The Myth of Say’s Law

Jean Baptiste Say (1767–1832) is credited with Say’s law or Say’s law of markets (“loi des débouchés”, in French), of which Walras’ law appears to be a modern neoclassical restatement. Although Say did not use the expression “law” to describe his views, his writings on this subject are to be found in A Treatise on Political Economy (or the Traité d’économie politique in French), Book 1, Chapter 15 (Say 1832: 132–140; the first edition of which was published in 1803) and in the Catechism of Political Economy (Say 1816: 103–105).

In modern formulations of Say’s law, there are two main variants of it:

(1) Say’s Identity
According to Baumol (1977: 146), this

“is the assertion that no one ever wants to hold money for any significant amount of time, so that, as a result, every offer (supply) of a quantity of goods automatically constitutes a demand for a bundle of some other items of equal market value.”

(2) Say’s Equality
Again, according to Baumol (1977: 146), Say’s Equality

“admits the possibility of (brief) periods of disequilibrium during which the total demand for goods may fall short of the total supply, but maintains that there exist reliable equilibrating forces that must soon bring the two together.”

The issue of what J. B. Say himself thought is complicated by the fact that there was more than one edition of his Treatise on Political Economy. The second edition was published in 1814 and has a revised version of Say’s law (Baumol 1977: 147), while in the first edition the law of markets is not so complete. It was only in the second edition of the Treatise on Political Economy (1814) that Say’s discussion is identifiable as a “form of a type of Say’s equality, i.e., supply and demand are always equated by a rapid and powerful equilibration mechanism” (Baumol 1977: 159).

A reading of the modern interpreters of the law of markets make it clear that by Say’s equality, Say did not mean that downturns in the business cycle cannot occur. Say was attempting to show that there could not be a general glut or general overproduction of all commodities, and that there could never be an overall shortfall in aggregate demand. Say’s view was compatible with the possibility of downturns caused by individual commodities being overproduced. That is, there could be specific but limited types of commodities where overproduction occurred relative to demand for those commodities. Say’s law of markets appears to be compatible with short-term gluts of specific commodities. As Steve Keen has argued:

“[sc. before Keynes] mainstream economics did not believe there were any intractable macroeconomic problems. Individual markets might be out of equilibrium at any one time – and this could include the market for labour or the market for money – but the overall economy, the sum of all those individual markets, was bound to be balanced” (Keen 2001: 189).

On the neoclassical and classical view, there could not be a downturn caused by an overall deficiency in aggregate demand: slumps were caused by sectoral imbalances/sectoral disequilibrium or by external shocks. Aggregate supply could never exceed aggregate demand (Kates 1998: 4–5).

John Maynard Keynes in the General Theory had this to say about Say’s law:

“From the time of Say and Ricardo the classical economists have taught that supply creates its own demand;—meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product …. As a corollary of the same doctrine, it has been supposed that any individual act of abstaining from consumption necessarily leads to, and amounts to the same thing as, causing the labour and commodities thus released from supplying consumption to be invested in the production of capital wealth” (Keynes 1936: 18–19).

Keynes’ remark about the classical economists is correct (Baumol 1999: 200). For example, Adam Smith held these ideas:

“In all countries where there is tolerable security, every man of common understanding will endeavour to employ whatever stock he can command, in procuring either present enjoyment or future profit. If it is employed in procuring present enjoyment, it is a stock reserved for immediate consumption. If it is employed in procuring future profit, it must procure this profit, either by staying with him, or by going from him. In the one case it is a fixed, in the other it is a circulating capital. A man must be perfectly crazy who, where there is tolerable security, does not employ all the stock which he commands, whether it be his own, or borrowed of other people, in some one or other of those three ways.” (Smith 1811: 198).

