The Second Coming of Keynes

[phk]

 The Second Coming of Keynes

Mises Daily by Lilburne | Posted on 7/22/2009 12:00:00 AM

Paul Krugman wants to be our savior. Moreover, he wants to be a specific kind of savior: a magus of the scientific age, a blackboard prophet.

The roots of this curious ambition can be seen in his recent profile in Newsweek:

    Krugman says he found himself in the science fiction of Isaac Asimov, especially the "Foundation" series "It was nerds saving civilization, quants who had a theory of society, people writing equations on a blackboard, saying, 'See, unless you follow this formula, the empire will fail and be followed by a thousand years of barbarism.'"

Now here we are at an economic zero hour for the American empire, and perhaps for modern civilization itself, and many in the global urban elite think this establishment triathlete with his Princeton professorship, his New York Times column, and his Nobel Prize, has the equation for salvation. So what is Krugman's formula? What commandments does the magus have scrawled on his blackboard for us, his plebian flock?

To understand that, one must understand Krugman's intellectual heritage, such as it is.

Paul Krugman is a devotee of John Maynard Keynes. He's such a hard core disciple that he was Keyensian when Keynesianism wasn't cool: the period between the 1970s stagflation, which seemed to disprove Keynesian doctrine, and now, when it is groundlessly renascent due to our society's stunted memory span. He himself proudly admits his devotion to Keynes. He has written such headlines as "The Greatness of Keynes" and "Why Aren't We All Keynesians Yet?" But what does it mean to be keen on Keynes? What diagnosis does Krugman's Keynesian economics have for the economic crisis, and what remedies does he prescribe?
The Keynesian Diagnosis: A Deadly Case of Frugality

In the Keynesian whodunit mystery of depression economics, the culprit is nothing other than savings. That's right, savings: that necessary precondition for all capital development, thereby all gains in productivity, and thereby all increases in general human prosperity.

The Keynesian story of depressions in a nutshell is that (1) excessive savings leads to (2) underconsumption which leads to (3) unemployment. Unemployment engenders even more dread savings, completing the loop of a vicious cycle. This theory was a spit in the face of hundreds of years of progress in economic thought. Economists before Keynes painstakingly, analytically, and progressively built up a mighty edifice of knowledge and truth, all of which centered around how markets find optimal prices and equilibrate in response to changing situations. Keynes blithely dismissed it all as "orthodoxy" and falsely characterized the market as an inherently dysfunctional mechanism that tends to seize up into long-lasting depression without intervention from the wise government.

Paul Krugman completely buys the Keynesian story. He wrote recently,

    one of the high points of the semester, if you're a teacher of introductory macroeconomics, comes when you explain how individual virtue can be public vice, how attempts by consumers to do the right thing by saving more can leave everyone worse off. The point is that if consumers cut their spending, and nothing else takes the place of that spending, the economy will slide into a recession, reducing everyone's income.

So to Krugman, the road to economic hell is paved with the good intentions of frugality. This "underconsumption theory" is basically what he's talking about whenever you read Krugman warning ominously about "saving gluts," the "paradox of thrift," "consumer capitulation," "insufficient aggregate demand," etc., etc. It's all just adult jargon dressing up a childish theory. As Gary North wrote, underconsumption theories

    speak of saving as if it were a system for hiding paper currency under a mattress. They refuse to answer this crucial question: What does the bank do with the money that a consumer deposits instead of spending? Put another way: What analytical or conceptual difference does it make whether a saver deposits a dollar [in] his bank, which the bank will lend, or whether he spends it, enabling the seller to deposit the dollar in his bank, which his bank will lend?

And even if saving were a matter of greenbacks and mattresses, any particular amount of such "hoarding" would not lead to underconsumption, as Murray Rothbard showed in his economic treatise Man, Economy, and State, but merely "an increase in the real value of their cash balances and of the monetary unit." This would depress business revenues in nominal terms, but it would lower business costs as well, leaving businesses just as profitable in real terms as before.
The Keynesian Remedy: Spend Your Way to Riches

Since Krugman has such a backwards diagnosis of depressions, it should be no surprise that his Keynesian remedies would be equally wrongheaded, and disastrously destructive. The Keynesian prescription to ward off depression is government stimulus. This is what Krugman is talking about whenever he calls for "priming the pump." Keynesian stimulus comes in two forms: monetary and fiscal. With monetary stimulus, a central bank (like the Federal Reserve) greatly increases the money supply, which dramatically lowers interest rates, which in turn stimulates spending. This is the "pro-bubble" side of Krugman's economics, which I've written about here and here. His now-notorious prescription of an induced housing bubble was to be accomplished (and was actually accomplished) via monetary stimulus. Krugman said in an interview with Lou Dobbs:

    Meanwhile, economic policy should encourage other spending to offset the temporary slump in business investment. Low interest rates, which promote spending on housing and other durable goods, are the main answer. (emphasis added)

This was his prescription for the recession in 2001. The rest is housing bubble history.

