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Say's Law for Our Time

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From the Archives : Originally published September 04th, 2002
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Category : Fundamental Ideas





How many times have you heard the unthinking comment that we need to keep consumption burning brightly because "consumption is two-thirds of GDP"?

There it is, after all, in black and white. If you look up the GDP release, you see that, in 2001, nominal GDP was $10 trillion dollars and change, while personal consumption expenditures were a touch under $7 trillion. QED.

Fair enough, but be aware that this is very much a circular argument which presupposes that this GDP measure can provide an accurate reflection of the process of wealth generation in the first place (when in fact it is rooted in J.M. Keynes's facile identity that Income = Consumption plus Investment, +/- Net External Trade and Government).

So, let us assume that what makes us rich is not consumption. Consumption is merely that fraction of our income and assets that we decide to exhaust today in pursuits other than those which will either add to the possibilities of greater output in future, or act as a prudential fund against unforeseen needs.

Clearly, it is production that matters, for this is what ultimately lifts us out of savagery. That this should be controversial shows how far we have fallen from the good common sense of our forefathers.

For we can play Oliver Twist all we like, importunately holding up our plates for more, but unless we offer something in return, we are unlikely to be able to rely on our portion being replenished at will.

This simple insight was encapsulated by the classical economist Jean-Baptiste Say, who expressed this to the effect that Supply creates its own Demand. Or, to put it in colloquial English, "You want some of these here beans? What you got in yer wagon to trade fer 'em?"

For the best part of the century that witnessed the flowering of Manchester liberalism, Say's aphorism came to be taken for granted, as a truism. Namely, it was accepted that if you worked to produce a saleable good (or to offer a saleable service), you were then entitled to exchange it for the fruits of someone else's efforts at a price to be freely negotiated between the two of you.

Should the wants of vendor and purchaser not coincide exactly, or should the two be separated by even the width of an ocean, this was no problem, so long as men felt they could rely upon tokens of exchange that equitably reflected the work which went into their generation--that is, upon an honest money to use as a medium of this indirect exchange.

Sadly, the idea of resorting to work and entrepreneurialism, as a means to material well-being, has historically become a poor second to the idea of acquiring resources through theft. This robbery is always most effectively perpetrated when disguised and when legally underwritten by the threat of political violence--i.e., when it is committed by the State.

This comes about because theft is a much less arduous task than the capitalist process of striving best to serve the capricious tastes and fluctuating relative valuations of consumers in open competition with one's fellow entrepreneurs. It is also a much more glamorous occupation and is more likely to grant one a fabled posterity: few children are read tales of successful grocers and haberdashers at bedtime, preferring to hear of the heroic thefts of conquerors, warriors, and presidents instead.

Thus, what John Berger aptly defined in his book, The Sinews of Power, as the "fiscal-military state," or what the Austrians less charitably decry as the "warfare-welfare state," invariably sees those at the pinnacle of political-military power, disrupting this benign process by siphoning off a tribute every time goods pass over the shop counter. In this they are usually abetted--if not actually manipulated--by those who control the purse strings.

They used to exact this levy by sheer brigandage and the overt threat of physical force; now, the means are more subtle and tend to involve the hidden redistribution of resources through the Unholy Trinity of Debt, Taxes, and Paper Money.

Now, one of the sad facts of such impositions is that they always lead to undue hardship. The entrepreneurial bourgeois and the diligent artisan alike have to carry to market not just goods for their own utility, but also goods sufficient to support a posse of bureaucrats, court lackeys, armoured hooligans, tax gatherers, assessors, monopolists, subsidy-mongers, and welfare dispensers, as well as the power elite and their financiers themselves.

If this parasitism is sufficiently subtly interwoven in the social fabric--as nearly a century of fiat money and creeping collectivism has largely accomplished today--the impoverished and bewildered creators of wealth cry out for help in their anguish and foolishly come to mistake the shaggy pelts of the state wolfpack for the robes of a gentle shepherd whom they trust will tenderly deliver them from their miseries.

Thus, government frustration of the market process inexorably leads to the call for the government to Do Something once again to counteract its own malfeasance. As an astute 18th-century Briton succinctly put it, "Armies beget taxes, taxes beget unrest, unrest begets armies."

