WEBVTT NOTE 22. The "Trade Cycle" 1 00:00:00.000 --> 00:00:05.000 Chapter 22. The Trade Cycle. 2 00:00:10.000 --> 00:00:15.000 A sudden collapse of the marginal efficiency of capital? 3 00:00:17.000 --> 00:00:28.000 Keynes begins his Chapter 22, Notes on the Trade Cycle, by telling us that if his theory of what determines the volume of employment is right, 4 00:00:28.000 --> 00:00:34.000 It must be capable of explaining the phenomena of the trade cycle. 5 00:00:34.000 --> 00:00:41.000 Though this chapter professes to be merely an application of the theories hitherto expounded, 6 00:00:41.000 --> 00:00:44.000 it actually adds many new errors. 7 00:00:44.000 --> 00:00:51.000 I doubt whether many avowed Keynesians have ever really worked through the general theory, 8 00:00:51.000 --> 00:01:01.000 But most of them have probably read this chapter, which is one of the least technical in the book, or at least popularizations of it. 9 00:01:01.000 --> 00:01:09.000 It contains the essence of those practical recommendations that have done so much harm. 10 00:01:09.000 --> 00:01:14.000 The essential character of the trade cycle, Keynes begins by telling us, 11 00:01:14.000 --> 00:01:22.500 and especially the regularity of time sequence and of duration, which justifies us in calling it a cycle, 12 00:01:22.500 --> 00:01:28.000 is mainly due to the way in which the marginal efficiency of capital fluctuates. 13 00:01:28.000 --> 00:01:36.500 The trade cycle is best regarded, I think, as being occasioned by a cyclical change in the marginal efficiency of capital. 14 00:01:36.500 --> 00:01:39.000 Page 313 15 00:01:39.000 --> 00:01:45.960 Now, as we have already pointed out, the marginal efficiency of capital, like most of the key 16 00:01:45.960 --> 00:01:52.720 Key Keynesian terms, is vague, and is used by Keynes in several different senses. 17 00:01:52.720 --> 00:01:59.560 At one time it seems to mean the actual present yield of capital assets, at another time the 18 00:01:59.560 --> 00:02:06.560 expected future yield of specific capital assets, and at still another time it seems 19 00:02:06.560 --> 00:02:12.640 seems to mean merely the outlook for business profits, regardless of the specific return 20 00:02:12.640 --> 00:02:15.840 to a specific capital asset. 21 00:02:15.840 --> 00:02:22.560 If we give the marginal efficiency of capital this broad meaning, it does not make much 22 00:02:22.560 --> 00:02:29.920 sense whether we say that changes in the marginal efficiency of capital cause the trade cycle, 23 00:02:29.920 --> 00:02:36.600 However, that changes in the trade cycle cause changes in the marginal efficiency of capital, 24 00:02:36.600 --> 00:02:42.240 because in this broad sense, changes in the marginal efficiency of capital and changes 25 00:02:42.240 --> 00:02:47.640 in the business outlook turn out to mean pretty much the same thing. 26 00:02:47.640 --> 00:02:55.080 If, however, Keynes's proposition were that trade cycle movements are caused, initiated 27 00:02:55.080 --> 00:03:02.440 and led by independent changes in the specific returns to specific capital assets, it would 28 00:03:02.440 --> 00:03:07.320 be too implausible on its face to be worth disproving. 29 00:03:07.320 --> 00:03:14.120 Keynes's belief that there is some recognizable degree of regularity in the time sequence 30 00:03:14.120 --> 00:03:22.680 and duration of the upward and downward movements, page 314, of the business cycle is debatable. 31 00:03:22.680 --> 00:03:29.360 The closer the investigation, the less regular the duration that seems to emerge. 32 00:03:29.360 --> 00:03:35.240 The first problem is that of agreeing upon any specific way of measuring the length of 33 00:03:35.240 --> 00:03:37.280 business cycles. 34 00:03:37.280 --> 00:03:42.520 The possible indices or combinations thereof are infinite. 35 00:03:42.520 --> 00:03:51.280 Taking Koch production as one index, Burns and Mitchell found that, from 1914 to 1932, 36 00:03:51.280 --> 00:03:57.720 The length of the expansion phase of what they distinguished as five distinct cycles 37 00:03:57.720 --> 00:04:05.420 varied between fifteen and forty-four months, of the contraction phase between ten and thirty-seven 38 00:04:05.420 --> 00:04:13.220 months, and of the full cycle between twenty-six and fifty-seven months. 39 00:04:13.220 --> 00:04:17.920 These ranges would no doubt be greater if more cycles were studied. 