Say’s Mistake or Say’s Brilliance – Say’s Law, Banking and Credit
One of Jean Baptiste’s Say’s earliest jobs was in the insurance industry, providing Insurance to Frances trade with its colonies. An observer of such trade would have noticed something very interesting. The trading vessels would have arrived at France’s West Indian Colonies ready to take on board a cargo of sugar in their holds, but the holds were not empty on arrival, they were full of goods which were traded even before the sugar can producers had been paid for their wares.
In these circumstances it is easy to see how Say could have believed that trade is equivalent to barter, with money acting a pure and fleeting ‘momentary function’ (1819: 56-57)..
In a letter to Malthus
All those who, since Adam Smith, have turned their attention to Political Economy, agree that in reality we do not buy articles of consumption with money, the circulating medium with which we pay for them. We must in the first instance have bought this money itself by the sale of our produce (…) From these premises I have drawn a conclusion (…) the consequences of which appear to have alarmed you. I had said: As no one can purchase the produce of another except with his own produce; as the amount for which we can buy is equal to that which we can produce, the more we produce the more we will purchase. From whence proceeds this other conclusion, which you refuse to admit, that if certain commodities do not sell, it is because others are not produced, and that it is the raising produce alone which opens a market for the sale of produce (Say, 1820: 440-441; revised translation, based on Say, 1821).
Says treatment of his ‘law of markets’ was but fleeting in his first edition.
It is worthwhile to remark that a product is no sooner created than it, from that instant, affords a market for other products to the full extent of its own value. 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 creation of one product immediately opens a vent for other products. (J. B. Say, 1803: pp.138–9)
Later apologists for Say, and Critics of Keynes, state he misunderstood and missaplied Says Law. Says of course did not state – Supply creates its own demand, that was JS MIll’s description of Says Law.
Nothing is more true than that it is produce which constitutes the market for produce, and that every increase of production, if distributed without miscalculation among all kinds of produce in the proportion which private interest would dictate, creates, or rather constitutes, its own demand.
—John Stuart Mill, Essays On Some Unsettled Questions of Political Economy (1844), “Of the Influence of Consumption On Production”, p. 73
Critics of Keynes such as Kates state a correct formulation is that sales creates demand, and indeed in Keyne’s Z function of aggregate supply he assumes no unsold inventory. But note that Says made this assumption too as he assumes that production immediately creates demand even before products are sold. It is this issue of immediacy and the dismissal of the impact of saving hoarding that was objected to by Malthus and Keynes.
Of course there will be some effective demand even before final consumption products are sold from the ‘instant’ of production (including intermediate goods), during the period of production of the good and all intermediate goods and capital goods to create them there will be a ‘wages flow’ will will sustain a certain level of demand. However without sales and without profits this flow will decline as the capital advanced for production is absorbed and as capital goods depreciate. The system will not reproduce.
Returning to the case of those ships holds. Merchants would fill the holds because they knew that not all sugar growers would sell at once, there would be overlapping supply and demand. It would be less common for goods to be ordered in advance from the other side of the Atlantic by individual plantation owners. any goods would be ordered by intermediate traders and these were likely to pay on receipt of those goods given the uncertainty of delivery. Hence the Merchants would have to purchase the consumption goods on credit before they are sold. Of course where goods are purchased on credit the effective demand is equal to the sale of the product + the credit minus the repayments of debt minus receipts ‘saved’ (not spent). If credit merely ‘turns over’ so that credit is advanced at the same rate of repayment then effective demand will not be influenced by credit – it will net out. But in circumstances of growth or recession they will not even out, net debt credit receipts and repayments and net savings (in real terms) will influence effective demand.
Says had an unusually advanced treatment of Banking for the time he was writing (predating Thorton for example). He accepted the utility of notes of exchange and fractional reserve banking. Though a ‘metallist’ in advocating metals as the ultimate store of value and advocating full reserve banking with all loans backed by securities. He therefore held to the ‘currency school’ as it would be later be called rather than the ‘banking school’ where credit did not have to have full reserve backing, securities simply had to cover the probability of default and hence paper money could be created, not simply intermediated, backed by the goods the credit would create.
So Says did have an implicit theory of banking where mercantile credit would ensure that a demand would be created for goods the moment they were created (‘without miscalculation’ to add JS Mills clarification). But in holding to the false currency school view of money as a pure intermediary he incorrectly failed to ignore changes to money creation and saving in the foundation of the ‘law of markets’.