Keynesian Theory
According to Keynesian Theory, a recession is caused when there is not enough “aggregate demand” to soak up all the goods and services in the economy. The way around this is to force more consumption.
“Consumption – to (state) the obvious –is the sole …object of all economic activity”[1]
“the more virtuous we are, the more determinedly thrifty. The more obstinately orthodox…the more our incomes will have to fall…Obstinacy can bring only penalty and no reward. For the result is inevitable”[2]
This can be done by the government extracting your money and spending it for you by way of a fiscal stimulus. Governments dedicated to the principles of laissez-faire would be better off to
“fill old bottles with bank notes, bury them at suitable depths in disused coal mines which are then filled…with town rubbish, and leave it to private enterprise … to (invest in) dig(ing) the notes up again.”[3]
“Can American Spend Its Way to Recovery?” This was the title to an article written by Keynes in 1934 for a magazine called Redbook.
“Why, obviously!”
“A man poor can make a nation wealthy”[4]
Once the poor man is penniless, he should borrow so as to continue spending.
If some projects are uneconomical at current interest rates, the rates must be lowered so that businesses pursue them, thus driving up aggregate demand. The ultimate target rate should be zero.
“I should guess that a properly run community…ought to be able to bring down the ….(general rate of business profit and interest) approximately to zero within a whole generation.[5]
You should also create money out of thin air and place it in the banks so it can act just as savings would do, then require the banks to lend it out.
In the crazy Keynesian world, there is no appreciation that if you want to purchase something more costly than your monthly income, you should save. Where immediate means are insufficient, debt is always the answer.
The first gigantic bailout, fiscal stimulus, and massive printing money session (QE) has all come to pass and the effects are wearing off. The liquid share indexes such as FTSE are falling, as we predicted many months ago. Long ago on this site we explained why QE would not work.
The mantra of Keynes and his modern day followers is that one man’s spending is another man’s income, therefore if we all consume, there will be no recession.
The problem with Keynes is he did not have a theory of capital. To the mathematician Keynes, capital is summed up as the blob called K, a homogeneous blob that can mysteriously change form one thing to another to suit the needs and requirements of the people automatically. He did not consider that during the 20’s as money was made artificially cheap, borrowers invested in longer methods of production — more capital-intensive methods — to produce goods for which there was no real demand for once the printing presses had stopped producing cheap money. This led to excess build up of capital producing goods no one really wanted. The bust was inevitable. Some of the key errors of the Keynesian system are explained here.
The Irish Route
In the current recession, we have postponed the inevitable correction. Our policy makers can take what I call the “Ireland route” or the “Keynesian Malaise route”. In case you did not read Liam Halligan’s article is this week’s Sunday Telegraph, I will quote directly from his wise words:
Last week, it emerged that the Irish economy has climbed out of recession. New data showed GDP grew by a buoyant 2.7pc during the first three months of 2010, reversing a contraction of the same size during the previous quarter. This is highly significant – and not only if you’re Irish.
A year and a half ago, Ireland endured nothing less than an economic implosion. After a decade of rampant borrowing and spending, the Celtic Tiger was shot between the eyes. The country’s runaway housing market and related construction boom turned to bust. All told, the Irish economy shrunk 7.1pc in 2009 – and be an even more shocking 11.3pc if you exclude profits made by the numerous multinational companies attracted to modern Ireland.
After several years of surplus, economic slowdown and “sub-prime” landed Ireland with an almighty budget deficit in 2009 – no less than 14.3pc of GDP. Faced with this, the Irish rolled-up their sleeves and imposed a fiscal squeeze equivalent to around 6pc of GDP – though a combination of pay and public spending cuts going beyond those now proposed in the UK.
It’s been painful, and will continue to be so, but it’s working.
…
Ireland’s recovery is troublesome, though, for a hard-core of neo-Keynesian economists, those still banging the drum for yet more government borrowing and spending. Such loose thinking is legion – hard-wired into the minds of many. The UK’s tough new fiscal measures have been greeted with howls of protests by numerous economists who should know better. Less government spending will make things worse, they say, not better. Yet Ireland shows that if you knuckle down, take the medicine and reassure your creditors, then recovery can be relatively swift.
