Say’s law and the destruction of savings

Apr 1, 2021·Alasdair Macleod
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 thew 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 which 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 organised 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 endeavours 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 labour, 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 labour 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 specialised skills to maximise 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 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 labour requires capital resources, including labour 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 labour 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 realised?

The fundamental error behind inflationary financing

In a free market economy with sound money acting as the intermediary factor in the division of labour, some consumption must be put aside to provide one of the forms of capital assembled to enable businesses to anticipate consumer demand. It is part and parcel of how markets allocate economic resources. The point is that the source of progress in mankind’s condition is the deferment of a portion of consumption. We can confirm this with the evidence: a savings driven economy, such as Germany and Japan in the post-war decades and China today creates wealth for its citizens, while those nations that discourage and destroy savings underperform. And if it was not for the ability of their people to work around their spendthrift governments’ policies of discouraging saving, these economies would have seen the same level of progress as that idealistic beacon for card carrying socialists of an earlier generation, the USSR.

All reasoning and the evidence inform us that saving is a vital element of economic progress and cannot be replaced without unintended consequences. Keynes’s dismissal of that truth is entirely responsible for the decline in living standards of spendthrift nations relative to those that save. Today, it has led to America losing its power over rival savings-driven nations. In only three decades, China has evolved on the back of an extraordinary level of savings to challenge spendthrift America, both in terms of the totality of its economy and its technological advancement. America’s response is to further its own economic destruction through a combination of an unwinnable financial war to secure more international debt funding for itself, a trade war to make its consumers pay higher prices for Chinese and other sourced imports, and the acceleration of monetary inflation to pay for its economic protectionism.

Through quantitative easing, part of that monetary inflation is earmarked directly and indirectly for the financing of production, replacing savings that are increasingly flying away into anything speculative that avoids holding bank deposits and bonds that pay little or no interest. There is not even the barest nod to time preference that is any lender’s natural expectation. And Keynes’s derived concept, that the state should permit a budget deficit to stimulate economic “growth” — a term devoid of real meaning — has become an escalating and permanent feature of the relationship between government and industry.

The neo-Keynesianism that evolved from the denial of Say’s obvious truths in the early pages of Keynes’s The General Theory has turned out to be little more than a scam to invent a role for government intervention. Marked by the pandemic shutdowns commencing in early 2020, monetary inflation in the US has taken off, with M2 money supply increasing by 27% over the last twelve months. That’s an additional $4,162bn of deposit money, taking total money supply to almost match the net value of annual national transactions – GDP. In a savings-driven economy, that is to say an economy where individual actors decide who to lend to, every borrower and potential borrower has access to monetary capital, so long as he can satisfy the lender or the lender’s intermediary regarding his purpose and creditworthiness. Instead, the transformation of savings into monetary capital has been disrupted, and deposit money at the banks is little more than a parking lot for monetary inflation.

The inability of the state to direct monetary resources

Jean-Baptiste Say described the role of savings, and how individuals, or their agents, by deciding what to do with them provided the capital to finance production. Capital was always a scarce commodity which required an interest compensation for both time preference and lending risk. And businesses which planned to make profits on their ventures were generally quick to rectify their mistakes to limit losses on their invested capital.

The advent of a magic money tree removes this discipline and businesses have learned that money is no longer scarce. Through inflation, a business taking out debt at suppressed interest rates knows it benefits additionally from the transfer of wealth to it from the lender, reflected in higher prices for its products in due course. It is by creating this effect that central banks believe they can stimulate production. But it is a fraud on savers, who, naturally decide to take equity in businesses that benefit from inflationary financing in preference to holding bank deposits and fixed interest debt.

Today, in economies such as the US, UK and much of that of the EU, traditional savings for interest play a minor part in providing capital for producing businesses. Instead, capital is increasingly sourced through monetary inflation (such as a pass-through from QE aimed at pension funds) and by the inflation of bank credit. While banks make commercial assessments in their lending, central banks and other government agencies are unable to do so.

