John Tamny’s recent post at RealClearMarkets distressed me and I’ll try to explain why. Here’s his thesis from the very beginning of his post:
In a recent piece for the Wall Street Journal, columnist Justin Lahart wondered “If Americans don’t buy so many cars and trucks, will they buy other things instead?†Supposedly the answer to his question “could matter a lot to the economy.â€
Lahart’s economic analysis is informed by the teachings of John Maynard Keynes. Keynes believed that consumption was the driver of economic growth, and his teachings broadly inform the analysis of economists, along with most who write about economics. But is it correct? Simple logic indicates that it isn’t. Consumption really doesn’t matter.
When you get right down to it, the study of economics is about just three things: supply, demand, and money. Or, if you’d rather talk about flows than stocks production, consumption, and the issuance of credit.
I’ve not an economist but I’ve taken quite a few economics courses including a year-long introduction sequence, a year-long treatment of microeconomics (individual buying and selling decisions), a year-long treatment of macroeconomics (the big things in the economy like GDP, unemployment, etc.), a one quarter course on banking, and a one quarter course on labor economics.
And I’m a practical guy. I don’t think it makes any more sense to talk about consumption in isolation from production than it does to talk about production in isolation from consumption. Granting primacy to one or another is sophistry.
I do know enough to recognize Say’s Law when I see it. Say’s Law is usually stated as “supply creates demand”. The early economist David Ricardo (a very smart, savvy guy) believed that and it was the prevalent view until the 1930s.
But the 1930s saw something that should have been impossible if Say’s Law were true. There was a general glut and resulting mass unemployment. That’s what prompted John Maynard Keynes to conclude that Say’s Law was wrong.
I’d have more confidence in Mr. Tamny’s sweeping conclusions if I thought that he’d taken an economics course beyond the one quarter survey required for MBAs.
Tamny is incorrect regarding the function of banks in a modern capitalist economy. They don’t act as intermediaries moving money from saver to borrower; they can and do create money and do not require deposits to make loans.
As I’ve written before when I see something that’s obviously wrong it’s hard for me to get past it.
I wonder how he explains the shortfall in business investment over the period of the last 18 years? If he’s right it can’t be because of inadequate demand.
More economics courses doesn’t guarantee anything. You could study at, say, the U of Chicago and come away with a very distorted view of economics. I strongly agree that the consumption vs demand argument is fairly silly. There are clearly times when neither explanation works. While economics has useful ideas, it is least useful in the area that is used to make policy, macroeconomics.
One of the things which most continues to bother me is economists ability to just ignore time as a factor when they use their beliefs to influence policy. For example, in the long run trade is, on balance, a good thing. Yet, I think it is pretty clear that in the short run it can be harmful for a lot more people than it helps.
Steve
“….continues to bother me is economists ability to just ignore time as a factor when they use their beliefs to influence policy. For example, in the long run trade is, on balance, a good thing. Yet, I think it is pretty clear that in the short run it can be harmful for a lot more people than it helps.”
WTF. They don’t. It’s called economic dislocation and there is a rich literature about it. Accept it or not. Assistance in transitioning, amount kind, and duration. What rises to the level of need for assistance…….
They even talk about it at thinly disguised wiccan retreats like The University of Chicago…….
Going to Dave’s point, Tamny is making the mistake of assuming that a dollar saved automatically equates to a dollar of productive investment (the infamous S=I identity). But this is an ex post identity; it applies only after all sales are finalized and therefore includes inventory accumulation. So S=I can literally mean the quantity of money unspent (saved) equals the quantity of goods and services that go unsold.
Which is why Keynes made the argument we can put ourselves into a depression by saving too much.
And that illustrates my point well. Greater knowledge of the subject matter might have allowed him to avoid that error.
My sense is that Mr. Tamny’s argument is a philosophical or ideological one rather than an economic one. I think he’s trying to make a minarchist case.
I saw an article or video clip of John Tamny explaining fractional reserve lending: Sue deposits $100 in Bank A. Bank A lends $90 to Joe, and he deposits it in Bank B. Bank B lends $81 to Fred … That is fully reserved lending.
Sue has $100, and she lends $90 to Joe. Joe has $90, and he lends $81 to Fred. Sue cannot use the $90 she lent. Joe cannot use the $81 he lent. Reserving a fraction of your money is meaningless.
If Sue needs $100 to fix her car, she only has $10 to pay the mechanic, and Joe has the same problem. If Fred lends $72, he has the same problem.
With fractional reserve lending, Sue would declare herself a bank, and
she would use the $10 dollars to purchase stock in her bank. Then, she would create $90 dollars to replace the $90 she lent to Joe. If Joe did the same, the Sue-Joe-Fred economy would have $270 instead of Sue’s original $100.
Banks do have capital requirements.
Tasty,
The fractional reserve model doesn’t actually exist in modern banking systems, although the textbooks all assume it does. The Bank of England explained how money creation works today in a pretty good document here:
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf
@Ben Wolf
Fractional reserve lending does exist, but not the way it is explained. It should be called Leveraged Reserve Lending. Textbooks describe full reserved lending, and they never explain how money is created through lending.
I have seen that article, and it does explain money creation through lending. The article is from the Quarterly Bulletin 2014 Q1, and there is a preceding article about the concept of money (Money in the Modern Economy: an Introduction). This article goes awry rather quickly.
The problem with the money multiplier is that the capital requirements constrain the maximum amount of credit to be created, but there is no requirement for this availability to be lent. The last nine years have proved that central bankers cannot increase lending through interest rates or that they have any effect on the economy.
My disagreement with their definition of money should not be news to anybody.
How banks create money was covered in the first week of my banking class. Maybe the first day.