In this way, the fourth decade of this century--after a long period of false and frenzied prosperity that was fueled like today, largely by debt--witnessed a crisis, caused not by the breakdown of free market capitalism, as the state's apologists have maintained ever since. Rather, the Great Depression was caused by the febrile convulsions made inevitable by the suppression of the market's workings throughout a decade of monetary deceit and a consequently unsupportable credit expansion. This was worsened by the willful frustration of the international division of labor through high tariffs, and by the unwillingness to settle the entwined issues of inflationary war debt and punitive reparations in a timely and realistic manner.

In the midst of this turmoil of the depression, the ever-opportunistic and dangerously meretricious Keynes stepped forward, seeking to persuade people that Say had it all back to front: that, in fact, it was Demand that created its own Supply ("Please, sir, may I have some more?") and that all we needed was to give people extra monetary tokens, unbacked by anything tangible, for the prodigals to restore us to prosperity simply through spending them.

But if we reckon that being bribed to set fire to an overplanted forest is likely to add less value than would setting a new clearing price for any surfeit of lumber, or exploring to what other exciting new productive uses we can put the wood, let us go back to this question of production, to see why Keynes and all his Myrmidons are wrong.

We need to visualize the critical concept of the structure of production, the idea that what we are dealing with is not a crude hydrological exercise in plumbing, as actually physically embodied by Keynes's acolyte, Phillips, of "curve" fame. Instead, we must return to F.A. Hayek's useful motif of the economy as a right-angle triangle, with elapsed time along the bottom, and some measure of output, or revenues, going up the page.

Raw materials and capital goods are way up there at the apex, far distant in time from their final realization as consumers' goods. Consumption itself represents a slice along the nearby vertex, and "fixed investment," as arbitrarily defined in the GDP numbers, is merely a sliver along the hypotenuse.

There are multiple steps and innumerable interconnections in this structure, a structure which is, in fact, not so much a simple triangle as it is a multi-dimensional manifold, knotted with loops, feedbacks, and bifurcations.

Meshed in all this complexity, we must never lose sight of the fact that the passage of time is an immutable constraint, and also that since most activities take place at times remote from their fruition in consumption, savings are an essential element for the support of such deferred consummation.

As an aside, to know how much time one has to complete a process, one must know what savings are available for the sustenance of its factors. The means by which both are signaled is the natural rate of interest. That is why any interference with this regulatory influence by the action of the central bank is so prejudicial to prosperity.

Returning to our theme, we should begin to see that GDP can only give us a very partial (in both senses!) insight into the mechanisms at work.

Keynes effectively wants us to believe we can truly appreciate the artistic achievements, the engineering prowess, and the religious sensibilities of the Egyptian builders by taking the Great Pyramid of Cheops and weighing the first course of blocks at the base, then adding in some reckoning of the amount of whitewash limning the rest of the masonry.

So, for a fairer picture--though still only a crude sketch of the whole intricate mechanism at work--consider the BEA's Input-Output data instead. For 1998, when these were last compiled, nominal GDP stood at $8.8 trillion, and personal consumption was $5.9 trillion. Manufacturing seemed to be fairly inconsequential at $1.5 trillion in the GDP numbers ("Nobody cares about manufacturing anymore!") and made a smaller contribution than either finance ($1.7 trillion) or services ($2.1 trillion).

But now look at what was actually being made and sweated over within the economy, providing jobs, on the one hand, and the opportunity of profits on the other. Let us sneak a glimpse at the division of labor in all its glory.

The total gross output of the economy now comes to $15.4 trillion in turnover, and manufacturing--at $3.9 trillion--suddenly swells to being the largest constituent of them all, 55 percent greater than finance, and 10 percent larger even than the much-vaunted service sector.

Manufacturing emphatically does matter, for it now becomes responsible for fully a quarter of all productive activity and--here is the crucial point--60 percent of that provides an input for other intermediate industries, and 60 percent of that fraction, in turn, goes back into the other stages of manufacturing itself, with only 25 percent destined straight for consumption and a lowly 15 percent to the GDP-defined "fixed-investment" category.

Armed with this fresh perspective, now ask yourself whether you are ready to continue to accept blindly that we are living in a "service economy," or that all will be well "as long as the consumer keeps spending" (rather than if the worker--and the manufacturing worker, at that--keeps usefully producing), or that businesses merely have an "inventory problem" (not a fixed-capital problem) to overcome.

But, under the Keynes version--espoused uncritically by central banks, Wall Street "analysts," and politicians everywhere--if business falters, do not be alarmed! We can simply send people to the shops waving their new Federal Reserve purchasing coupons, and urge them to be profligate.

