Violating Say’s Law
Keynes’s dogma, as stated in his magnum opus, The General Theory of Employment, Interest and Money, attempts to refute Say’s Law, also known as the Law of Markets. J.B. Say explained that money is a conduit or agent for facilitating the exchange of goods and services of real value. Thus, the farmer does not necessarily buy his car with dollars but with corn, wheat, soybeans, hogs, and beef. Likewise, the baker buys shoes with his bread. Notice that the farmer and the baker could purchase a car and shoes respectively only after producing something that others valued. The value placed on the farmer’s agricultural products and the baker’s bread is determined by the market. If the farmer’s crops failed or the baker’s bread failed to rise, they would not be able to consume because they had nothing that others valued with which to obtain money first. But Keynes tried to prove that production followed demand and not the other way around. He famously stated that governments should pay people to dig holes and then fill them back up in order to put money into the hands of the unemployed, who then would spend it and stimulate production. But notice that the hole diggers did not produce a good or service that was demanded by the market. Keynesian aggregate demand theory is nothing more than a justification for counterfeiting. It is a theory of capital consumption and ignores the irrefutable fact that production is required prior to consumption.Central bank credit expansion is the best example of the Keynesian disregard for the inevitable consequences of violating Say’s Law. Money certificates are cheap to produce. Book entry credit is manufactured at the click of a computer mouse and is, therefore, essentially costless. So, receivers of new money get something for nothing. The consequence of this violation of Say’s Law is capital malinvestment, the opposite of the central bank’s goal of economic stimulus. Central bank economists make the crucial error of confusing GDP spending frenzy with sustainable economic activity. They are measuring capital consumption, not production.
Two Paths of Capital Destruction
The credit expansion causes capital consumption in two ways. Some of the increased credit made available to banks will be lent to businesses that could never turn a profit regardless of the level of interest rates. This is old-fashioned entrepreneurial error on the part of both bankers and borrowers. There is always a modicum of such losses, due to market uncertainty and the impossibility to foresee with precision the future condition of the market. But the bubble frenzy fools both bankers and overly optimistic entrepreneurs into believing that a new economic paradigm has arrived. They are fooled by the phony market conditions, so bold entrepreneurs and go-go bankers replace their more cautious predecessors. The longer the bubble lasts, the more of these unwise projects we get.Another chunk of increased credit goes to businesses that could make a profit if there really were sufficient resources available for the completion of what now appears to be profitable long term projects. These are projects for which the cost of borrowing is a major factor in the entrepreneur's forecasts. Driving down the interest rate encourages even the most cautious entrepreneurs and bankers to re-evaluate these shelved projects. Many years will transpire before these projects are completed, so an accurate forecast of future costs is critical. These cost estimates assume that enough real capital is available and that sufficient resources exist to prevent costs from rising over the years. But such is not the case. Austrian business cycle theory explains that absent an increase in real savings that frees resources for their long term projects, costs will rise and reveal these projects to be unprofitable. Austrian economists explain that a declining interest rate caused by fiat money credit expansion does not reflect a change in societal time preference — that is, society's desire for current goods over future goods. Society is not saving enough to prevent a rise in the cost of resources that long term projects require. Despite central bank interest rate intervention, societal time preference will reassert itself and suck these resources back to the production of current goods, where a profit can be made, and away from the production of future goods.
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