“What is annually saved is as regularly consumed as what is annually spent, and nearly in the same time too; but it is consumed by a different set of people. That portion of his revenue which a rich man annually spends is, in most cases consumed by idle guests, and menial servants, who leave nothing behind them in return for their consumption. That portion which he annually saves, as for the sake of the profit it is immediately employed as a capital, is consumed in the same manner, and nearly in the same time too, but by a different set of people, by labourers, manufacturers, and artificers, who re-produce with a profit the value of their annual consumption. His revenue, we shall suppose, is paid him in money. Had he spent the whole, the food, clothing, and lodging, which the whole could have purchased, would have been distributed among the former set of people. By saving a part of it, as that part is for the sake of the profit immediately employed as a capital either by himself or by some other person, the food, clothing, and lodging, which may be purchased with it, are necessarily reserved for the latter. The consumption is the same, but the consumers are different” (Smith 1811: 240).

These passages are essentially an assertion of Say’s Identity (Baumol 1977: 158). Keynes also states:

“Thus Say’s law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment” (Keynes 1936: 26).

This was perhaps a mischaracterization of Say’s actual ideas (Kates 1998; Keen 2001: 189–190). In this passage, Keynes was refuting the reformulation of Say’s law by John Stuart Mill and Alfred Marshall. Say did in fact acknowledge that downturns in the business cycle could happen. Baumol has even argued that

“Say and other writers recognized that the zero value of the sum of excess demands, or supply creates its own demand (“Say’s identity”), may not hold in the short run. Say’s passage in his Letters to Malthus … even suggests an explanation – a desire to hoard or, as we would now put it, a temporary excess demand for money. But they thought the market would fairly quickly and automatically restore equilibrium” (Baumol 1999: 201).

In other words, it appears that Say eventually partly though not fully understood what Keynes himself believed: changes in liquidity preference can cause insufficient demand and involuntary unemployment. Both Say and J. S. Mill in some writings even appear to have allowed that failures in aggregate demand can cause recession (Hollander 2005: 383-284).

However, the general view of Say and the 19th century classical economists seemed to be that recessions and involuntary unemployment could occur, but mainly by sectoral imbalances (though Hollander maintains that Say and Mill glimpsed that failures of aggregate demand might be involved), and that Say’s law of markets was the mechanism by which equilibrium was rapidly restored in a free market economy (Kates 1998: 14).

So what does all this prove? That Say’s law of markets is true? Hardly.

In fact, Keynes still refuted the version of Say’s law in J. S. Mill and Marshall, even if they did not understand Say properly.

And a careful examination of Say’s writings on demand and production shows that his reasoning is deeply flawed. A good starting point is this passage in Say’s Catechism of Political Economy (1816: 103–105):

On what does the vivacity of the demand depend?

On two motives which are—1st. The utility of the product, that is, the necessity the consumer has for it:—2nd. The quantity of other products he is able to give in exchange.

I conceive the first motive. As to the second it appears to me that it is the quantity of money that the buyer possesses which induces him to buy or not.

That is also true: but the quantity of money which he has, depends on the quantity of product with which he has been able to buy this money.

Could he not obtain the money otherwise than by having acquired it by products?

No.

If he had received the money from his tenants?

His tenant had received it from the sale of part of the products to which the earth had contributed.

If he had received the interest of a capital lent?

The undertaker who employed that capital had received the money which he paid, on the sale of a part of the products to which his capital had concurred.

If the purchaser had obtained this money by gift or inheritance—?

The giver, or he from whom the giver had obtained it, had it in exchange for some product. In every case the money, with which any product is purchased, must have been produced by the sale of another product; and the purchase may be considered as an exchange in which the purchaser gives that which he has produced, (or that which another has produced for him), and in which he receives the thing bought.

What do you conclude from this?

That the more the purchasers produce, the more they have to purchase with, and that the productions of the one procure purchasers to the other.

It appears to me, that if the buyers only purchased by means of their products, they have generally more products than money to offer in payment.