Manufacturing, for so long misled by the total distortion of the prices of capital, inputs, and final sales, will then automatically reorient itself to satisfy these demands--despite the fact that it was patently unable to do this sustainably, much less profitably, before the masses were given their extra vouchers.

We are told, by the Inflationists, that currently there is overproduction and that prices are falling. If we do not take care, consumption will falter unless we induce the Fed to prop up demand by expanding the supply of money.

Granted, there is specific overproduction perhaps--the distortions of the credit expansion have ensured that, thank you, Sir Alan--so there may be a surfeit of automobiles and disk drives and broadband capacity, among many others. But do we really have everything else we want for the asking?

Do we have the best shoes, the finest clothes, limitless energy with no harmful waste products, instant medical treatment, the highest standards of education for our children, delay-free means of transport--in fact, all the delights of an earthly Paradise?

Of course not.

You must therefore be able to appreciate that consumption is highly unlikely to fail through any sudden fulfilment of the consumers' endless shopping list--barring a miraculous outbreak of religious hysteria, a global conversion to asceticism.

What instead may fail--indeed, has been failing--is these would-be consumers' ability to comply with Say's Law.

They are unable to find an outlet for their particular skills and talents because the matrix of relative (never absolute, much less average) prices has been made replete with harmful rigidities--thanks to the Fed and the rest of the government --and so cannot adjust to offer them a niche.

Moreover, such niches as do exist are harder to exploit to their maximum because so much scarce capital has been wasted or misallocated, giving people fewer tools with which to work.

This, in turn, means these unfortunates cannot buy all they want, except by taking up yet more debt, and this only perpetuates those faulty entries in that all-important matrix of relative prices. It also progressively alienates their future incomes, and thus comes to jeopardize the soundness of their increasingly foolhardy, morally hazardous lenders.

Put differently, supply creates its own demand, except where unsaved credit intrudes, and that can only prolong the agony, not cure the misalignment

But this is all very well in theory. Surely, there must be too much production. For why else do we constantly hear the lament on everyone's lips that "Businesses have no Pricing Power!"--a wail which usually precedes a call for more Fed funny money to combat this malaise?

It is a pivotal fact that this misses the larger truth: businesses NEVER have control over prices--not on a free market. Rather, what has been removed from them today is some measure of influence over their costs.

This has come about because the vast effusion of unsaved credit is propping up demand from those who supply nothing in return, except their credit cards and their home equity cash-outs.

If all these nonsuppliers were instead left to price themselves back into productive work before they bought things, and if the goods they could no longer honestly afford in the interim were allowed to fall in price to reflect this fact, more businesses might then be able to take up what would now be both cheaper labor and cheaper resources. They would be induced to do this because this relative repricing would help furnish them with a greater faith that their hopes of making a genuine return on capital were not in vain.

This they could also do, since they would have more assurance of successfully supplying a mix of goods and services that was more nearly in tune with the expression of only those wants which had justifiably earned their gratification in the demander's own concurrent contribution to output. That way, the economic organism would be likely to rediscover its holistic, dynamic balance between the yin and yang of production and consumption, and investment and saving.

That way, only those who Supply could Demand in their turn.

Extra fiat money can do little to substitute for this necessary immune response, or to speed this time-consuming recuperative process. It cannot give the outfoxed chessmaster two moves to his opponent's one to avoid a mate, nor can it teach infantrymen instantly to ride cavalry chargers to repel the foe.

It cannot create wealth, for wealth is only minimally coincident with today's mockery of money.

It can, however, arbitrarily transfer ownership of what wealth still exists. It can lock sub-par businesses in place and suck their creditors deeper into the mire alongside them. It can thus foster an unwelcome competition for resources which elevates their costs beyond the reach of truly productive businesses. It can choke the Garden with the weeds of those undertakings which are only able to flourish under these highly artificial conditions--the housing boom springs to mind today.

Unfortunately for the legions of Inflationists (Californian Money Managers, or otherwise!), there are no shortcuts to betterment, but there are all too many diversions, distractions, and dead ends, and the most misleading road map in the world is the one printed at 20th Street and Constitution Avenue in Washington, deep inside the Marriner S. Eccles building.



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Sean Corrigan is Chief Investment Strategist for Diapason Commodities Management Lausanne & London
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