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Keynesian Economists Ignore Say's Law. We're Paying the Price.

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Keynes did not refute Say’s Law. He rejected it emotionally, but he did not advance a single tenable argument to invalidate its rationale.

- Ludwig von Mises, Planning for Freedom

Of the many obstacles to Keynes’s new economics, the most significant was what is commonly termed Say’s law. He overcame it by playing a blinder, recasting it into a barely comprehensible aside which vaguely approximated to something that could have related to the principal elements of something described as a law. But it is properly understood only in expanded form as an explanation of how and why free markets work. Today, if you ask economists about Say’s law, they will most often revert to a variation of Keynes’s misdirection.

Keynes’s single reference to Say’s law in the General Theory is early on page 26, dismissing it so that his book can then proceed on the basis it doesn’t even exist. This is the relevant passage:

Thus, Say’s law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment. If, however, this is not the true law relating the aggregate demand and supply functions, there is a vitally important chapter of economic theory which remains to be written and without which all discussions concerning the volume of aggregate employment are futile.

So, the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output. The best one can say is Keynes’s statement it is not untrue, but it is only one conclusion derived from the law, not the law itself. No matter: Keynes then proceeds to write that vitally important chapter of economic theory referred to in the clip above, which he now invents, before the reader, perhaps in thrall to the writer’s reputation, has time to reflect that the most fundamental truism of classical economics has been summarily dismissed.

To appreciate the depth of this travesty, we must dispense with potted versions of Say’s law, and examine what classic economics actually says to us on the matter. Ever since Man discovered the benefits of social cooperation, he has learned that each person has personal skills and characteristics which he can use to maximise his output. By exchanging his output for the output of others, he satisfies most effectively his own needs and wants as well as those with whom he interacts. Trade between individuals is facilitated by the use of a common commodity, suited and acceptable to all, in a system of indirect exchange. It is the basis of the division of labour and the glue that cements social cooperation and cohesion.

Stated so baldly, only an ignoramus can disagree with Say’s law. Keynes’s sleight of hand amounts to an acknowledgement of the obstacle its truth presents to his intentions. This truth must be smothered. From its concealment emerges the foundation of macroeconomics, that somehow, what happens at an individual level is different at a community level. But that cannot be true either, because Say’s law is a description of cooperation at a community level. The creation of macroeconomics must then assume nations are not comprised of cooperating communities, a proposition equally impossible to accept, but upon which Keynes then proceeds.

Following his dismissal of Say’s law, the remainder of the book develops the foundation for macroeconomics, a world somehow apart from human experience. If a community thrives through the division of labour, there is no room for a third party in any of the individual transactions between buyers and sellers. Keynes now tells us that at a macro level there can be a third party, the state. Now, the democratic state can justify an economic role, guiding the nation in a direction it determines for the benefit of those it represents.

The root of the logic behind his wish-list in his conclusions to the General Theory is that by redistributing wealth from those who disproportionally possess it to those who do not, the economic benefits to society as a whole outweigh the damage to the wealth of some individuals. And since, in accordance with the principals of the division of labour, some consumption is selfishly put aside for future use as savings to be recycled into capital investment, savers must be euthanised (rentiers as Keynes put it), along with exploitative capitalists. While admitting that both their starting points do not hold up to scrutiny, Keynes’s creation of macroeconomics is perhaps even less tenable in logic than Marx’s inventions in Das Kapital, because Marx did not sully his effort with unworkable compromises.

The fear with which the establishment held for communism a century ago was that it threatened to rob the bourgeoisie of everything. Keynes’s macroeconomics, appearing to be founded upon familiar free-market territory, was gladly embraced by the establishment. It is, nonetheless, alternative socialism. Importantly, by handing responsibility for the creation of money to governments and their central banks, it is also inflationism, just as much as John Law’s policies were, which in an earlier era led to the Mississippi bubble and the subsequent destruction of the French economy.

But it is the compromising nature of Keynes’s macroeconomics that has been key to its survival, while the uncompromising nature of Marxism, despite the suppression and widespread slaughter of its opponents, which demonstrably failed. In the Asian communist states, it is estimated that over a hundred million people died through executions and starvation. The political systems of the two largest slaughterers of their populations, the Soviet Union and China, collapsed, to be reinvented as mercantilist states. The Keynesian interventionists are yet to fail so dramatically, but nonetheless appear to be on a trajectory to do so.

The Economic Consequences of Lord Keynes

Keynesian socialism has survived so long because it never quite strangled free enterprise. So long as individuals have some freedom to divide their labour, they have a remarkable ability to adapt to the circumstances forced upon them by governments.

In the rare instances where governments strictly limit their economic burden on their productive sectors, it has been shown by its omission that Keynesian socialism is an economic cost, and not a benefit. Logic supports the evidence: if you destroy some people’s wealth an economy is worse off. You don’t need to be a classical or Austrian economist to understand that. What does require a grasp of economic theory is to explain why Keynes’s trade cycle is not rooted in private sector activity at all, but is the consequence of state intervention, particularly on the money side. The trade cycle is only the symptom; the credit cycle is the cause.

By advocating an increased monetary role for the state, Keynes has made the credit cycle considerably worse and more destabilising. The evidence pointing to the cause and therefore the guilty party is routinely obliterated by macroeconomic claptrap, bending of statistics and yet more monetary debasement, a process than cannot carry on indefinitely. The legacy of debt that has consequently arisen ensnares both governments and private sectors in debt traps, whose springing is only deferred by yet more monetary inflation. So freely is state currency made available that everyone now expects money will be provided without it being earned. Governments are so overburdened with existing debt and inescapable future liabilities that their only escape route appears to be from ever-deeper negative interest rates and accelerating debasement of the currency.

The invented science of Macroeconomics always bends to justify itself. Banks are now ceasing to create credit for the productive economy, except for the largest and most secure borrowers. Macroeconomists barely notice. In reality, inflationism now produces no benefits other than bare survival for governments and their licenced banks. Instead of the promised utopia, Keynes’s socialism has taken us all to the chasm’s edge that destroyed communism in the 1980s.

We are systemically blind to the consequences of overturning Say’s law and the other principles of economics established in the nineteenth century and subsequently developed by the Austrian masters.

If only we had listened to Hayek. Keynes’s utopian dream is turning into a nightmare for us all.

Excerpted from Our Costly Dalliance with Lord Keynes

Alasdair Macleod is the Head of Research at GoldMoney.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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