Every producer asks for money in exchange for his products, only for the purpose of employing that money again immediately in the purchase of another product; for we do not consume money, and it is not sought after in ordinary cases to conceal it: thus, when a producer desires to exchange his product for money, he may be considered as already asking for the merchandise which he proposes to buy with this money. It is thus that the producers, though they have all of them the air of demanding money for their goods, do in reality demand merchandise for their merchandise (Say 1816: 103–105).

Say believed that any short-term glut in particular commodities would be quickly eliminated.

First, Say holds that buyers of commodities cannot obtain money except by having acquired it from the sale of other commodities. This is also expressed in A Treatise on Political Economy, Book 1, Chapter 15:

“A man who applies his labour to the investing of objects with value by the creation of utility of some sort, can not expect such a value to be appreciated and paid for, unless where other men have the means of purchasing it. Now of what do these means consist? Of other values of other products, likewise the fruits of industry, capital and land. Which leads us to a conclusion that may at first sight appear paradoxical, namely, that it is production which opens a demand for products” (Say 1832: 133).

Here Say is clear that only production of other commodities provides the money to pay for “products” (a related question is what he means by “capital”: if this means investment money then it is obvious that Say naturally thinks of money as a commodity too). A form of this idea is sometimes encountered on libertarian blogs. For example, one will find Austrians asking questions such as “how could people have money if they hadn’t produced something to exchange for money?”

The answer is that without production people would have no commodities (= wealth) for consumption. They might still have money. The premise of such a question is that without prior production there is no money to purchase commodities. This commits Austrians to the view that money is a “produced” commodity. But today we live in a fiat money world. Money is no longer “commodity” money. It is not “produced” in the way that gold and silver are dug out of the ground. Today fractional reserve banking creates money through debt, and open market operations create new money in the form of bank reserves. This is the real world in which we live, and even in Say’s own time fractional reserve banking was creating fiduciary media without prior creation of commodities.

Say’s law appears to require a world where money is produced like any other commodity, and this is one condition for the law of markets to work. But the condition does not exist today: Say’s law is irrelevant to modern fiat money using economies, where money also has a store of value role.

The second fatal and ridiculous flaw in Say’s argument is the belief that “every producer asks for money in exchange for his products, only for the purpose of employing that money again immediately in the purchase of another product.”

In fact, it simply isn’t the case that producers of commodities (whether individuals or businesses) or the recipients of the money profits of the firm like workers or owners will always use the money they earn from the sale of commodities “only for the purpose of employing that money again immediately in the purchase of another product.” Money can be saved and it can become idle. Capitalism also has markets for real and financial assets. Money can flow into the purchasing of financial assets. If there are financial assets or real assets whose prices are rising, modern capitalists, producers and even workers might decide to start speculating on asset prices. This would take money away from the purchasing of commodities and instead tie it up in exchanges on asset markets, as money alternates between being (1) held idle before buying assets and (2) purchasing assets, and then being held idle again by the new owner of the money in preparation for further speculation.

Another fatal flaw in Say’s reasoning is that money has no utility and cannot be used as a store of value:

“for we do not consume money, and it is not sought after in ordinary cases to conceal it” (Say 1816: 104).

“For, after all, money is but the agent of the transfer of values. Its whole utility has consisted in conveying to your hands the value of the commodities, which your customer has sold, for the purpose of buying again from you; and the very next purchase you make, it will again convey to a third person the value of the products you may have sold to others” (Say 1832: 133).

“Money performs but a momentary function in … double exchange; and when the transaction is finally closed, it will always be found, that one kind of commodity has been exchanged for another” (Say 1832: 134).

“When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should diminish in his hands. Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable. But the only way of getting rid of money is in the purchase of some product or other. Thus, the mere circumstance of the creation of one product immediately opens a vent for other products” (Say 1832: 134–135).

