Let’s be thankful for Say’s Law

by Eric Shierman

On this Thanksgiving, we all have many things to be thankful for in our private lives. Despite the endless flow of bad news out there, we have a lot to be thankful for in our public policy lives as well. Despite the hyperbole of political rhetoric, we can be thankful that Barack Obama is not a real socialist like Hugo Chavez. Despite our super committee’s failure to reach a debt reducing deal, we can be thankful that the yield on ten year Treasuries remains 3%, having not shot up to 7% as it has for France, Spain, and Italy. Since none of these things are guaranteed to be permanent, I would like to focus your thankfulness on something constant like Say’s Law.

Jean Baptist Say was a French economist that identified how any supply of a commodity could sell so long as prices are allowed to adjust. While he did reserve for the possibility that one commodity could be so overproduced relative to all other commodities that a price of zero would not deplete inventories, his law explains why this cannot happen on a systemic level. Thanksgiving being such a food orientated holiday, I would like to use something edible to demonstrate this law in action by showing the relationship of McDonald’s McRib sales and pork prices.

mcrib

McDonald’s being such an effective force in marketing, it would be natural to assume this is purely a sales gimmick like Disney bringing its back-listed movies in and out of theaters, but there is an unmistakable role that the price of pork has in McDonald’s timing of the return of the McRib to its menus, and there is an unmistakable role McDonald’s decision has on pork prices. Here is the data for pork prices over the last decade and the previous five times McDonald’s sold the McRib.

pork prices and the McRib

McDonald’s clearly waits until the price of pork drops to a point that guarantees its promotion will be profitable. McDonald’s purchases then cause a recovery in pork prices. This is a microeconomic example of something happening simultaneously to all the other goods and services available in an economy as the dynamic complexity of aggregate demand works itself out.

There is a fundamental asymmetry between inflation and deflation as macroeconomic phenomenon. A little inflation gradually threatens to compound into a lot of inflation as wages chase prices, savers stop being suckers, and consumers accelerate their purchases to save money from expected higher future prices. There is no ceiling to contain hyperinflation, but Say’s Law shows how there is a natural floor to prevent hyperdeflation. There is a price point for every commodity that triggers a market clearing sale.

obama eating mcrib

Politicians, many of whom love the McRib as much as the next guy, tout the threat of perpetual deflation to justify the patronage spending of stimulus packages, agricultural subsidies, and moratoriums on foreclosures. In their attempt to prop up prices to avoid the temporary pain of deflation, politicians prevent markets from reaching their clearing prices, prolonging the pain.

The fact that it does not have to be this way is something we all can be thankful for.

Eric Shierman is a partner at Creative Destruction Investment Partners, writes for the Oregonian under the pen name “Portland Aristotle” on the MyOregon blog, and is the author of the forthcoming book: A Brief History of Political Cultural Change. His articles can be read at:http://connect.oregonlive.com/user/PortlandAristotle/posts.html

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  • Professor

    But he is a real socialist. Get real.

  • Touchpad

    HP found the price point for tablets, didn’t they???

  • valley person

    I’m thankful that policy makers don’t follow your advice Eric, or we would have 30% unemployment by now instead of 9%. 

    • Steve Buckstein

      One correction, valley.  If they had followed Eric’s advice starting in, say 2007 or 2008, we might have had high unemployment for a few months, but now would be down to 3 or 4%, and our national debt wouldn’t be in the stratosphere. To avoid that short-term pain, you would have us suffer for so long that many people are willing fall for the “occupy” solutions that will only make things worse.  

      • valley person

        I don’t think so Steve. Eric is a smart, well educated guy who has a certain set of ideas about monetary and fiscal policy that sound an awful lot like the set of ideas that guided Hoover, and are presently guiding Europe. A stable currency above all else, and let deleveraging do its thing. “Liquidate the farmers, liquidate the bankers, liquidate stocks, liquidate real estate….”

        It may be good free market economics, but its real bad social policy.

        I would have us “suffer” less through social spending during downturns. Like Keynes advised.   Let downturns run their course sure, but along an artificial bottom that reduces total suffering.  

  • Bob Clark

    I think the federal deficit spending could actually be neutral to general price levels, but this requires a rather herioc assumption current government leaders can actually be trusted to invest in productive endeavors.  Instead, we get political slush funds for the re-election of Obama (funds for teachers and police from the feds is a clear cut way of funneling federal monies into union dues for subsequent donation to Obama’s re-election campaign).  Then there are the solyndra’s – whose executives gave big time to Obama’s campaign and then got a half billion dollar in federal funds even though federal staff knew Solyndra’s business plan was highly dubious.

    In contrast to the current presidential regime, I look at the Columbia River Dam system built with federal dollars and with labor not demanding “prevailing wages” and you know within government exists the potential to actually spend monies productively.  Governor Chris Cristie seems like a government leader who knows a thing about being productive with public monies.  But Obama seems very miscast in the role of fostering productivity in public expenditure.  I remember even Al Gore set about on a mission to streamline federal agencies.  But no such effort from the Obama.

  • valley person

    Not being an economist, I had to look up ‘Say’s Law.” As I suspected, its part and parcel of “classical economics, or all that which preceded Keynes.  

    “A little inflation gradually threatens to compound into a lot of inflation as wages chase prices”

    Are you are saying that a low rate of inflation over a long time will, like compound interest result in “a lot” of loss in the value of a dollar? If that is your point, so what? If a gradual loss in the value of a dollar is offset by ever increasing productivity, after inflation income and wealth, who cares that a “dollar,” which is merely a denomination of a currency, could buy more at some past date? The median US household income wage in 1967 was $6000. Today it is over $50,000. Adjusted for inflation it is $10,000 higher. So a median household has 25% more purchasing power with a dollar that is worth a whole lot less. Who cares about that 1967 dollar?

    If on the other hand you mean that a moderate inflation rate (say 3%) always leads to a higher inflation rate (ending I suppose in hyper inflation) that has not been the case in the US or any other advanced economy since Germany in the 1920s, which was a unique circumstance. Federal Reserve Bankers know how to reduce inflation rates. They appear to have a harder time inducing a bit of needed inflation. (Its psychologically hard for them). There is a ceiling to prevent hyper-inflation long before it manifests. If it were otherwise, we would have had hyper inflation long ago. Hyperinflation is the boogie man classical economists are always warning about, but it never appears. Must be a reason for this. 

    There may be a price point for any commodity that allows it to clear inventory. The problem, as Keynes pointed out, is extrapolating micro-economics to macro. Deflation, as in ALL goods and services having to drop in price, triggers the opposite of hyper-inflation. People put off purchases, waiting for the price to come down more, leading to less production, more layoffs, less purchasing power, lower prices, and more misery.   And deflation appears to be a lot harder to reverse than inflation, because one essentially has to throw new money into a hole faster than it is being dug.

    Waiting to hit bottom in the macro economy, for the inventory of everything to clear,  is what brought classical economics to an end. Its what Mellon advised Hoover. Its amazing to me that  a person as smart as Eric would be advocating this today.

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