Say’s Law And The Destruction Of Savings

This article explains the fundamental mistake behind Keynes’s General Theory, the vade mecum for all macro and mathematical economists today. It is no exaggeration to say that his casual rejection of Jean-Baptiste Say’s economic theories in his off-hand interpretation of them, that demand creates its own supply, is at the root of the global economic and monetary crisis today.

There never could be a simple aphorism that captures the writings of Say, whose Treatise ran to six editions in his lifetime, continually expanded as his carefully reasoned analysis evolved.

There is no doubt that Keynes’s denial of the simply argued and irrefutable theories of Jean-Baptiste Say is directly responsible for today’s economic and monetary conditions. Having denied the role of savings and free markets, neo-Keynesians have replaced savings as the source of productive capital by pure inflationism, and free markets by state intrusion, leading to state monopolies and obstructive regulations.

We look at the aspects of Say’s findings relevant to our current situation, identifying the gross errors stemming from the economic establishment’s denials of them, to further our understanding of our current condition and our economic and monetary prospects.


The neo-Keynesian establishment, which is in charge of monetary policy, has a problem. It needs to fund a soaring government deficit, which is its top priority. Essentially, other than taxes there are two sources for this funding, the deployment of savings and the printing of money. It is never really clear where this money comes from: if it comes from savings, then savers divert capital resources from private sector actors to the government, and that is bad news for the productive economy which needs capital resources. If it does not, then it comes from the expansion of credit from the banks and the shadow banking system.

The latter is monetary expansion, otherwise known as monetary inflation and a hidden tax that transfers national wealth to the government. The source of this finance is not quantitative easing, except perhaps indirectly. QE is targeted at pension funds, insurance funds, and other private sector actors in the investment industry, including banks and their off-balance sheet interests, with the avowed intention of stimulating financial risk-taking by these institutions reinvesting the proceeds in corporate debt and equities. QE is there to create an artificial wealth effect, and not to fund the government.

Pigeon-holing monetary actions into these separate functions ignores crossovers between them. For example, a pension fund investing QE cash in a corporate bond already trading on the secondary market buys it from a seller. And the seller, in seeking to reduce his investment risk, might use the proceeds to subscribe for new US Treasuries.

So far, so normal. And even the neo-Keynesians who follow money flows surely understand this. But they have not amended their textbooks to account for the hidden consequences of their monetary policies since the lessons of the 1970s, if not from before. But since then, with interest rates being continually reduced there has been an important change; the relationship between genuine savings and monetary inflation in government funding has seen the growth of ordinary Americans’ savings in bank deposits and fixed-interest bonds virtually eliminated. Instead, the shift in savings has been from interest-bearing bank deposits and fixed interest bonds into equities, leaving only organized investment management collecting savings and investing some of them in fixed interest such as government debt. And now monthly QE of $120bn is inflating equity allocation as well.

For all intents, we can now assume that the US Government’s deficit is financed by monetary inflation. The Fed is left juggling with a bubble and an anti-bubble. The bubble, so far, has been inflated — the increase of non-fixed interest financial asset prices and the spread of a feel-good factor in the investing classes. The anti-bubble is the collapse of the real economy, overburden by monetary inflation amongst other related factors. We see stocks rising, leading us to believe that as soon as the dreaded lockdowns end, good times will return. They won’t. Observe the chaos in global supply chains, compounded this week by the blockage of the Suez Canal. Observe the bankruptcies of airlines, hotels, and tourism. Observe the evolving collapse of the EU, which is now looking unlikely to emerge from pandemic lockdowns any time soon. Observe mounting insolvencies and bad debts, which highly leveraged banks are desperately trying to duck. Observe the zombie corporations, the principal private sector beneficiaries of declining interest rates. Observe the descent of decent free-market business into crony capitalism. Observe, if you can, that money-printing is making things worse by debauching the currency and has been the root cause behind all these problems.

The accumulating consequences of socialism, monetary debasement, and the intellectual bankruptcy of governments everywhere is obvious to anyone with half a mind to observe them. And having observed them, there is only one conclusion: the world is not going to emerge from the pandemic into a state-managed outcome of milk and honey for all. Central to the disaster is the absence of savings and the discipline on capitalists to repay them. Keynes’s paradox of thrift, his desire for the euthanasia of the saver, has finally been achieved, as has Keynes’s replacement for them: the provision of monetary capital by the state — not funded out of declared taxes, but by invidious money-printing.

The macroeconomics invented by Keynes deny the role of savings as a fundamental component of free markets. Monetary inflation hides the consequences of this error until they are suddenly sprung upon us. What are they? They can be summed up in an eventual collapse of both the financial asset bubble and the purchasing power of money whose only virtue is faith in the state and its finances.