Not only are they unequipped to do so, but they are driven by political considerations which give little or no weight to business calculation. They make the mistake of regarding GDP as the sole indicator of their success. But GDP is just a transaction total in a given time period and is only increased by debasing the unit of account. It does not reflect in any way the economic benefits of those transactions. GDP includes government spending, spending which in the aggregate detracts from economic value, by which is meant the benefits to consumers, by taking away their wealth and imposing state monopolies upon them instead.

Spendthrift governments have taken it upon themselves to finance virtually all economic liabilities which are not being financed by bank credit. It has become a circularity with no meaning to it other than hidden costs: taxes and inflation take away from production and consumption in greater amounts to provide the capital and stimulus in lesser amounts. And the agency for it, the state, is additionally clueless about how the diminished quantity of input is best spent.

Consequently, the direction of inflated money is inevitably aimed at supporting government and political interests to the detriment of a free-market economy dedicated to serving the consumer. Zombie corporations, which employ large numbers of workers inefficiently, are in the front line for handouts, because politicians are more interested in job preservation than commercial advancement. Bankers buy political influence with donations to protect the privileges afforded to them by their banking licences. And the supposed stimulus generally fails to reach the bulk of businesses, the unvoiced small and medium size enterprises which make up a Pareto 80% of any advanced economy.

The US Government is now sending fiat money direct to consumers, on what threatens to become a regular basis, and has increased weekly welfare benefits. In the short-term this magic munificence has increased cash balances for some individuals, who are bound on the whole to spend it when they can. Already, the mathematical economists are anticipating a GDP recovery. But the consequences will be a significant jump in prices; or put more correctly, a downward shift in the dollar’s purchasing power. This cannot be concealed convincingly by CPI methods of evidential suppression.

The error is to take insufficient account of the imbalance between future consumption and current production — too much money will be chasing too few goods. Already, we have seen big ticket items such as housing rising in price on the back of accumulating deposit money and cheap mortgage finance. When the pandemic recedes and some form of normal activity returns, we will almost certainly see prices for vital everyday goods, such as food and energy, rise significantly.

The dynamics behind this expectation are not difficult to distinguish. Commodity prices have risen substantially following the reduction of the Fed’s fund rate to the zero bound on 20 March 2020 and the Fed’s whatever-it-takes statement the following Monday. That is one form of input capital whose cost has risen substantially. We can expect labour costs to rise as well, as businesses start hiring again, unemployment benefits having risen to compensate for covid lockdowns and discouraging a return to work for basic income. That leaves the third form of input capital — the money to make it all work. But US banks have little regulatory room to expand their balance sheets to accommodate the anticipated boom, and the interest cost can be expected to increase, if only to reflect demand for working capital.

Therefore, the ability of goods providers to expand production to meet expected demand is severely restricted. And as noted above, the ability of any government to provide the finance to the bulk of the productive economy beyond a cadre of crony capitalistic zombies is similarly restricted. On these grounds alone, the marginal effect on prices promises to be dramatic. But that is not all.

Global supply chains have not recovered from the distribution chaos of a year ago. It is no longer just a case of resuming payments, but cargo containers are in the wrong places, causing delays and congestion, and container rates have increased dramatically. US gross output before the pandemic stood at about $38 trillion, which is an approximation of onshore supply chains. A significant portion of these is fed by offshore supply chains, emanating from China, Japan, the EU and elsewhere. It will be impossible to get production expanded without logistics returning to normal, according to logistics experts unlikely to happen before the year-end.

The lack of understanding by statist economists and forecasters, that imbalances between production and consumption are the inevitable consequence of monetary expansion, is also evidenced in their belief that a rise in the general level of prices is impossible in a contracting economy. This is relevant to conditions today, because before covid lockdowns there was evidence that the cycle of bank credit was turning down and combining with the adverse effects of the US’s trade tariff war with China. A doppelganger for the fall in the S&P 500 index from early-February last year to 16 March neatly copied the first phase of the 1929-32 Wall Street crash, though it has recovered since on the effects of accelerated QE fuelling the stock market with unprecedented levels of monetary inflation.

