6 February 2023
I finished part one with the observation that defining saving as income minus saving is misleading. An increase in the demand to hold money is not an increase in savings. Cash balances and savings perform different functions. Keynesians make no distinction between savings and cash balances; therefore they can, and do, assume that savings are not spent. But as Ricardo pointed out: “To save is to spend.”1
The ‘problem’ of equality between savings and investment arises when we define savings in purely monetary terms (which we usually do) and investment at given prices. When investment exceeds savings we have inflation. The excess investment means that the banking system has created new credit. This led some economists to jump to the absurd conclusion that we can have investment without savings. They obviously have not heard of ‘forced savings2.
Unfortunately a gold standard is not a permanent barrier to inflation when the banking sector operates a fractional system. When in the eighteenth and nineteenth centuries the banks issued an excessive amount of notes this caused the market price (actually the paper price of gold) of bullion to exceed the mint price of gold causing the foreign exchanges to fall leaving the banking system no choice but to reduce the note issue3. The result was rising unemployment, bankruptcies. falling prices and saving exceeding investment4. If Krugman were right about an increase in the demand for cash balances causing recessions then instead of the exchanges falling they would have risen and gold would flow into the country5 instead of out of it. Krugman seems congenitally incapable of distinguishing between the demand to hold money and the action of saving it.
In short, it is monetary policy that cause discrepancies between savings and investment. These are fundamental facts, among many others, that Keynes’ disciples have refused to grasp. Moreover, what matters is gross saving defined as the total expenditure needed to maintain the economy’s capital structure. Anything in excess of this is net investment: that addition to the capital structure that raises the standard of living. The one of the great economic errors of today is the belief that GDP measures growth. The economic argument that consumer spending drives growth was rightly considered by classical economists to be a dangerous fallacy.
Roosevelt’s supporters brag that America’s average annual growth rate of about 4 per cent from 1933 to 1940 validates Roosevelt’s proto-Keynesian big spending interventionist policies he called the New Deal. Not stressed, as Alvin Hansen noted, is the vital fact that the so-called recovery was based entirely “on expanding consumer demand… and plant and equipment was geared narrowly, in quite an unusual degree, to the immediate requirements of consumption”6. (Another important fact they ignore is that the average annual rate of unemployment never fell below 14.3 per cent.)
What was the result of this consumer driven recovery? Arthur Lewis7 calculated that from 1929 to 1938 net capital formation plunged by minus 15.2 per cent Professor Higgs8 calculated that from 1930 to 1940 net private investment was minus $3.1 billion, about 3 per cent of GDP in 1940. Benjamin M. Anderson9 estimated that in 1939 there was more than 50 per cent slack in the economy. In plain English, America’s capital stock had shrunk.
Capital consumption is always marked by a rise in the average age of machinery. This is precisely what we find under Roosevelt’s brilliant New Deal policy, the same policy our ignorant greens and Keynesians swoon over. The amount of metal working machinery more than 10 years old rose from 48 per cent in 1930 to 70 per cent in 1940, an increase of 45.8 per cent. Roosevelt’s New Deal failed because consumer spending does not drive an economy.
As a rule consumer incomes do not cover the net output of industry. If it were otherwise then the country would be consuming its capital stock. Industry consists of multi-stages of production which means total expenditure must exceed incomes. In short, many payments are made that do not enter the income stream. This is why it is enough for wages and salaries to cover the costs of producing the final product. Business spending will, if allowed, do the rest. If, for any reason, business spending is severely curtailed capital consumption will be the result. Unfortunately, devotion to scripture has given Keynesians a Pharisaic approach to the subject that leaves little room for genuine economic debate.
