Economy Swamped by Confusion as Money Supply Goes Wild

By: Gerard_Jackson

What passes for economic commentary these days is enough to drive one to drink. Let's start with Mike Steketee, another of Rupert Murdoch's resident lefties. He tells us that Nicholas Gruen — an economist — “found that cutting taxes for low and middle-income earners generated the largest response in increased employment”. This is just another version of the consumption-drives-the-economy fallacy.

What Gruen is saying is that more jobs will be created by those with a higher propensity to consume. Keynesian hogwash. Consumption does not matter. Let us apply a little wisdom from a couple of nineteenth century economists, the sort of folk that the likes of Gruen and Steketee seem to think are passé. These men understood very well that which ‘modern' economists now sneer at. To wit, the fact

that consumption is posterior to production, as it is impossible to consume what is not produced. Consumption in the necessary order of things is the effect of production, not production the effect of consumption. (James Stuart Mill, Commerce Defended , C. and R. Baldwin, 1808, p. 79).

Now the above is so obvious any layman would wonder why it needs to be continually stated. Because the economics profession has swallowed the mercantilist fallacy (thank you, Lord Keynes) that consumption is the source of production. Speaking for his contemporaries John Stuart Mill stated:

I apprehend, that if by demand for labour be meant the demand by which wages are raised, or the number of labourers in employment be increased, demand for commodities [consumer goods] does not constitute demand for labour. I conceive that a person who buys commodities and consumes them himself, does no good to the labouring classes; and that it is only by what he abstains form consuming, and expends in direct payments to labourers in exchange for labour, that he benefits the harbouring classes, or adds anything to the amount of their employment”. (John Stuart Mill, Principles of Political Economy , University of Toronto Press, 1965 p. 80)

When John Stuart Mill pointed out that “the demand for commodities [consumption goods] is not the demand for labour” he was merely stating what his contemporaries knew to be true. Consumer spending does nothing to raise productivity. To say that today's economists are schizophrenic on this point would be to understate the situation. Their indifference to the early economists reminds me that shortly before his death Keynes felt the need to remind the profession “that the classical teaching embodied some permanent truths of great significance”. ( The Balance of Payment of the United States , The Economic Journals , June 1946). It's a pity that he left it so late.

Now we have Saul Eslake, according to whom tax cuts would be

adding to the inflationary pressures that typically start to build in circumstances such as these, and thus to upward pressure on interest rates. ( The Age , Tax cuts invite a rate rise , 18 October 2007)

Spare me! Anyone seriously acquainted with Say's law of markets would know immediately that this is nonsense. As the old economists used to say: “supply constitutes demand”. Professor Hutt makes this clear:

When I sell fruit grown in my garden, what I receive and what the purchaser pays me are the same! But what is equally true, and which illustrates Say's law, is that I dispose of an identical value out of the money's worth I receive from that sale whatever I am destined to acquire in return for it .[Italics in the original]. ( A Rehabilitation of Say's Law , Ohio University Press: Athens, 1974, p. 34).

In the light of Say's law we can now see that genuine tax cuts cannot raise ‘aggregate demand'* — they only change its composition. Aggregate demand is treated as having basically two components: private spending and government spending. It should follow that if a government cuts taxes it can only maintain the same level of spending by borrowing from the public or inflating the money supply. The present surplus is the product of a massive monetary expansion. Reserve Bank figures show that from March 1996 to July 2007 currency grew by 101.6 per cent, bank deposits by 177.7 per cent and M1 by 169 per cent.

It is patently obvious that this expansion is the source of the government's massive revenue flow. Yet money supply is never mentioned by our commentariat. The same people who ignore the Reserve's dangerous monetary policy are the same ones who warn us about the inflationary consequences of tax cuts. These people are not content with putting the cart in front of the horse. They also shoot the poor beast.

On Henry Thornton's site we find the following quote from Reserve Bank Deputy-Governor Ric Battellino regarding Australia's record debt ratio:

... deregulation, innovation and lower inflation have simultaneously increased the supply, and reduced the cost, of finance to households.

Henry Thornton interpreted Battellino's comments as meaning that

The explosive growth of debt ratios is all about consenting adults optimizing their portfolios. Most of the increased borrowing is by wealthier households who have used it to purchase assets and thus become even wealthier.

Our debt ratio is 160 per cent of GDP and all the Reserve Bank's Deputy-Governor can say is that it doesn't matter because it's between consulting adults. By the same token runaway inflation would not matter either so long as consenting adults continued to buy and sell. At least the post-Keynesian Steve Keen realises that there is something very wrong here and it means that

we're headed for, to coin a Keatingesque phrase, “the recession we can't avoid”. ( ABC News Opinion , The elephant in Australia's economic living room , 15 February 2007).

What is unnerving here is that none of these economists have linked the “explosive growth of debt” to our exploding money supply. Where in heavens name do they think all this credit came from? The Reserve spends years flooding the economy with credit and no one notices? It's like someone flooding their house by leaving the taps running and then wondering where all the water came from..

I've said it before and I'll say it again: It ain't going to get better.

*Strictly speaking this need not be true. If the refunds are invested so that the capital structure is expanded then we can say that the cuts expanded demand. See How the Laffer curve really works

By Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes' economics editor.

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