Consulting by RPM || Free Advice Blog

Mises Was a Keynesian Too, Apparently

I am eager to see how the anti-Keynesians explain this one away–but they are a clever bunch, and I know they will come up with an argument. Let’s set the scene:

In this post, I pointed out that because they didn’t want to give Keynes an inch, some modern Austrians were forced to deny that savings was equal to income minus consumption, so long as the savings consisted of increased cash balances. Here’s the example I used:

15-year-old Johnny mows my lawn every week, and I pay him $20 each time. Every week, he spends $15 of it going to the movies with his friends, but he puts $5 in a piggy jar on his bureau.

After a year, he has accumulated $5×52 = $260 which he uses to buy a nice watch. Johnny says, “I’m sure glad I consumed less than my income all year, saving $5 per week. Then I used my accumulated savings to buy a watch. I deferred consumption all year in order to buy a nice good later on.”

Wenzel says, “What the heck are you talking about? Are you a Keynesian Johnny? You haven’t saved at all.”

Are you guys all comfortable with that? You don’t think Johnny was saving $5 per week?

Originally, no one had the audacity to nakedly say, “Right Bob, Johnny isn’t saving.” Wenzel made a sarcastic crack while ignoring the point, and Major Freedom danced around the issue by saying Johnny was indeed deferring consumption (without explicitly saying this constituted saving).

But Major Freedom is no coward (he leads men into battle every day). In the comments he bit the bullet and declared:

In your example, Johnny is not an investor. He is only a consumer. So his consumption to investment ratio is infinity. He is spending 100% of his income on consumption, and 0% on investment. His time preference is therefore infinitely high, and so he earns zero interest. This is true even if Johnny hoard $5 in cash each week.

The reason why it is problematic for you to say that by hoarding $5 each week is “saving” is because there is no objective time frame to define a holding of cash as “saving.” You implicitly defined “saving” in your example as “hoarding a portion of one’s income, in cash, and do so for one year.”

Major Freedom may be interested to read this analysis from a major economist, who apparently is a Keynesian on this issue as well:

In recent years economists have paid special attention to the role cash holding plays in the process of saving and capital accumulation. Many fallacious conclusions have been advanced about this role.
If an individual employs a sum of money not for consumption but for the purchase of factors of production, saving is directly turned into capital accumulation. If the individual saver employs his addi- tionai savings for increasing his cash holding because this is in his eyes the most advantageous mode of using them, he brings about a tendency toward a fall in commodity prices and a rise in the mone- tary unit’s purchasing power. If we assume that the supply of money in the market system does not change, this conduct on the part of the saver will not directly influence the accumulation of capital and its employment for an expansion of production.18 The effect of our saver’s saving, i.e., the surplus of goods produced over goods con- sumed, does not disappear on account of his hoarding. The prices of capital goods do not rise to the height they would have attained in the absence of such hoarding. But the fact that more capital goods are available is not affected by the striving of a number of people to increase their cash holdings. If nobody employs the goods-the nonconsumption of which brought about thc additional saving-for an expansion of his consumptive spending, they remain as an incre- ment in the amount of capital goods available, whatever their prices may be. The two processes-increased cash holding and increased capital accumulation-take place side by side. [Human Action, pp. 518-519]

To refresh everyone’s memory, the reason this is apparently so important is that Keynes was arguing interest wasn’t the return to saving, since someone who saves in the form of increased cash balances doesn’t earn interest. Yet if you want to insist (as Austrians do) that interest isn’t really about money, but instead is about “real” goods, then do what Mises does above: Say that increased cash holdings pushes down prices compared to what they otherwise would be, and so the real rate of return on cash balances is higher than it otherwise would be.

If prices are falling, then even with a zero nominal rate of interest on cash, you could earn a positive real rate of return on that “investment.”

My problem with this is that we are denying what is staring us in the face: The market rate of interest is about money, and it’s amazing that Austrians of all schools are analyzing interest by abstracting away from money. Yet if you want to do that, then the above is how you should evade Keynes’ argument. Don’t deny that living below your means is necessarily saving.

PS: Let me give you a warning. For sure I can find Hayek more explicitly defining saving the way I am doing (in contrast to Mises talking about production in the above quotation, not income), but I also think I can find Mises doing it when he’s talking about accounting and the concept of capital in Human Action. So if you’re going to object that the above quotation doesn’t get the job done, OK, but tread carefully since I am pretty sure I can find more damning ones to the Wenzel-Freedom position.