How do we explain widespread unemployment if it is not caused by a fall in aggregate demand, is the Keynesian response to anyone who challenges their doctrine. So long as real wage rates (gross rates) are held above their market clearing rates unemployment will remain a problem. It’s real money wage rates and real prices that count. And that’s why Keynes wrote:
Whilst workers will usually resist a reduction of money-wages, it is not their practice to withdraw their labour whenever there is a rise in the price of wage-goods [consumption goods]10
That let the cat well and truly out of the bag. Let’s use inflation to con the workers into thinking they are getting wage increase when in fact inflation is being used to cut their real wages. Keynes evidently did not have a high regard for the intelligence of the average worker. After denouncing the classical economists’ policy on wage adjustments he then lets it in through the backdoor. This is a case of eating your cake and still having it.
Some Keynesians argue that “the ability to hold money creates economic uncertainty”. This is plain silly. What creates uncertainty is lack of foresight. We have economic uncertainty because we do not know the future, not because people can hold cash. If people suddenly act to accumulate cash holdings it is because current events have changed their expectations. This is something that the likes of Krugman never take into account.
Once it is realised that what is being discussed is not savings but an increased demand for cash balances the economic picture should immediately become clear. Hoarding is another name for cash balances. To Keynesians it is the economic equivalent of leprosy and has to be treated before it infects (depresses) the economy. Far from being a barren or anti-social action hoarding, however, is a highly productive economic activity that yields a return.
This is another economic fact that Keynesians have never come to grips with. Individuals hold money only to the extent that it yields a return that exceeds the expected return from expenditure. Uncertainty is the root of the demand to hold money. Hence money balances are speculative in nature. The great Keynesian fear is that a large, if not sudden, increase in the demand to hold money will send the economy into a depression.
Now it is true that a sudden and significant demand for cash balances would have a deflationary effect. But it needs to be remembered that a sudden and motiveless demand to increase cash balances is unheard of. Significant increases in the demand for cash balances are a secondary feature of deflations: large-scale liquidations create pessimism in the business community and depress investment and borrowing, borrowers try to acquire cash to pay off their debts, banks accumulate reserves and falling prices induce consumers and business to hold more money.
These are the conditions that prevailed in the US from 1930-1932 when prices fell and production collapsed. Yet the phenomenon of increased hoarding during a deflation and the reasons for it was well-known to the classical economists. So what we have regarding hoarding and depressions is another Keynesian case of putting the cart in front of the horse.
Australia’s experience11 in the Great Depression, which Australia’s right has chosen to ignore, is the stake that should be driven through the heart of Keynesianism
1“Mr. Malthus never appears to remember that to save is to spend.”
Edited Piero Sraffa, The Works and Correspondence of David Ricardo, Liberty Fund, Inc., Vol. II, 2004, p. 449.
2The first detailed description of the process of forced saving was given by Thomas Malthus. Unfortunately, he failed grasp. Every economist would learn from reading his remarkable essay
Thomas Malthus, Edinburgh Review, February 1811, pp. 363-372
3There was a dispute at the time over whether demand deposits were money or not with Samuel Jones Loyd, later Lord Overstone, and Ward Norman arguing they were not money while Robert Torrens, William Clay, James Penning and George Arbuthnot insisting that they were.
6Cited in The Economics of Recession and Revival: And Interpretation of 1937-38 by Kenneth D. Roose, Archon Books, 1969, p. 174.
7Arthur Lewis calculated that from 1929 to 38 net capital formation plunged by minus 15.2 per cent
Arthur Lewis, Economic Survey 1919-1939, Unwin University Books, 1970, p. 205.
8Higgs calculated that from 1930 to 1940 net private investment was minus $3.1 billion.
Robert Higgs, Depression, War, and Cold War, The Independent Institute, 2006, p. 7.
9Anderson estimated that in 1939 there was more than 50 per cent slack in the economy.
Benjamin M. Anderson, Economics and the Public Welfare: A Financial and Economic History of the United States 1914-1946, LibertyPress, 1979, pp. 479-48.
10John Maynard Keynes, The General Theory of Employment, Interest and Money, Macmillan, St Martin’s Press for the Royal Economic Society, 1973, p. 9).