We’ve written about how How Mises Dismissed that Whole Keynesian Thing with a Decisive One Liner.

In that article, astute readers will have noted, the theme was that what happens to the money is not important to the state of an economy. The only question that counts is, “Was there increased net production, or not?”

This article continues where that article left off. We stand by everything written there, but to cross all the t’s and dot all the i’s, we are here going to discuss Keynes’s argument that what happens to the money is terribly important. We’ll present his seemingly flawless argument, then show the flaws in it.

Keynes [see Chapter 3 of his work, or do a search on this humble site for Keynes] thought hoarding was a big problem, in fact, The Problem, the one that caused all recessions. His thinking was that a business is constantly expending money by paying salaries and other expenses, and of course needs money coming in to keep on functioning. Normally, it gets the money it needs from the sale of its products, and from investments people make in the business.

But if people start hoarding their money in large amounts, instead of buying products or investing, the business will have no money coming in. It will not be able to function. Multiply this for all businesses in an economy, and you have a recession.

Austrians disagree and claim that hoarding is not a problem at all. [Human Action, end of chapter 18, or have a look here. But why not? Isn’t Keynes raising a valid issue? Don’t businesses indeed need money coming in to function? And if money is hoarded, doesn’t that mean the money won’t be coming in? How can Austrians deny such a rock solid demonstration as the one Keynes presented?

The answer is very simple. A business does not need money per se, it needs purchasing power. Money coming in is just a means of having that purchasing power. But any way at all that a business can get purchasing power will be just as good as getting money.

Now that we realize that the goal is not money, but purchasing power, let’s see what happens when people hoard on a large scale. Say they hoard X dollars. That means they reduced the supply of money by X dollars. By the laws of supply and demand, reduced supply means increased price. The “price” of money is, of course, its purchasing power. So by hoarding money, they increase the purchasing power of the unhoarded money.

In other words, when X dollars are hoarded and held back from businesses, it increases the purchasing power of the money in the hands of the businesses or their non hoarding customers by X dollars. Every hoarded dollar, by the very act of being hoarded, creates a dollar of extra purchasing power. Bottom line: the business has no problem whatsoever functioning. The money may not be coming in, but the purchasing power is.

Devil’s Advocate: Dave, you are being simplistic. Sure, hoarding increases the purchasing power of the unhoarded money. But who says it’s a dollar for dollar ratio?

Smiling Dave: You mean the non hoarders might actually get richer? They might get a dollar and a half of increased purchasing power from every dollar hoarded?

DA: I’m saying they might get less.

SD: And you know this how?

DA: I can’t really say for certain. But neither can you.

SD: So what we have is an unproven assertion by Keynes, with no backup, that hoarding decreases purchasing power.

DA: I’m not saying that. For all I know, Keynes didn’t even think about the fact that hoarding increases everyones purchasing power.

SD: Nothing like an unproven assertion to turn economics on its head and determine govt policy.

DA: Smiling Dave, I know you aren’t that smart. You didn’t think this up by yourself. So let’s see some quotes, please.

SD: Oh, alright. Here’s Rothbard in his History of Economic Though, Vol 2:

And yet, as Turgot had hinted, hoarded cash balances that reduce spending will have the same effect as ‘overproduction’ at too high a price: the lower demand will reduce prices all round, real cash balances will rise, and all markets will again be cleared.

Again:

Bentham reached the acme of inflationism in his ‘The True Alarm (1801). In this unpublished work, Bentham not only continued the full-employment motif, but also grumbled about the allegedly dire effects of hoarding, of money saved from consumption that went into hoards instead of investment. In that case, disaster: a fall in prices, profits and production. Nowhere does Bentham recognize that hoarding and a general fall in prices also means a fall in costs, and no necessary reduction in investment or production.

DA: Keep up the good work, Dave.