in March, 1933, 6½ million were from the durable goods industries, nearly 6 million were from the "service" industries, and only 1½ million were from the consumption goods industries. Investment activity, in a word, is the tail that wags the industrial dog. (C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937, p. 235.)

Roosevelt's New Deal policies (bad deal would have been a far more accurate description) not only did nothing to restore the consumption-investment balance they actually acted against it by trying to maintain prices at the pre-depression levels, intimidating business and raising taxes. This approach completely ignored the fact that since 1929 real wages had continued to rise. When real wages rise as a result of increased capital accumulation this is something to be applauded. (Incidentally, despite the rantings of the left there is no way that capitalists can prevent productivity-induced increases in real wages). But when real wages rise as a consequence of deflation then persistent widespread unemployment becomes unavoidable. (What happens is that the real wage exceeds the value of the employees' product).

In these circumstances the adjustments that were necessary for a sustained recovery could not be made so long as government meddling prevented the structure of relative prices from fully responding to the changed monetary conditions. This situation amounted - as Professor Hutt put it - to one of maintaining "withheld capacity" by preventing the necessary liquidations. In simple English, demand was being suppressed. (On withheld capacity see William H. Hutt, The Keynesian Episode, LibertyPress, 1979). As William Röpke put it: "The restoration of equilibrium creates purchasing power. " (William Röpke, Crises and Business Cycles, William Hodge and Company, LTD, 1936, p. 83.)

So the lesson of history along with yesterday's wisdom tells us that Obama's statist policy is one that will retard a true recovery and become a blight on the US economy. The free market cure is to liquidate the maladjustments and allow prices and costs, including wages, to readjust to the proper proportions between production and consumption, which in turn should be dictated by consumer preferences, not by the Fed. One of the worst things that a government can do is to continually prop up what Mill called "miscalculations". This is exactly what Japan did and a fat lot of good it did her.

Comments

[HiSpeed:]

We had unsustainable consumption during which time people bought stuff they didn't need with money that didn't have. As the the savings rate finally go green and excess is worked off, the economy will revert to the new reality in which untempered borrowing from the future becomes a shadow of the former self. It's a shame that we're copying Japan's mistakes.

Mar 16 09:04 AM

[William Cowie:]

There's a fundamental difference between propping up miscalculations (bad) and Keynesian deficit spending to get the economy out of a paralyzed malaise (good). If I hear you correctly, you're syaing Obama promised the latter, but is delivering the former. That would be an unfortunate mistake.

The markets to date certainly seem to have drawn that conclusion. It may be, though, that the Commander in Chief of the Economy might be realizing that and be making some course corrections. We shall have to see...

Mar 16 09:05 AM

[socrateazz:]

This is very wise though not as clear as I would like. I think Obama's actions will appear to be successful in the short run. There are many reason's for that but the ultimate result of Obama's policies will be seen from this fall on. even then everybody can not remain depressed forever. For bad news becomes good news when compared to worse news. Bounces will come from that kind of thinking./ For 500,000 new jobs lost will not look bad compared to 600,000 new jobs lost. So that would be good news that is really bad news

Mar 16 10:16 AM

[Lilguy:]

Mr Jackson says,"This brings me to Obama's 'economic stimulus' that seems geared more towards enshrining a permanent Democratic majority and entrenching massive government spending than in promoting recovery."

Regrettably, having voted for Obama, I have to say I think Mr. Jackson is correct.

Nonetheless, the next Congressional election is less than two years away. If Pres. Obama doesn't have the economy at least at bottom and moving forward and upward, he and the Democrats are quite likely to lose their near-domination of Congress. In the Senate, banker-friendly Chris Dodd (D-Conn) is among those who may lose in the election in 2010. That would offset the likely inclusion of the Senator-elect & comedian Franken from Minnesota. If just one other Republican wins, all bets are off on BOTH the Obama economic strategy and his longer term political agenda.

About the only thing going for the Dems in the next election so far is the disorganization and lack of voice among the Republicans. I suspect they will correct that in time and, even if they don't, Senatorial and Congressional elections will be decided on state & local issues in which Republicans could have a preferred voice.

In short, Pres. Obama has until about next Spring to show that he can turn around the economy. After that, the odds increase that Republicans will gain enough in Congress to gridlock legislation and policymaking. I don't think the turn around will happen that soon, and I'm not sure whether gridlock or the bank-friendly economic policies of the Obama administration are the greater danger.

Next year promises to be an ugly one in politics. ...and then we have to start worrying about the 2012 Presidential election!

