But, in practice, general over-production, as popularly imagined, has never, so far as I can discover, been a chief cause of great disequilibrium. The reason, or a reason, for the common notion of over-production is mistaking too little money for too much goods.

— Irving Fisher, “The Debt–Deflation Theory of Great Depressions,” Econometrica 1, 4 (1933), p. 340.

I’m taking professor Joseph Salerno’s “Austrian Macroeconomics” course on Mises University (which I’m genuinely excited for), and one of the reading materials for this Wednesday’s lecture is Ludwig von Mises’ “Lord Keynes and Say’s Law.” The original purpose of this post was to ask for a citation, so I’ll do that first before moving on to what this post has developed into. The third paragraph reads as follows,

Whenever business turned bad, the average merchant had two explanations at hand: the evil was caused by a scarcity of money and by general overproduction. Adam Smith, in a famous passage in “The Wealth of Nations,” exploded the first of these myths. Say devoted himself predominately to a thorough refutation of the second.

I haven’t read The Wealth of Nations, and I’ve asked this question before, but I don’t ever remembering receiving a specific answer. Can anybody cite the “famous passage” (since we may have different editions, chapter and subtitle would be nice)?

The title, and much of the content, suggests that Mises is defending Say from Keynes. He makes it clear that Smith is associated with “exploding” the scarcity of money thesis, and Say with the general overproduction thesis. I’m not sure what Mises means when he characterizes one argument as being about the “scarcity of money,” because for many economists the “general overproduction” argument really boils down to a shortage of money. It may be that Mises has in mind theorists like John Law when he discusses Smith.

Apart from the above, there’s three aspects of Mises’ paper that people may disagree with,

1. His criticism of the notion of a general glut induced by a shortage of money;
2. His treatment of Keynes;
3. His narrative on the debate between Malthus, Sismondi, and Say.

The third is not something I know enough about (but, recently it has become more accepted that Say eventually conceded Malthus’ point). Regarding the first I won’t say much, because my own position is somewhat flaky (although I’ve criticized monetary equilibrium theory elsewhere). I will say that I think he missed the point. Wrote Mises,

Commodities, says Say, are ultimately paid for not by money, but by other commodities. Money is merely the commonly used medium of exchange; it plays only an intermediate role. What the seller wants ultimately to receive in exchange for the commodities sold is other commodities.

I think this far most economists will agree with Mises. But, the fact of the matter is that first a commodity has to be purchased with the medium of exchange. The monetary general glut theory holds that a shortage of money will impede this process from taking place. I think it’s clearest if we illustrate this conceptually. Suppose that there is a money stock of quantity ‘x’ and as soon as someone receives a dollar for her good, she turns around and spends it. Now, let’s say that the demand for money rises to ‘y,‘ implying that a shortage of ‘y – x.’ If prices don’t immediately adjust to the clearing, or equilibrium, values what happens is that those who would have otherwise received an aggregate of ‘y – x’ dollars no longer do (and the quantity of money in circulation falls to ‘x – [y – x]‘). If prices don’t adjust this implies a contraction in output.

The AD–AS graph to the left is rudimentary, but it helps get a visual understanding of what a “shortage of money” entails. My criticism of monetary equilibrium theory is that the firms adversely affected by the increase in cash balances will lose out either way, because monetary injections won’t necessarily target them. But, if we think about it a bit more I think my error becomes obvious. If we assume that prices are not flexible enough to maintain the original quantity of output, then as I stated above output will fall. However, if aggregate demand recovers through an increase in the stock of money to make up for the increase in cash balances, denoted as ‘y,’ then output will also recover. Now, my criticism is right in that this doesn’t mean the composition of output will remain the same. But, that can be seen as a benefit to maintaining monetary equilibrium: output is restored, but the composition of output is still guided by profit and loss.

I’ve written more than I wanted to on the concept of a monetary general glut. The purpose behind this post, other than that original question, is to comment briefly on Mises’ critique of Keynes. Throughout this short piece, there’s not one instance where Mises actually engages things Keynes wrote. Instead, he falls back on an appeal to authority — that all economists have agreed with him (I suppose that those which agreed with Malthus, Sismondi, and later Keynes, aren’t really economists) —, and the claim that Keynes’ theories are popular because they legitimize economic policies that have been used for decades, or even centuries, before the arrival of Keynes. It’s ironic, because he characterizes The General Theory as an “emotional” rejection, positing that “he did not advance a single tenable argument to invalidate its rationale” — nevermind that a theory being wrong doesn’t mean it’s “emotional.”

I’m no defender of Keynes, but this strikes me as one of Mises’ worst pieces of writing — maybe because it’s meant as a popular article, originally published in The Freeman, and popular articles aren’t usually rigorous. But, Mises was a brilliant economist and one really does expect more of him. It may be that his poor rendition of the “general glut” argument is a product of his unwillingness to more honestly engage Keynes, because Keynes’ theory is ultimately a variation of monetary disequilibrium. Keynes’ version is not about increases in cash balances, rather his business cycle theory relies on a breakdown in financial intermediation. As a result, much of “Lord Keynes and Say’s Law” is spent discussing physical general overproduction, and monetary disequilibrium gets inadequate treatment.

P.S. George Machen, in the comments, links me to an online version of The Wealth of Nations. This must be the passage Mises is referring to,

No complaint, however, is more common than that of a scarcity of money. Money, like wine, must always be scarce with those who have neither wherewithal to buy it, nor credit to borrow it. Those who have either, will seldom be in want either of the money, or of the wine which they have occasion for. This complaint, however, of the scarcity of money, is not always confined to improvident spendthrifts. It is sometimes general through a whole mercantile town and the country in its neighbourhood. Over-trading is the common cause of it. Sober men, whose projects have been disproportioned to their capitals, are as likely to have neither wherewithal to buy money, nor credit to borrow it, as prodigals, whose expense has been disproportioned to their revenue. Before their projects can be brought to bear, their stock is gone, and their credit with it. They run about everywhere to borrow money, and everybody tells them that they have none to lend. Even such general complaints of the scarcity of money do not always prove that the usual number of gold and silver pieces are not circulating in the country, but that many people want those pieces who have nothing to give for them. When the profits of trade happen to be greater than ordinary over-trading becomes a general error, both among great and small dealers. They do not always send more money abroad than usual, but they buy upon credit, both at home and abroad, an unusual quantity of goods, which they send to some distant market, in hopes that the returns will come in before the demand for payment. The demand comes before the returns, and they have nothing at hand with which they can either purchase money or give solid security for borrowing. It is not any scarcity of gold and silver, but the difficulty which such people find in borrowing, and which their creditor find in getting payment, that occasions the general complaint of the scarcity of money.

— Book IV, chapter I, p. 281 in the 2009 [2007] Harriman House edition.