It is clear that Say believes in neutral money, and he is deeply mistaken in thinking of money only as a neutral “veil” with no store of value function (for the concept of neutral money, see Visser 2002). Say’s analysis also ignores the role of financial markets in affecting demand for money.

It should be noted of course that Say’s ideas were later developed by the Classical economists, so Say’s law in that historical sense is not the same as the ideas found in Say’s own writings.

So what was Say’s law in its developed form and as held by modern defenders of it?

Thomas Sowell (1994: 39–41) argues that in Classical economics Say’s law can be expressed by these propositions:

“(1) The total factor payments received for producing a given volume (or value) of output are necessarily sufficient to purchase that volume (or value) of output [an idea in James Mill].

(2) There is no loss of purchasing power anywhere in the economy. People save only to the extent of their desire to invest and do not hold money beyond their transactions need during the current period [James Mill and Adam Smith].

(3) Investment is only an internal transfer, not a net reduction, of aggregate demand. The same amount that could have been spent by the thrifty consumer will be spent by the capitalists and/or the workers in the investment goods sector [John Stuart Mill].

(4) In real terms, supply equals demand ex ante [= “before the event”], since each individual produces only because of, and to the extent of, his demand for other goods. (Sometimes this doctrine was supported by demonstrating that supply equals demand ex post.) [James Mill.]

(5) A higher rate of savings will cause a higher rate of subsequent growth in aggregate output [James Mill and Adam Smith].

(6) Disequilibrium in the economy can exist only because the internal proportions of output differ from consumer’s preferred mix—not because output is excessive in the aggregate” [Say, Ricardo, Torrens, James Mill] (Sowell 1994: 39–41).

So this is Say’s law, according to the Classical economists.

First, it is perfectly possible that supply equals demand ex ante, which is asserted in proposition (1) and in the first statement in (4) (if one ignores the qualification “since each individual produces only because of, and to the extent of, his demand for other goods,” which does not follow at all), but to assert that it will always hold ex post is a non sequitur, without demonstrating the truth of propositions (2), (3), (5), and (6).

Unfortunately, these propositions cannot be held to be true.

Let’s start with proposition (2). Under conditions of uncertainty, money has utility (see my previous post “The Utility of Money in Post Keynesianism”, which I will use in what follows). It is deeply flawed to regard money only as a “neutral veil” that overcomes the inconveniences of direct barter. Such an idea is associated with the “neutral money axiom” (Davidson 2002: 19). In reality, people really do choose to hold money in and of itself as (1) a store of value and (2) a way of dealing with future uncertainty. Thus there is a precautionary motive for holding money, in addition to the transactions motive. Say’s law of markets requires neutral money or the idea that money only has a medium of exchange role. As Paul Davidson has argued,

“[in] an uncertain world, the possession of money and other nonproducible liquid assets provides utility by protecting the holder from fear of being unable to meet future liabilities” (Davidson 2003: 236).

The neoclassicals thought that only producible goods and services can provide utility. But money can have utility on its own account. So can liquid financial assets. The neoclassical view was that money has no utility, but only exchange value. The Austrian view also seems to be that money has no utility except for what can be obtained in exchange for it. The idea that money has no utility in itself is part of the three fundamental neoclassical axioms that Keynes rejected. The following three fundamental axioms are the basis of neoclassical economics and of Say’s law:

(1) the neutral money axiom (i.e., holding money by itself provides no utility),
(2) the gross substitution axiom, and
(3) the ergodic axiom.

If one assumes these false axioms, then one will believe that the “aggregate demand function is the same as the aggregate supply function” (Davidson 2002: 43). Post Keynesian economics requires the rejection of these axioms. In a fundamentally uncertain world, you have the problem of facing a possible lack of liquidity in the future (i.e., lack of money). This is why many people like to hold onto money, and precisely why money has utility – and in fact often has a great deal of utility.