There is every reason to believe that while stock prices have been rescued and fuelled by monetary inflation, the businesses they represent will fail to be saved, and over-leveraged banks will also fail. In that event, the neo-Keynesians believe that the falling consumer demand to which they attribute slumps in business activity leads to lower prices. But it denies the empirical evidence of all inflations: the worse the inflation the worse the wealth transfer out of the economy and faster the collapse in the currency. Clearly, in an inflationary episode, prices rise irrespective of whether the economy is “growing” or not. And as this article points out, official growth is the sum of monetary transactions and the only way in which GDP can grow is by debauching the currency.

Interest rates must rise

Another Keynesian fallacy is that in a slump, demand for monetary capital declines, leading to lower interest rates. They attempt to pre-empt this by monetary stimulus.

As well as reflecting lending risk, the cost of borrowing monetary capital is principally determined by time preference. In this context, for convenience we can conflate the difference between possession and non-possession of money with the change in its expected future purchasing power. Time preference was explained by Say’s slightly older contemporary, Turgot, and later by Eugene Böhm-Bawerk of the Austrian school. And Say himself got close to it in his understanding of capital in the broad sense, that it represented accumulated time.

By incorporating the expected future purchasing power in a bundled time preference, we can see how evolving expectations drive interest rates. The subject is of particular interest to marginal holders of a fiat currency, notably foreigners who do not require it for day-to-day transactions, but for a part of their operations. Thus, a foreigner requiring dollar balances to fund purchases in international markets will assess the future purchasing power of dollars held excess to his requirements and will sell them if the interest earned is insufficient to satisfy his time preference.

It all points to interest rates paid on deposits rising to compensate holders for the prospect of a deterioration of purchasing power, and any attempt by the Fed to suppress interest rates and bond yields will consequently lead to the dollar being sold on the foreign exchanges. When foreign holders of dollars drive a run on the currency, a rise in interest rates becomes inevitable.

So far, with some $27 trillion in deposits, T-bills and financial assets, a run on the dollar has yet to begin. While the dollar has lost some ground against other currencies in the last year, this is measuring pigs against pork. The real deterioration in its purchasing power is evident in commodity prices and other asset prices, all of which turned higher in the second half of March 2020, when the Fed removed any doubt about its plans for monetary inflation.

While the effect on commodity and financial asset prices has been dramatic, it is only recently that government bond yields have begun to rise. The reason is unlikely to be clear to establishment economists, who for all their bluster have little or no understanding of the consequences of inflation and the issues surrounding it. Rising prices are the outcome of a falling purchasing power for the medium of exchange, but it is rarely put in those terms, let alone any serious attribution made to them being a consequence of monetary inflation. You never hear anything about the market distortions, the transfer of wealth from savers to debtors, or the transfer of wealth from the productive private sector to the government — the most insidious form of tax. Instead, inflationism is lauded for its Keynesian virtues.

The destruction of savings and a total commitment to funding by inflationary means only leads to the destruction of the currency. We have seen this reducing the purchasing power of all fiat currencies. Time preference theory and the realisation that their purchasing power is being eroded tells us that excess currencies will be dumped by everyone unless interest paid compensates them sufficiently. Initially, it is foreigners who awaken to the transfer of their wealth to debtors and their governments. It so happens that the most exposed currency held by foreigners accounting in a different base currency is the dollar. Before resident Americans realise that they too should reduce their dollar exposure to a bare minimum, the dollar’s purchasing power will have declined significantly, measured against everything. Markets will then be wholly in charge of events, discrediting central banks and their governments. Interest rates will soar.

Bubbles will pop, the principal category being equity markets, driven initially by savers swapping debt for equity and then puffed further by QE. The repricing of government bonds, naïvely regarded by banks, investors and regulators as being the ultimate safe haven will threaten the existence of over-leveraged banks. And since the whole financial system has been inflated by a limitless expansion of money, the risk is then of a combined financial asset and currency collapse.

If only Keynes had understood what Say was getting at, abandoned his General Theory and instead promoted sound money, minimal state intervention and free markets, we would not be in this mess. But once a statist, always a statist, and we cannot put the clock back. Instead, we will surely reap the whirlwind of the destruction of savings by and in favour of inflationary financing.

[i] General Theory, Chapter 3, 1.
[ii] See Murray Rothbard, An Austrian Perspective on the History of Economic Thought: Vol 2, pages 4/5
[iii] Ibid. Pages 15/16.

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