Mar 16 11:24 AM

[samwise:]

What's clear is it only took the slightest complaint from the Chinese and this entire Adminstration suddenly did a 180. That's no accident and it ain't got nothin' to do with supply and demand! economics is interesting: but they always take government in its own right as somehow "uneconomic." That in fact is the exact opposite of truth. Hence the outrage and 180 by this administration, right? Surely you're not arguing that its corporate America that turned them around?!!!!! So Pelosi, Reed and Emmanual just got their balls ripped off. That's because the business of government is the economy--always and forever. To me that makes these very complex issues you have presented here very simple: what are you doing with the taxpayer dollars. NEEDLESS TO SAY I WOULDN'T WANT TO BE WORKING FOR AIG RIGHT NOW! But that's just for starters, right? We have Space Shuttles to launch, Navies to move. Terrorists to kill. Schools to save. The list is endless. Roaring into DC to create the biggest government in human history was doomed to fail. All the market did was simply manifest the silly idea that "YES WE CAN" meant "go f yourself--we won and you lost." So now we have "no you can't" or more apporpriately "welcome to the SHOW." I voted for BO because he's a young man. Good thing, too, because he's gonna a need that energy going forward because this Party's just gettin' started.

Mar 16 10:41 PM

[Al-USA:]

"
The free market cure is to liquidate the maladjustments and allow prices and costs, including wages, to readjust to the proper proportions between production and consumption, which in turn should be dictated by consumer preferences, not by the Fed.
"

The Ruling class does not care about "free markets", as the AIG bialout money now shows. Nor do they care about liquidating; in fact, the ruling class was thinking about getting bailed out by the American working/middle classes all along. See article below:

Banks Counted on Looting America’s Coffers
www.nytimes.com/2009/0...

Mar 16 11:30 PM

[austrian63:]

Keynesian deficit spending is never good since its sole purpose is to spur aggregate demand. It is Ketnesian policies of expansioanry (inflationary) monetary policy and interest rates below the natural rate which encourage high debt levels. Keynesian/government interference causes a misdirection of resourses (labor and materials) in the capital goods markets (construction, automobiles, durables and the like). Recessions are not casued by a lack of demand as consumers are buying groceries, clothes and other "consumer goods." Keynesian policies misdirect resources out of consumer goods into longer term, higher order capital goods.

Consumers can only buy so many cars, houses, washers and dryers. The just passed Keynesian stimulus package will direct more resources into these same industries and prolong the recession.


On Mar 16 09:05 AM William Cowie wrote:

> There's a fundamental difference between propping up miscalculations
> (bad) and Keynesian deficit spending to get the economy out of a
> paralyzed malaise (good). If I hear you correctly, you're syaing
> Obama promised the latter, but is delivering the former. That would
> be an unfortunate mistake.
>
> The markets to date certainly seem to have drawn that conclusion.
> It may be, though, that the Commander in Chief of the Economy might
> be realizing that and be making some course corrections. We shall
> have to see...

Mar 17 12:13 AM

[fireball:]

insanity is doing the same thing that doesn't work over and over. something like that which bubba said over and over. not sure who the author of the quote was. the u.s. prosperity is proof that a free society with minimal govt. (taxation) allows each to prosper to the best of their ability. the residue of that still makes the u.s. the chosen place even as rough as things are getting they are worse everywhere else (unless you prefer the nanny state to guide you through a mediocre life in exchange for "security".) the failure is the result of ever increasing government (socialism) and the slow unrelenting, attack on liberty and the productive. also the failure of politicians to reign in monopolies, cartels, and other organizations the constitution says should be gaurded against has been conveniently ignored. this would not serve our porksters self interest. lobbying is simply legalized bribery to betray constituents. the federal reserve is the banksters on steroids that jefferson warned of.
now it is called democratic socialism or modern socialism. re-label and try to force it on us again. a pig is a pig is a pig lipstick or not. it only works in primitive tribal societies (extended families).but the clans are very possessive of what they have. it sort of worked in the israeli kibbutzes as a temporary situation for mass immigration. the key is temporary and still the productive got screwed. socialism is tyranny. the lazy and stupid demand their "fair share" of the fruits of your labors. it is patriotic to pay more taxes? no it is patriotic to guard your freedom and defend the constitution and bill of rights against all enemies foriegn and domestic. sadly the worst enemies reside in d.c.. it is patriotic to learn what the legal government of this country is. i think you know what is, is.
"imagine a boot stomping on a human face forever."
God save the republic from the idiocy of political visionaries or maybe we better save ourselves.
i know how to protect myself, i wish i could help more than my family and friends. they cannot tax your income if you hold back your productivity, not everyone can take that course.
who is john galt?

Mar 17 06:08 PM