Moreover, Keynes in the General Theory made the fundamental point that fiat money and even commodity money have special properties:

“… money has, both in the long and the short period, a zero, or at any rate a very small, elasticity of production, so far as the power of private enterprise is concerned, as distinct from the monetary authority;—elasticity of production meaning, in this context, the response of the quantity of labour applied to producing it to a rise in the quantity of labour which a unit of it will command. Money, that is to say, cannot be readily produced;—labour cannot be turned on at will by entrepreneurs to produce money in increasing quantities as its price rises in terms of the wage-unit. In the case of an inconvertible managed currency this condition is strictly satisfied. But in the case of a gold-standard currency it is also approximately so, in the sense that the maximum proportional addition to the quantity of labour which can be thus employed is very small, except indeed in a country of which gold-mining is the major industry.
Now, in the case of assets having an elasticity of production, the reason why we assumed their own-rate of interest to decline was because we assumed the stock of them to increase as the result of a higher rate of output. In the case of money, however—postponing, for the moment, our consideration of the effects of reducing the wage-unit or of a deliberate increase in its supply by the monetary authority—the supply is fixed. Thus the characteristic that money cannot be readily produced by labour gives at once some prima facie presumption for the view that its own-rate of interest will be relatively reluctant to fall; whereas if money could be grown like a crop or manufactured like a motor-car, depressions would be avoided or mitigated because, if the price of other assets was tending to fall in terms of money, more labour would be diverted into the production of money;—as we see to be the case in gold-mining countries, though for the world as a whole the maximum diversion in this way is almost negligible” (Keynes 1936: 230–231).

Money has a zero or very small elasticity of production. This means that a rise in demand for money and a rising “price” for money (i.e., an increase in its purchasing power) will not lead to businesses “producing” money by hiring workers.

The property of zero or very small elasticity of production also applies to liquid financial assets. If consumers decide to buy less producible commodities and increase their holding of money or ownership of financial assets, unemployment will result in some sectors as demand for commodities declines. The price of financial assets will rise and it is possible that the price of money could also rise. But private businesses cannot hire the unemployed to “produce” or “manufacture” more money or financial assets to exploit profit opportunities in the high-price liquid assets (Davidson 2010: 255–256).

In classical and neoclassical economics, however, money is held to be a commodity (e.g., gold, silver or some other type of commodity). If the demand for commodity money rises, neoclassical theory says it can be “produced” like any other commodity by hiring unemployed workers. But this idea is utterly false in a world where the commodity money consists of rare metals like gold or silver, and certainly false in the modern world of fiat money.

The second special property of money and liquid financial assets is that they have zero or near zero elasticity of substitution:

“The second differentia of money is that it has an elasticity of substitution equal, or nearly equal, to zero which means that as the exchange value of money rises there is no tendency to substitute some other factor for it;—except, perhaps, to some trifling extent, where the money-commodity is also used in manufacture or the arts. This follows from the peculiarity of money that its utility is solely derived from its exchange-value, so that the two rise and fall pari passu, with the result that as the exchange value of money rises there is no motive or tendency, as in the case of rent-factors, to substitute some other factor for it.
Thus, not only is it impossible to turn more labour on to producing money when its labour-price rises, but money is a bottomless sink for purchasing power, when the demand for it increases, since there is no value for it at which demand is diverted—as in the case of other rent-factors—so as to slop over into a demand for other things” (Keynes 1936: 231).

“money has (or may have) zero (or negligible) elasticities both of production and of substitution” (Keynes 1936: 234).

Financial assets are not gross substitutes for commodities. The neoclassical gross substitution axiom is wrong. In both a commodity money and fiat money world, savings are held in the form of money and non-producible financial assets. An increase in demand for money and non-producible financial assets and rising prices of such liquid assets will not spill over into a demand for relatively cheaper commodities, because the elasticity of substitution of money and liquid assets is zero or near zero (Davidson 2010: 256–257; Davidson 2002: 44–45; see also Hahn 1977: 31). Even if wages and prices were perfectly flexible, there could still be “leakages” in aggregate supply in the form of speculation on financial asset markets which would be “non-employment inducing demand” (Davidson 2010: 257; Hahn 1977: 37).