The ironic thing is that monetary expansion, Krugman's cure for depressions, is the very poison that causes them in the first place. According to the Austrian Business Cycle Theory, which was first expounded in 1912 by Ludwig von Mises, the great Austrian economist who predicted the Great Depression, monetary expansion misdirects resources, causing excessive investment in stages of production that are more removed from the final products. This lengthening of the chain of production is unsustainable, given the actual amount of savings available for continuous investment. Eventually, businesses realize this fact, and that the malinvestments need to be liquidated and resources reallocated toward sustainable projects. Further monetary stimulus (or any government intervention for that matter) only serves to retard that reallocation process and to prolong the depression. For a nice primer on the true story behind business cycles, I recommend this article and this speech (video) by Thomas Woods.

According to Krugman's assessment of the current state of the economy, monetary stimulus has done pretty much all it could do (thank God for that!), and we are now coming upon a Keynesian "liquidity trap," which, as he characterizes it, is "a situation in which conventional monetary policy loses all traction. When short-term interest rates are close to zero … " What does Keynesian doctrine prescribe in such situations? It calls for massive fiscal stimulus: government spending intended to fill the hole in aggregate demand that underconsumption has left. This is how Krugman himself characterized it in February, according to a University of Pennsylvania e-newsletter:

    With monetary policy a non-starter, "That leaves nothing but government spending" to prime the pump, Krugman said. "That's pure Keynes."

Krugman estimated that the "spending hole" in the U.S. economy is $2.9 trillion dollars. Because of that, he complained, President Obama's stimulus package should be over three times its present size!

    "It's helpful, but it does not cover even one-third of the gap, so it's disappointing," Krugman said. Out of the $789 billion approved, only about $600 billion adds real stimulus, in Krugman's opinion. "So you've only got $600 billion to fill a $2.9 trillion hole."

The only hole that needs filling is the one in Krugman's understanding. As we have already seen, the notion that stimulus does any good by moving money out of mattresses and bank vaults is fallacious. And as Ludwig von Mises wrote,

    a government can spend or invest only what it takes away from its citizens … its additional spending and investment curtails the citizens' spending and investment to the full extent of its quantity.

[k-onmmunist]

Christ no.

Government has no business interfering in the economy.

[opebo]

Yes, Keynes was a genius and whoever wrote that article is an empty-headed right wing shill.  Thanks for sharing, phnkrocket.

[jokerman]

You must be logged in to read this quote.

The moron who wrote this article clearly doesn't even understand what Keynes said, much less have a refutation for it.

In a depression, by definition, savings is greater than investment.  Therefore people can deposit money in banks all they want, this "supply side" stimulus will not increase output. 

You must be logged in to read this quote.

I'm not even sure how people can think like this.  What exactly is their explanation for the Great Depression then?   They seem to view it as some sort of unnaccountable act of God that came down from the sky.

[Marokai Backbeat]

Christ no.

Government has no business interfering in the economy.

We all greatly appreciate your economic wisdom nicely summarized in libertarian one-liners.

[○∙◄☻¥tπ[╪AV┼cVê└]

You must be logged in to read this quote.

The moron who wrote this article clearly doesn't even understand what Keynes said, much less have a refutation for it.

In a depression, by definition, savings is greater than investment.  Therefore people can deposit money in banks all they want, this "supply side" stimulus will not increase output. 

You must be logged in to read this quote.

I'm not even sure how people can think like this.  What exactly is their explanation for the Great Depression then?   They seem to view it as some sort of unnaccountable act of God that came down from the sky.

Accountability and Right-wing economics never go together.

[Southern Senator North Carolina Yankee]

You must be logged in to read this quote.

The moron who wrote this article clearly doesn't even understand what Keynes said, much less have a refutation for it.

In a depression, by definition, savings is greater than investment.  Therefore people can deposit money in banks all they want, this "supply side" stimulus will not increase output. 

You must be logged in to read this quote.

I'm not even sure how people can think like this.  What exactly is their explanation for the Great Depression then?   They seem to view it as some sort of unnaccountable act of God that came down from the sky.

The reallocation of investment. The Austrian School and the Neoclassical school beleive that Economic growth is derived from the risk taking, and when the risk taking proves fruitful, you get economic growth, when it is not, you get recessions and depressions. The answer to a mistake in such risk taking would be the to let the market reallocate the the money following the rules of Supply and Demand. Its far more volatile and and doesn't produce economic periods like the 50's and 60's however I have come to the conlcusion that we may never see those periods of relative stabililty again. You can't have a strong dollar and be a net exporter at the same time like we we did in that period. You can't have your cake and eat it two. So that means that any growth has to be built on bubbles when the global damand isn't there to sustain a "really growing" 50's -70's style economy suchs as what we saw in the 20's, the 90's, and in the mid 2000's. So in actuallity it really doesn't matter what economic school you belong to or which one you have as policy. I guess in a way the only economic philosphy that really works is the Mercantilist notion of maintaing a favorable trade balance. The only way to achieve that would have the effect of reducing overal world trade which we have seen fail in the early part of the Great Depression.

Though I am not entirely unsure that the Great Depression wasn't an act of the almighty. It did produce the last generation of Americans that posterity could claim to be proud off, but thats a story for another day. 

