Money that is saved does not vanish into thin air. It is lent out by banks and other
financial institutions, being spent by different people for different purposes, but still
remaining just as much a part of purchasing power as if it had never been saved.
According to Say’s Law— supply creates its own demand.
What a group of French economists known as Physiocrats showed in the late eighteenth
century was that the production of goods and services automatically generates the
purchasing power needed to buy those goods and services. When the economy creates
another hundred million dollars worth of output, that is also another hundred million
dollars worth of wealth that can be used to buy this or other output. Production is
ultimately bought with other production, using money as a convenience to facilitate the
transactions.
During the Great Depression of the 1930s, for example, there was a massive increase of
unemployment, along with business losses for the economy as a whole. The greatly
reduced money supply of 1932 was incapable of buying the amount of output that had
been produced during the boom years that ended in 1929. More precisely, the 1932
money supply was incapable of buying the 1929 level of output at 1929 prices. Prices
began declining as a result of unsold goods, but prices did not fall fast enough or far
enough to restore immediately the full production needed to create a full employment.
Major malfunctions of the monetary system, including both massive bank failures and
counterproductive policies by the Federal Reserve Board, as well as restrictive tariffs that
disrupted international trade, and amateurish tinkering with the economy by both the
Hoover and Roosevelt administrations, turned a problem catastrophe.
John Maynard Keynes argued that government spending could put more money back into
circulation and restore the economy to full employment faster than by waiting for prices
to fall into balance with the reduced amount of money in circulation. But Keynes never
claimed that the economy had just produced too much.
President Herbert Hoover and then Franklin D. Roosevelt both tried to keep wage rates
from falling, as a means of maintaining the purchasing power of workers, as well as for
humanitarian reasons. But there was no way to keep employing the same number of
workers as before, at the same wage rates as before, when the money supply was onethird smaller.
Prices had to come down in the economy as a whole if everything was to be purchased
with a smaller money supply.
Some economists, including Nobel Prize winner Milton Friedman, have argued that it
was precisely government policies that kept the economy from recovering as quickly as it
had before, when left alone.
Whatever the merits or demerits of various political proposal, what must be kept in mind when evaluating them is that the good fortunes and misfortunes of different sectors of the economy may be closely related as cause and effect - and that preventing bad effects may prevent good effects. It was not accidental that Smith Corona was losing millions of dollars on its typewriters while Dell was making millions on its computers. It was not accidental that Safeway surged to the top of the grocery business while A&P fell from its peak to virtual oblivion. The efficient allocation of scarce resources, which have alternative uses, means that some must lose their ability to use those resources in order that others can gain the ability to use them Typewriters were no longer what the public wanted after they had the option to achieve the same end result and more with computers. Scarcity implies that resources must be taken from some places, in order to go to other places.
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