Thus a shortfall in aggregate demand is possible.

Moreover, there are other obvious leakages from the aggregate income arising from production that result in insufficient aggregate demand. There is no necessary reason why all the income will be spent on commodities in a particular time period, or even at all. Savings and changes in the rate of saving may happen.

Sowell’s proposition (3) above is also unacceptable. Classical advocates of Say’s law argued that saving would result in reasonably quick consumption or investment, but that simply does not follow. Money savings can become idle balances (“hoards,” in the terminology of Keynes). But even idle balances of money are not the only cause of a shortfall in demand. We can list the various “leakages” from aggregate income as described above, as well as some other ones, as follows:

(1) People desire to hold money as a hedge against future uncertainty (the “precautionary motive,” in Keynes’ theory), and since expectations are subjective such holdings can vary. In depressions or recessions, people may choose to hold more of their money as cash. In underdeveloped and pre-modern economies, hoarding can take the form of holding money physically outside of banks as cash or coin (Gootzeit 2003: 182). In the Great Depression, the rise in the hoarding of money was a significant factor, as it probably was in pre-1914 downturns in the business cycle (Wicker 1996: 144).

(2) As we have seen, even when people hold money either as individuals or as savings in financial institutions, not all the money will be invested in production of producible commodities (= goods and services). Money can be used to speculate on asset prices. New savings or a rise in savings can be diverted to purchasing of financial assets (or real assets) with the money used to buy such assets then flowing to other speculators, who buy new financial assets or hold money idle in the process of using it in further speculation on assets. Thus there is a “speculative demand” for money that can rise or fall.

(3) In modern economies where savings are held in demand deposits and saving accounts in banks, money is invested by banks themselves. But even here investment by banks will be subject to subjective expectations under uncertainty. In recessions or depressions when expectations are low, banks may simply choose to keep their depositors’ money as excess reserves or use it to buy financial assets on secondary markets. Thus even modern banks can “hoard” by reducing investment and leaving money in idle balances (at central banks or held in reserve for speculation on financial assets).

(4) Money income can be spent on imports causing a trade deficit, which in pre-fiat money days could result in a contraction of the money supply and deflationary pressures.

(5) A government might levy taxes and a run budget surplus without re-injecting that money back into the economy (and effectively destroying it).

Once propositions (2) and (3) of Say’s law above are shown to be false, propositions (4) and (5) collapse completely, and the idea that supply equals demand ex post cannot be possible.

For all these reasons, aggregate demand failures can cause recessions, whenever aggregate demand falls short of supply. Equilibrium will not result and is not necessarily a condition of free markets. Say’s law is a myth.


APPENDIX 1: SAY ADVOCATED PUBLIC WORKS

In his discussion of the introduction of labour saving machines, Say recognised that this would create short term unemployment, and in a footnote actually advocated public works spending by government:

“Without having recourse to local or temporary restrictions on the use of new methods or machinery which are invasions of the property of the inventors or fabricators a benevolent administration ran make prevision for the employment of supplanted or inactive labour in the construction of works of public utility at the public expense as of canals, roads, churches or the like …” (Say 1832: 87).

This must come as an embarrassing shock to Austrians who so frequently cite Say’s work with approval.

APPENDIX 2: RESERVATION DEMAND DOES NOT RESCUE SAY’S LAW

Reservation demand is defined as a type of demand in which producers or sellers of commodities hold their commodities off the market and refuse to sell them, because they expect higher prices in the future.

Reservation demand was never invoked by J. B. Say or other classical economists in defence of Say’s law, but one modern libertarian defence of Say’s law appears to use this concept.