[Tetro Kornbluth]

Hold on a minute, the period 1950-1973 also saw the period of greatest state control in the economy's of most western nations. So doesn't that then contradict the Austrians? (And I don't know whether 'risk' is something worth rewarding anyway).

[k-onmmunist]

Christ no.

Government has no business interfering in the economy.

We all greatly appreciate your economic wisdom nicely summarized in libertarian one-liners.

Get a life.

[Southern Senator North Carolina Yankee]

Hold on a minute, the period 1950-1973 also saw the period of greatest state control in the economy's of most western nations. So doesn't that then contradict the Austrians? (And I don't know whether 'risk' is something worth rewarding anyway).

Yes the Austrians aren't perfect, and neither are the other economic schools. However a devotee of the Austrian school would probably argue that other factors created the economic growth which carried on in spite of the high level of Gov't Intervention. Such "other" factors would be the lack of a real economic competitor till the late 1960's early 1970's, the fact that the US had 90% of the world's wealth or something. The Dollar was at astronomically high values cause Eurpean countries gave us there gold supply in exchange for Dollars to rebuild there economies. While at the same time being the only industrial power untouched by the war our products dominated the world market. Many of these factor began to disappear in the late 60's and early seventies leading to the 1970's economy of growing competition, inflation, and a declining dollar. This arguement is merely a conjecture as I am not a proponent of the Austrian school. I probably actually fall closer to the Neoclassical school, with use of Keynesian policies at certain times like deflationary cycles we are in now, hence my support of "a" stimulus.

[Marokai Backbeat]

Christ no.

Government has no business interfering in the economy.

We all greatly appreciate your economic wisdom nicely summarized in libertarian one-liners.

Get a life.

Well, the least you could do is elaborate once or twice. At least phkn posts news articles. (Albeit at a spamming pace.)

[k-onmmunist]

Christ no.

Government has no business interfering in the economy.

We all greatly appreciate your economic wisdom nicely summarized in libertarian one-liners.

Get a life.

Well, the least you could do is elaborate once or twice. At least phkn posts news articles. (Albeit at a spamming pace.)

I might later. Nonetheless, you sniping at me is just childish.

[Marokai Backbeat]

Christ no.

Government has no business interfering in the economy.

We all greatly appreciate your economic wisdom nicely summarized in libertarian one-liners.

Get a life.

Well, the least you could do is elaborate once or twice. At least phkn posts news articles. (Albeit at a spamming pace.)

I might later. Nonetheless, you sniping at me is just childish.

I do it all the time, you should be honored.

[Filuwaúrdjan]

However a devotee of the Austrian school would probably argue that other factors created the economic growth which carried on in spite of the high level of Gov't Intervention. Such "other" factors would be the lack of a real economic competitor till the late 1960's early 1970's, the fact that the US had 90% of the world's wealth or something. The Dollar was at astronomically high values cause Eurpean countries gave us there gold supply in exchange for Dollars to rebuild there economies. While at the same time being the only industrial power untouched by the war our products dominated the world market. Many of these factor began to disappear in the late 60's and early seventies leading to the 1970's economy of growing competition, inflation, and a declining dollar.

The Golden Age of Capitalism was not only golden in the United States you know...

[opebo]

However a devotee of the Austrian school would probably argue that other factors created the economic growth which carried on in spite of the high level of Gov't Intervention. Such "other" factors would be the lack of a real economic competitor till the late 1960's early 1970's, the fact that the US had 90% of the world's wealth or something. The Dollar was at astronomically high values cause Eurpean countries gave us there gold supply in exchange for Dollars to rebuild there economies. While at the same time being the only industrial power untouched by the war our products dominated the world market. Many of these factor began to disappear in the late 60's and early seventies leading to the 1970's economy of growing competition, inflation, and a declining dollar.

The Golden Age of Capitalism was not only golden in the United States you know...

Precisely!  The real proof of the delights of Keynesianism is seen not only in the US, but in every other developed country.

It really is mind-boggling that the right-wingers continue to oppose Keynesianism purely out of spite.

[Tetro Kornbluth]

However a devotee of the Austrian school would probably argue that other factors created the economic growth which carried on in spite of the high level of Gov't Intervention. Such "other" factors would be the lack of a real economic competitor till the late 1960's early 1970's, the fact that the US had 90% of the world's wealth or something. The Dollar was at astronomically high values cause Eurpean countries gave us there gold supply in exchange for Dollars to rebuild there economies. While at the same time being the only industrial power untouched by the war our products dominated the world market. Many of these factor began to disappear in the late 60's and early seventies leading to the 1970's economy of growing competition, inflation, and a declining dollar.

The Golden Age of Capitalism was not only golden in the United States you know...

But haven't learned anything else from this forum that the only economy to judge policies upon is the United States. No other countries matter (cf. Any thread on the Great Depression, New Deal, etc).

[k-onmmunist]

Christ no.

Government has no business interfering in the economy.

We all greatly appreciate your economic wisdom nicely summarized in libertarian one-liners.

Get a life.

Well, the least you could do is elaborate once or twice. At least phkn posts news articles. (Albeit at a spamming pace.)

I might later. Nonetheless, you sniping at me is just childish.

I do it all the time, you should be honored.

What?