Say’s law

The root of Keynes’s misconception was his desire to create a justification for the state’s intervention in the economy. In order to do so he had to dismiss free-market capitalism, and with it the central tenet of classical economics — Say’s law. This problem occupied his mind in the 1930s, and he could not dismiss it convincingly. But he had to for his General Theory of Employment, Interest, and Money, published in 1936, to make apparent sense. In that seminal work, his references to Say’s law were two in number, both of them early on in the General Theory so that he could develop his thesis in the rest of the book.

Keynes’s is one example of arguments based on endeavors by his contemporaries to escape the strictures of Say’s law in an attempt to progress economics beyond its classical origins. He takes to task the theory that he describes as,

…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…[i]

by misconstruing the concept. Note that the central element of the division of labor, which is what it is all about, is missing from Keynes offhand dismissal: that is to say the role of money and especially of prices.

Jean-Baptiste Say never condensed what was subsequently ascribed to his name into a short aphorism. Instead, he wrote a book, Traité d'Économie Politique, first published in 1803, which by its sixth edition had almost doubled in length. His skill was to describe in terms accessible to the reading public the principles of free markets and sound money, and why they delivered economic progress. He explained it in the context of individuals and their interaction, despising the manipulation of people for social engineering.[ii] Like the Austrian School that later emerged following Carl Menger from the 1870s, he convincingly demolished the cost theory of labour and mathematical economics. Murray Rothbard put it this way:

In a surprising and perceptive prefigurement of modern controversies, Say goes on to explain why the logical deductions of economic theory should be verbal rather than mathematical. The intangible values of individuals, with which political economy is concerned, are subject to continuing and unpredictable change: “subject to the influence of the faculties, the wants and the desires of mankind, they are not susceptible of any rigorous appreciation, and cannot, therefore, furnish any data for absolute calculations”. The phenomena of the moral world, noted Say, are not subject to strict arithmetical computation.[iii]

Another important element ignored by Keynes was time. A business has to make payments ahead of its sales. It has to buy materials and assemble the other factors of production. It has to pay suppliers, including the acquisition of higher levels of production; all this in advance of selling a single unit of production. To equate, as Keynes appeared to do, today’s sales with today’s consumption is wrong, because a business has to pay its employees ahead of their production being realised, for which it requires monetary capital.

We cannot know the full extent of Keynes’s reading, and Rothbard wrote the second volume of his History of Economic Thought decades after Keynes’s General Theory. But clearly, Say’s observations were chalk to Keynes’s cheese, disproving everything that followed on from his denial of what had become a cornerstone of free-market economics.

The concept of the division of labor was only part of Say’s Traité. In Say’s law, we extracted a truism, that over the longer term, and not Keynes’s implied shorter term, there must be a balance between what is produced and what is consumed, because we work with our specialized skills to maximize our output so that we can acquire those goods and services that we need and desire. To allege, as Keynes did, that this is the same as “that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output” arrives at the wrong conclusion by skating over the relevant factors. Central to Say’s actual argument was that changes in demand would lead to surpluses of some commodities and shortages of others, which would, left to markets, correct themselves through the price mechanism — that’s why it is nonsense to ignore the role of money and prices. A fall in some commodity and goods prices would create unemployment, that much is obvious. But left to themselves in free markets unemployment and the opportunities created elsewhere would always correct this situation over time. It is part and parcel of how free markets evolve to meet the needs and wants of consumers.

Government intervention is therefore undesirable and unnecessary and can only hamper the market’s natural tendency to adjust to an ever-changing situation, which is the condition necessary for progress. In denying Say’s law, Keynes was misleading us by claiming a short-term adjustment problem was the same as an absolute.

Furthermore, the division of labor requires capital resources, including labor itself, without which it cannot deliver its potential.

As a mathematician, Keynes had little or no understanding of deductive aprioristic theory. He demonstrated a bias against the “unearned” income of the idle rich living off the interest on their capital. But the role of savings was fully addressed by Say. He explained why capital as a fund of savings naturally earns interest. Capital is a tool of business and of calculation, and in this money is the only form of capital whose cost is so denominated. Just as commodities have a price, and labor its wages, the time-use of capital comes with a cost, and that cost, its freely set interest rate, is an integral part of functioning markets.

Savings as a source of capital are needed by entrepreneurs, who are prepared to bid up for them having estimated in their business calculations and knowing what rate of interest is affordable to them. This is not the usurious assumption that Keynes appear to have assumed; that greedy work-shy capitalists withhold their spending, thereby restricting output potential. Furthermore, Keynes’s mathematical macroeconomics has driven us down a blind alley whose endpoint is now reached. His paradox of thrift is such a case: subtract from current consumption by saving and you have less consumption; therefore, do away with savings to enhance consumer demand. Simply put that was the level of his thinking. It was the same with interest rates. But zero, and even negative interest rates in some places have destroyed the utility of savings as a source of finance for businesses. The belief that lowering interest rates stimulates production and consumption has been found wanting.

Instead, we have unlimited quantities of fiat currency, which over time has eroded the currency’s purchasing power. So why, with zero interest rates banished by the central banks, are we not seeing Keynes’s vision being realized?

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Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information ...

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