Sunday, December 28, 2008

Resuscitating Keynes: Oh No, Not Again

Dr. John Maynard Keynes must get tired of being dug up over and over again by economists looking for a mentor in times of crisis.

[Thanks to "Return of the Living Dead" for the image.]

I must say, his mistaken formulas sure do have staying power.

Dr. Martin Wolf, writing today in the Financial Times, goes digging again; but it's useless. Why? Because we are not all Keynesians now, even if a US president and Milton Friedman once said we were, probably in a moment of frustration.

In fact, the opposite is true: Keynes's unfounded notions of pushing on a string will subject us all to its deleterious effects today, just it did our ancestors back in the 1930s.

Bailouts, debt financing, government spending, inflating the money supply to save debtors and attempt the futility of restoring failing demand--all have been tried, and all have done much more harm than good.

No, Dr. Keynes did not teach us the following "three broad lessons" in spite of what Dr. Wolf says:

Non-Lesson No. 1

"... [Keynes believed] we should not take the pretensions of financiers seriously. ... Not for him, then, was the notion of 'efficient markets.'"

This is a non sequitur if I've ever seen one. Keynes may have been cynical about bankers; but I bet he'd love to rise from the dead to confirm that he always believed in efficient markets. Where does Wolf get the connection?

Non-Lesson No. 2

"The economy cannot be analysed in the same way as an individual business. For an individual company, it makes sense to cut costs. If the world tries to do so, it will merely shrink demand. An individual may not spend all his income. But the world must do so."

Wolf talks of "the world" as if we were all parts of one entity acting in concert. In fact, each nation is acting as an individual; and each nation's government should act as an individual, i.e. should cut costs, indeed must cut costs when the money is no longer there to pay for them.

A government can only spend money it doesn't have in three ways: borrow it, confiscate it through taxes, or create it. Because we are already a debtor nation we should not do the first; the second will exacerbate the current shortage of discretionary income; and the third will eventually cause the dollar to collapse, thereby leading up to the confiscation of all dollar-holders' purchasing power--not something to do when foreigners hold a good chunk of your debt.

Of course demand is shrinking. You may not have noticed, but the bubble has burst. The demand we once had was a mirage. And you can't revive a nation's economic demand by stuffing it with borrowed or artificial money like the foie gras of some goose--or rather, you can, but it won't work because this goose is dead. You'll get nothing to show for your efforts except a bag of ruffled feathers.

And Dr. Wolf is forgetting that it is not for lack of will that we or our governments cannot "spend all our income." It is the "income" that simply isn't there, unless we attempt to fabricate it out of more monetary helium, which is how we got the bubble in the first place. (See my article, plus page 2 and 3 linked on my blog, for my view on how this happened.)

Non-Lesson No. 3

Now, this is the one that really gets my blood boiling, so I'm going to have to breathe deeply as I punch my keyboard.

"In the 1930s, two opposing ideological visions were on offer: the Austrian; and the socialist. The Austrians--Ludwig von Mises and Friedrich von Hayek--argued that a purging of the excesses of the 1920s was required. Socialists argued that socialism needed to replace failed capitalism, outright. These views were grounded in alternative secular religions [my italics]: the former in the view that individual self-seeking behaviour guaranteed a stable economic order; the latter in the idea that the identical motivation could lead only to exploitation, instability and crisis."

I don't have enough room here to analyze the error in Wolf's statements about the Austrians, but I'll say that the Austrian view of the 1920s is shared by more than one empiricist. I'll just name one: Edward C. Harwood of the American Institute for Economic Research.

To call the Austrians a "secular religion" may have a scrap of truth to it; but that doesn't mean they are wrong about their analysis of the 1920s. Dr. Wolf's criticism is more a statement about their description of their own methodology, rather than their theories; and in fact, the Austrians are quite empirical in their methodology in spite of themselves.

Even if they weren't, the Doctor mustn't throw out the baby.

More erroneous statements

Both Wolf and Keynes continue to err with the following affirmations:

- "[Keynes recognized] that the minimum state was unacceptable to a democratic society with an organised economy." Nothing could be further from the truth. Such a minimum state is unacceptable only to those who claim humans have the capability of organizing such a society's economy, which we can't, to wit our present mess.

- "Keynes would have insisted that ... [m]arkets are neither infallible nor dispensable. ... [T]hey can also go seriously awry and so must be managed with care." Keynes may indeed have so insisted; but no one has yet proven that humans can manage markets, in fact quite the contrary; the more we try to macromanage them, the more markets rebel.

- "The election of Mr. Obama surely reflects a desire for just such pragmatism." The election reflects no such thing. It reflects a slight majority's secular-religious belief in the spread-the-wealth Obama-Messiah, and/or shows an aversion to Bush and anyone like him.

- "The shorter-term challenge is to sustain aggregate demand, as Keynes would have recommended." You cannot sustain what doesn't exist. You can try to recreate it; but you will fail, just as Roosevelt did back in the 1930s. (See "pushing the string," above.) Roosevelt, with Keynes's encouragement, began the monetary inflating that is the scourge of the fiat-money 20th Century.

- "Also important will be direct central-bank finance of borrowers." This is a good way to transfer solvency problems from the private sector to the taxpayer; nothing more, nothing less.

- "A debt-for-equity swap is surely going to be necessary." Bailouts for special interests; nothing more, nothing less--and one of those special interests is politicians themselves, because it reinforces the electorate's belief in the politicians' capacity to "do something about it."

And on and on the good Doctor goes, making one Keynesian mistake after another.

Wolf finishes with a most sappy and hubristic "We must do better. We can do so, provided we approach the task in a spirit of humility and pragmatism, shorn of ideological blinkers."

Oh, gag me with a spoon. Who is the secular-religious one now?

Keynesian economists lack an understanding of simple market dynamics, and of how far the world has distanced itself from them. To blame the free market for 1929 or for our current turmoil is like blaming a train wreck on the train itself, instead of on the inebriated engineer.

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Blogger PrestoPundit said...

Wolf doesn't know his history or his Austrian economics.

Hayek was an empiricist.

A good many British socialists had a Hayekian view of the trade cycle and of the pure theory of economic coordination -- and they learned it straight from Hayek.

Wolf -- brown up to his eyeballs.

7:48 PM  

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