Morgan Reynolds – February 24th, 2009
“In medical science, practices that have no chance to cure but are likely to kill a patient would be declared quackery,” declares author Michael Lundeen, “but in ‘political science,’ quacks like Greenspan and Bernanke are the go-to guys to keep the entrenched bureaucracy — entrenched.”
Very true and this insight highlights the most mind-boggling aspect of all the ongoing, disastrous Keynesian interventions, namely, the collective failure to learn from obvious past experience. Professional economists are the most guilty parties of all. For many years dominant professional opinion held that postwar prosperity, although characterized by mild downturns, was a Keynesian tour de force. Then its reputation began to fade because of the “stagflation” of the 1970’s, an inexplicable phenomenon under basic Keynesian theory, plus the incoherence and ad hoc nature of Keynesian and neo-Keynesian theory. Today however it seems as if none of that happened and Keynes is back, bigger than ever.
But have we misunderstood Keynes? Not at all. In his watershed 1936 book, The General Theory of Employment, Interest and Money, he argued that classical analysis did not apply to “the economic society in which we actually live, with the result that its teaching is misleading and disastrous” (p. 3). The cause of depression, Keynes concluded, is that “effective demand is deficient” (p. 380). Keynes dismissed blaming overpricing of labor for mass unemployment as well as distorted pricing fueled by credit expansion as the cause of malinvestment, boom and bust. He explicitly denounced “competitive wage-rate reductions” and competitive international wage cutting. He claimed the world would not “much longer tolerate the unemployment which, apart from brief intervals of excitement, is associated — and, in my opinion, inevitably associated — with present-day capitalistic individualism” (p. 381). He found that “a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment” (p. 378).
Prices performed no explicit coordination role in Keynes’s theory (and this guy is declared a “great economist”?) aside from an interest rate that might bring saving and investment into equality, though not necessarily at a full employment level. According to Keynes, investment must be stimulated to the point that corresponds to full employment through low-interest rate policies. Sustained, artificially low interest rates? Sounds familiar. An artificial boom followed by an inevitable bust? Not in Keynes’s world, no, because the cycle “is mainly due to the way in which the marginal efficiency of capital fluctuates” (p. 313) in its mysterious way. So Keynes leaves us with no causal theory of the trade cycle except that, putting aside his evasions and ambiguities, investment spending fluctuates.
Many sensible authors have recently cited the Great Depression and post-1990 Japan to show that Keynesian “remedies” not only fail to restore the market economy back to health but rather deepen the disease. Equally instructive is the conversion from a U.S. wartime economy that took place from 1945 to 1947. The full story is available in the pathbreaking book, Out of Work: Unemployment and Government in Twentieth-Century America (1993) by Richard Vedder and Lowell Gallaway.
Back in the day, Keynesian economists had predicted a severe postwar depression once the stimulus of government spending on war ended. Fiscal policy swung dramatically from “stimulus” to “contraction” in Keynesian terms. The 1945 deficit was a staggering 22 percent of GDP, equivalent to $3 trillion today, and the deficit had been even higher at 28 percent of GDP in 1943. In 1947—49, however, there were budget surpluses. By the first quarter of 1946, government purchases dropped by two-thirds! Overall, federal spending plunged from $93 billion in 1945 to $55 billion in 1946 and $35 billion in 1947. But the predicted depression never came; there was, instead, a rather smooth adjustment to peacetime full employment. Common predictions of 9 million unemployed turned out to be four times too high.
Keynesian economists then devised an ad hoc explanation — a “pent-up” demand for consumer goods — to account for the smooth adjustment to plunging government spending and expanding peacetime employment and production. Households supposedly spent and consumed America rich. How? Based on an inversion of Keynes’s corrupt statement of Say’s law of markets: namely, “demand creates its own supply.” Yet the facts refute this interpretation. Between 1944 and 1947, personal consumption expenditures replaced only one-quarter of the decline in so-called autonomous expenditures — that is, the sum of government purchases of goods and services, gross private domestic investment, and net exports. Consumption spending remained below predicted levels all the way to mid-1947 after demobilization and conversion from military to civilian production had been virtually completed. Furthermore, consumption cannot precede production, to state the obvious. Consumers cannot purchase goods that do not exist. Before revival of mass production of civilian goods, producers had to convert from wartime to peacetime manufacturing and services, that is, they had to invest.
Why was the transition so smooth? Keynes’s prescription to spend ourselves rich is not only contrary to common sense but the facts and proper economic theory. By contrast, a classical analysis highlights three causes for postwar conversion:
Government retreated and thereby freed up the price system to perform its coordination function.
Government swung from massive, wasteful spending and borrowing to a smaller wastrel and even a net saver-lender, thereby reducing interest rates and stimulating a civilian investment boom.
Real wage rates fell, stimulating civilian reemployment because labor’s “price was right.”
Keynes was right about one thing: “The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else.” Keynes is resounding proof of the power of wrong ideas. I leave it to the reader as an exercise to apply the lesson of the 1940’s to the consequences of today’s stimulus policies and their conceivable if unlikely cessation.
February 24, 2009
- Peter Trabant on A Real Astronaut at Texas A&M University
- Thomas Potter on Economics of War
- Morgan Reynolds on A Real Astronaut at Texas A&M University
- joseph p bell on A Real Astronaut at Texas A&M University
- Bill Cain on A Real Astronaut at Texas A&M University
- Morgan Reynolds on Econ 101 According to Reynolds
- joseph p bell on Econ 101 According to Reynolds
- ameritrustusa on Conclusive Evidence 9-11 Planes Were Fake
- NELSON THALL on Conclusive Evidence 9-11 Planes Were Fake
- Anonymous on Conclusive Evidence 9-11 Planes Were Fake
- Economics of War
- A Real Astronaut at Texas A&M University
- Conclusive Evidence 9-11 Planes Were Fake
- Government and Media Spill Crocodile Tears Over 9/11 Again
- Econ 101 According to Reynolds
- Dr. Judy Wood Destroys the 9/11 Plane Fraud
- New 9/11 Alchemy Video Rocks!
- The Emperor Exposed: Buzz Aldrin Concedes We Never Went to the Moon
- On 9/11 Lawsuits Against Iran and Saudi Arabia
- Did the Apollo Lunar Module Have a ‘Throttlable’ Engine?
OTHER SITES TO VISIT