…
The neo-Keynesians are guilty of Alice in Wonderland economics. They say the status quo is better, but given the massive fiscal pressures we face, and the threat of default, there is no status quo.Had Ireland kept spending as before, its deficit would have spun completely out of control – with default causing economic chaos. Fiscal austerity is tough. Reality hurts. There’s always a market in telling people what they want to hear – even if the message amounts to utter nonsense.
Earlier in the article, Liam mentions the Bank of International Settlements report, which gives a truer picture of our debt.
Even if we accept the UK government’s figures of a £900 bn national debt at the end of this year, with GDP projected at around £1.4 trillion and the state accounting for 1 half of it, this implies a private sector GDP of around £750 bn. With interest service alone at £45 bn this year, this implies that 6% of all private sector activity is paying our national debt interest service. In addition to the redemption and ongoing tax extractions, it is mad to go down the Keynesian Malaise path of more fiscal spending and money printing. I vote we go down the Irish route as quickly as possible. Halligan is right.
N.B.
The great snake oil salesman himself said :
“the duty of ordering the current volume of investment cannot safely be left in private hands.”
This is from page 320 of the General Theory. Now with over half of the banking sector in the ownership of the State and lending targets set and politicians in government embarking upon initiatives to “get lending going again,” it is no big step to see that soon the State will become the allocator of capital in the economy. So watch out for this next step in the tragic mess we are in.
[1] Keynes, The General Theory 1973, page 104.
[2] Keynes, The General Theory 1973, page 111.
[3] Keynes, The General Theory 1973, page 129.
[4] Collected Writing (Vole 21) page 334.
[5] Keynes, The General Theory 1973, page 220.
I think Mises once said that the defining characteristic of a capitalist economy was private banking. Lose that and capital is set to be allocated according to govt fiat and little else.
With regard to your last paragraph, the Tories’ Green Investment Bank is a case in point. In fact, the Tories are swimming in pin-striped advisers, eager to tell them how government should allocate capital in ways like this. By strange coincidence, this usually turns out to be the things that the pin stripes themselves are investing in.
With regard to Ireland, it might be a good idea to wait for more sustained performance. The things you highlight were indeed brave and good, but they have done other things that were less well-advised, and may well come back to bite them. I am thinking in particular of NAMA. We have some direct experience of some of the toxic debt on their books, and they will need a lot of luck or patience to get the 70%+ valuations that they hope to get on a lot of it – it looked more like 20% in the case we looked at.
And having just been over for other purposes, it seems that the property and credit market, on which their house of cards is built, is still thoroughly gunged up. Have a google for Paddy Kelly (developer and hotelier) for just one example of the still-unresolved contradictions. He is supposedly “broke beyond broke” and persona non grata at the Irish banks for his wildly-optimistic “helicopter investing”, and yet he is listed as one of the lead figures in a new, EUR 2bn, town-centre development in Bray. Why and how on earth would someone be spending that sort of money on a new development given the financial and economic conditions and the excess capacity of leisure and housing development already in the market? Have they really learnt their lesson?
From what I heard over there, patience is running thin with austerity measures that aren’t delivering improvements that can be sensed by the man in the street. They could get lucky and the GDP improvement feeds through to a wider sense of wellbeing before people rebel, but it’s a bit early to say for sure and to rely on it as an example.
Imagine a small island, which operates under the division of labour and has a fixed money supply of 1000 conch shells used as currency.
A hurricane hits the island, wiping out much of their industry, but washing anothe 1000 conch shells ashore.
In Keynes world, the islanders are now rich beyond their wildest dreams – the islanders however would probably not agree.
@ Not an Economist
It is quite straightforward for Treasury Credit – the absence of a central bank has not harmed Hong Kong – to be issued directly to those requiring it, for the purpose of the circulation of goods and services and the creation of productive assets.
Credit allocation may then be managed professionally by a private provider whose agreed costs are covered and who shares in the outcome. This latter may be achieved by making a ‘guarantee charge’ into a default pool, and giving the credit service provider a performance related bonus.
@Bruno Prior
Your experience of Ireland is consistent with mine. The underlying value of NAMA assets is drastically below the initial valuation, and the effect of austerity measures will further reduce the capability of the population to finance property occupation at real price levels, never mind fantasy levels.
Ireleand’s only escape route – devaluation – is denied them by € membership.