As J. T. Salerno notes,

“Rothbard (1993, pp. 350–56, 662–67) was the first to analyze the demand for money in terms of its exchange demand and reservation demand components. In 1913, Herbert J. Davenport … also clearly identified these two partial demands for money but ultimately failed to integrate them into an overall theory of the demand for money” (Salerno 2006: 40, n, 4).

Rothbard sets out the types of reservation demand in relation to commodities:

“The sources of a reservation demand by the seller are two: (a) anticipation of later sale at a higher price; this is the speculative factor analyzed above; and (b) direct use of the good by the seller. This second factor is not often applicable to producers’ goods, since the seller produced the producers’ good for sale and is usually not immediately prepared to use it directly in further production. In some cases, however, this alternative of direct use for further production does exist. For example, a producer of crude oil may sell it or, if the money price falls below a certain minimum, may use it in his own plant to produce gasoline. In the case of consumers’ goods, which we are treating here, direct use may also be feasible, particularly in the case of a sale of an old consumers’ good previously used directly by the seller—such as an old house, painting, etc. However, with the great development of specialization in the money economy, these cases become infrequent” (Rothbard 2004 [1962]: 253).

Rothbard (2004 [1962]: 755ff.) treats money as a commodity and analyses the supply and demand for it “in terms of the total demand-stock analysis” he had used in Chapter 2 of Man, Economy, and State, and this obviously has relevance to Say’s law, and is indeed applied to it in Hoppe, Hulsmann, and Block (1998: 40).

To see how the concept of reservation demand is applied to money we can turn to Rothbard’s Man, Economy, and State: A Treatise on Economic Principles (1962):

“When a seller keeps his stock instead of selling it, what is the source of his reservation demand for the good? We have seen that the quantity of a good reserved at any point is the quantity of stock that the seller refuses to sell at the given price. The sources of a reservation demand by the seller are two: (a) anticipation of later sale at a higher price; this is the speculative factor analyzed above; and (b) direct use of the good by the seller. This second factor is not often applicable to producers’ goods, since the seller produced the producers’ good for sale and is usually not immediately prepared to use it directly in further production” (Rothbard 2004: 253).

So, in relation to commodities, Rothbard’s definition is in line with the generally accepted definition. But there is absolutely no necessary reason at all why (1) the value of commodities not sold due to reservation demand would equal (2) the total value of unsold commodities in a given period. Many commodities will remain on the shelves simply because they were not sold.

Moreover, Rothbard treats money as a commodity since he is an advocate of the gold standard. When we come to money, Rothbard also uses the concept of reservation demand:

“The total demand for money on the market consists of two parts: the exchange demand for money (by sellers of all other goods that wish to purchase money) and the reservation demand for money (the demand for money to hold by those who already hold it)” (Rothbard 2004: 759).

“More important, because more volatile, in the total demand for money on the market is the reservation demand to hold money. This is everyone’s post-income demand. After everyone has acquired his income, he must decide, as we have seen, between the allocation of his money assets in three directions: consumption spending, investment spending, and addition to his cash balance (‘net hoarding’). Furthermore, he has the additional choice of subtraction from his cash balance (‘net dishoarding’). How much he decides to retain in his cash balance is uniquely determined by the marginal utility of money in his cash balance on his value scale. … We have now to look at the remaining good: money in the cash balance, its utility and demand. Before discussing the sources of the demand for a cash balance, however, we may determine the shape of the reservation (or ‘cash balance’) demand curve for money” (Rothbard 2004: 759).

Rothbard’s reference to everyone acquiring “his income” can presumably refer to total factor payments from production (aggregate supply). Rothbard now defines “reservation demand” for money as the money flowing into cash balances (net hoarding).

It is here that libertarians might jump on Rothbard’s analysis to argue that Say’s law can be saved from collapse by applying the concept of reservation demand to money.

