“The Cutting Edge Of Husbandry”

Dolors & Sense

by Sanford Rose

KISSIMMEE, FL—(Weekly Hubris)—5/24/10—Perhaps the greatest insight of modern economics is that supply does not create its own demand, as Say’s celebrated law (incorrectly ascribed to Jean-Baptiste Say, circa 1800) alleges.

True, output self-evidently creates enough income to clear all markets if all the income were used in a timely fashion. But it is not.

More of the income may be saved than is anticipated. That extra savings is supposed to reduce interest rates so that people will be motivated to increase their investments enough to soak up the surge in savings. But this doesn’t happen.

The unanticipated increase in some people’s savings can be matched by an unanticipated demand for credit from those who miss the income generated from the sale of the goods and services that were formerly bought by those who have now decided to save, not spend. So the interest rate doesn’t budge—at least in the short run.

No new investment is immediately forthcoming. So, with less current spending and the same investment—indeed, often less since the temporary decline in spending can cause investors to commit fewer funds to new projects—supply has not created its own demand.

Supply is redundant. So future output falls and, with it, future savings.

The potential for this type of market breakdown has dogged the free-enterprise system for generations. The trigger for the 2007-2009 recession was somewhat different, but at the heart of the crisis lay an imbalance between savings and investment behavior.

The Asians saved too much; we could not employ their savings, derived from displacing US production, in productive investments. Instead we channeled those savings into unsustainable housing speculation.

The crisis was wrenching, but the basic system still has not changed. Some similar dysfunctionality is likely to recur in the next few years.

The world’s biggest savers—e.g., China, Japan and the oil exporters—continue to squirrel away stashes, called current-account surpluses. The world’s biggest spender—the US—has reduced its current-account deficit as a percent of gross domestic product, but still consumes or “dis-saves” at an unsustainable pace (although now, of course, it is the government not the consumer sector that is building up the IOU’s).

If the Chinese could spend more and/or the US could employ Chinese savings more quickly in productive investments (read: global smart grid), the imbalances might not accumulate. At present, Chinese thrift continues to augur global waste.