Monday, June 6, 2011

Faith Based Economics

A person makes an product he doesn't need but that he is willing to trade for things he does need. There is a faith, a deep assumption, that there will be other people making products for which he can swap. He offers his products and other people offer theirs. Trades are made, and everyone is richer. Repeat, and the economy rolls on.

I have just turned Keynesian Economics on its' head.

How so? Because I have not relied on the manipulation of the money supply to make trades possible. I have simply concentrated on a simple truth: there must be production before there can be trade. Keynesian theory holds that there cannot be production without demand, and thus the need for a surplus money supply to always be hunting for more goods to buy, which then 'stimulates' production. Get it? Keynesianism says production comes second, and the clammoring for goods comes first.

But that is not how it really works. People may say they need or want a good, but, until they actually lay their money down to buy it, producers can only guess. Consumers rarely contract for their purchases in advance of production. The farmer does not take orders and prepayment first, then plant the crops to be delivered in the future. No, the farmer takes a chance...he has faith...that he will be able to exchange his crops for money or goods someone else produced that he wants more. The demand is in the production; the demand is the supply.

But the Federal Reserve, and the Keynesian academics, have said that they must manipulate the money via low interest rates to spark consuming in order to encourage production. One can make the observation that goods not sold or exchanged will clog the market place and cause the producers of those goods to stop producing, thereby causing the entire chain of production to slow down or cease altogether. People will lose their jobs. Companies will go bankrupt. So the Federal Reserve must provide 'liquidity' via inflating of the money supply to keep the goods flowing through the marketplace.

But think about their theory traders are coming to the market with nothing to trade. They have no goods or services to offer, just pieces of paper with which they garner some of the marketplace's goodies. They have a sweet deal. No need to sweat to produce, say, a chair to trade for a wheelbarrow. Instead, they can cheaply print up (or borrow) some paper with numbers, and exchange that paper for the wheelbarrow. The wheelbarrow makers is impressed with the quick sales. The market seems to be booming, but in fact it is short one chair. The traders who accepted the new money have less to choose from, as there is no chair in sight. As the wheelbarrow maker tries to spend his new money on the limited numbers of goods available, he will bid up prices and end up with less than he expected from his original trade.

The faith that underlies the entire market is an expectation of the availability of tradable goods. To produce a wheelbarrow with no hope of trading for a chair means there is no reason to produce the wheelbarrow in the first place. Production is an act of faith in other's production. If that faith is disrupted, then the amount of produced goods dwindles and the economy declines.

Ahem...I just Googled "supply side economics" on a hunch that I was not the first to think of the market economy as a place where people brought their goods to trade. Sure enough, the description for 'supply side economics' in Wikipedia is almost exactly what I have written above. I was pleased to see that the article referenced the Austrians and Classical economics as the ultimate 'supply siders,' but I was less happy with the general impression that the theory had been disproved. In fact, a tertiary belief, that tax revenues would go up as tax rates went down, was pretty convincingly disproven except in certain circumstances. The rest of the theory, stands.

So much for my 'original' thoughts.

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