But what can the expression “reservation demand” mean when applied to money? When applied to commodities, it means that commodities are held off the market by sellers in expectation of higher prices in the future. Logically, then, reservation demand for money would be holding money in expectation of a higher price for money in the future in terms of its purchasing power. That is, a higher price for money can only mean a rise in money’s purchasing power, whether through general price deflation or falls in the prices of a commodity or commodities one wishes to purchase. Rothbard’s other comments support this:

“an expectation of a rise in the … [purchasing power of money] in the near future will tend to raise the demand-for-money schedule as people decide to “hoard” (add money to their cash balance) in expectation of a future rise in the exchange-value of a unit of their money. The result will be a present rise in the [purchasing power of money]” (Rothbard 2004: 768).

But Rothbard’s definition of “reservation demand” as all net money added to and held in cash balances (“net hoarding”) includes forms of idle money that cannot legitimately be called “reservation demand.” Rothbard has changed the meaning of “reservation demand” in a sleight of hand.

At most, “reservation demand” for money can only describe one subcategory of Keynes’ speculative demand for money: that category that involves holding money in expectation of general price deflation or price falls in one or other commodities.

Speculative demand for money includes many other categories, including holding money to buy assets expected to rise in price in the future.

And even if one chooses to make “reservation demand” for money in its only proper sense equal to its value as inserted into aggregate supply, this still leaves other idle money balances not spent on consumption or investment in capital goods.

A revised version of Say’s law according to the libertarian defence can be given here:

Aggregate supply (AS) = total factor payments + value of money held in reservation demand
equals Aggregate demand (AD) = consumption + investment on capital goods + value of commodities and money in reserve demand.

This still does not save Say’s law. Although the value of all commodities held by “reservation demand” equals the value of such commodities included in total factor payments, there will still be the value of commodities not purchased by consumption or investment on capital goods in AD left over.

As for AD, the value of total factor payments will be divided into these three categories when spent in aggregate demand:

(1) consumption payments;
(2) investment on capital goods;
(3) money held by reservation demand (a speculative demand for money);

But money from total factor payments can also be diverted into

(4) money held idle by precautionary motive (money held because of uncertain future);
(5) money held for other speculative demands;
(6) money held idle in financial market transactions.

Although money held in (3) will by definition equal money held in reservation demand in aggregate supply, there is still the likelihood that money will be held idle by the precautionary motive (4), other speculative demands (5), and in financial market transactions (6).

Rothbard’s sleight of hand is to lump (3), (4), (5), and (6) into one category he called reservation or ‘cash balance’ demand.

This can be used to then argue that Say’s law holds because the category “cash balance demand” is by definition equal to that value in aggregate supply when it is inserted into AS.

But this trick will not save Say’s law. In (3), (4), (5), and (6), money will be idle and not spent on aggregate supply. Without total factor payments going to purchase commodities or to capital goods investment, aggregate demand failures can occur.

I also note that Hoppe, Hulsmann, Block, in response to Selgin and White (1996), have also used the concept of reservation demand in discussing Say’s law and in arguing against the existence of fiduciary media:

“[Selgin and White] have overlooked Say’s law: all goods (property) are bought with other goods, no one can demand anything without supplying something else, and no one can demand or supply more of anything unless he demands or supplies less of something else. But this is here not the case whenever a fiduciary note is supplied and demanded. The increased demand for money is satisfied without the demander demanding, and without the supplier supplying, less of anything else. Through the issue and sale of fiduciary media, wishes are accommodated, not effective demand. Property is appropriated (effectively demanded) without supplying other property in exchange. Hence, this is not a market exchange which is governed by Say’s law – but an act of undue appropriation” (Hoppe, Hulsmann, Block 1998: 40).

One obvious consequence of such a view is that Say’s law can only hold in a world without fiduciary media, fractional reserve banking and fiat money! For Say’s law to work in the way postulated here there must only be commodity money and no fractional reserve banking or fiduciary media. We don’t live in such a world, so Say’s law does not hold.


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