40 00:04:17.920 --> 00:04:39.380 Moreover, the peak and trough months of these cycles do not correspond very closely if we shift to other indices, such as coal production, steel production, petroleum output, cotton stocks at mills, calves slaughtered under federal inspection, etc. 41 00:04:39.380 --> 00:04:45.700 Passing over these difficulties, what seems to be true is that business cycles are phenomena 42 00:04:45.700 --> 00:04:51.780 that occur typically over a period of a few years, rather than over a period measured 43 00:04:51.780 --> 00:04:57.900 in days or weeks on the one hand, or decades on the other. 44 00:04:57.900 --> 00:05:04.220 This is particularly because this is the amplitude and type of fluctuation we have arbitrarily 45 00:05:04.220 --> 00:05:10.780 decided to call the trade cycle or business cycle and partly because there is a certain 46 00:05:10.780 --> 00:05:18.020 viscosity in the economic system so that changes at any point normally take a certain time 47 00:05:18.020 --> 00:05:21.580 to make their effects felt more generally. 48 00:05:21.580 --> 00:05:24.460 There are exceptions even to this. 49 00:05:24.460 --> 00:05:31.780 A labor strike or an enemy bombing or a flood or a fire or an earthquake or even a holiday 50 00:05:31.780 --> 00:05:39.580 may bring business almost to a halt in a single day from a period of great activity, and activity 51 00:05:39.580 --> 00:05:43.340 may just as promptly be restored. 52 00:05:43.340 --> 00:05:49.180 But we ordinarily do not count such changes when we study business cycles. 53 00:05:49.180 --> 00:05:56.420 Keynes's belief in the regularity of duration of trade cycles, however, is an important 54 00:05:56.420 --> 00:06:00.540 part of the theory he puts forward to explain them. 55 00:06:00.540 --> 00:06:08.860 A more typical and often the predominant explanation of the crisis is, he declares, not primarily 56 00:06:08.860 --> 00:06:15.340 a rise in the rate of interest, but a sudden collapse in the marginal efficiency of capital. 57 00:06:15.340 --> 00:06:16.820 Page 315. 58 00:06:16.820 --> 00:06:22.940 Now, the truth or importance that we attach to this statement depends once more upon the 59 00:06:22.940 --> 00:06:30.240 interpretation we give to Keynes's ambiguous term, the marginal efficiency of capital. 60 00:06:30.240 --> 00:06:36.640 If it means merely the outlook for business profits, which in this context it does seem 61 00:06:36.640 --> 00:06:40.560 to mean, then it is true but obvious. 62 00:06:40.560 --> 00:06:46.080 For a collapse in the outlook for business profits is in turn merely another name for 63 00:06:46.080 --> 00:06:48.160 a collapse of confidence. 64 00:06:48.160 --> 00:06:54.580 A collapse in the state of confidence is of course an inherent part of the crisis. 65 00:06:54.580 --> 00:07:00.740 But this merely raises the question, what caused confidence to collapse? 66 00:07:00.740 --> 00:07:04.980 What caused the outlook for profits to turn sour? 67 00:07:04.980 --> 00:07:10.040 What brought on the sudden collapse in the marginal efficiency of capital? 68 00:07:10.040 --> 00:07:16.220 This is merely one more illustration of the confusions Keynes gets into through the ambiguity 69 00:07:16.220 --> 00:07:18.660 of his own terms. 70 00:07:18.660 --> 00:07:26.140 If the marginal efficiency of capital means the expected yield of capital assets, as Keynes 71 00:07:26.140 --> 00:07:33.980 frequently tells us it does, then it is an expectation, a psychological phenomenon, dependent 72 00:07:33.980 --> 00:07:40.060 on the general outlook for business profits as businessmen estimate that outlook correctly 73 00:07:40.060 --> 00:07:41.940 or incorrectly. 74 00:07:41.940 --> 00:07:48.340 If the marginal efficiency of capital means, as it seems on its face to mean, the present 75 00:07:48.340 --> 00:07:59.340 If it is not the physical productivity of capital assets, then clearly it is not this that collapses in the crisis, either as cause or consequence. 76 00:07:59.340 --> 00:08:10.340 If, finally, the marginal efficiency of capital means the present monetary value of the goods that capital instruments helps to produce, 77 00:08:10.340 --> 00:08:20.340 The collapse in that monetary value may cause a collapse in the marginal efficiency of capital, but the causation is not the other way round. 78 00:08:20.340 --> 00:08:31.340 In sum, Keynes's explanation of the crisis as a sudden collapse of the marginal efficiency of capital is either a useless truism or an obvious error, 79 00:08:31.340 --> 00:08:38.340 according to the interpretation we give the phrase, the marginal efficiency of capital. 80 00:08:38.340 --> 00:08:43.340 When Governments Control Investment 81 00:08:43.340 --> 00:08:51.340 It is significant that Keynes's explanation of the crisis exonerates a rise in the rate of interest as the chief culprit, 82 00:08:51.340 --> 00:09:00.340 in spite of his tendency elsewhere to make excessive interest rates and liquidity preference the main cause of unemployment. 83 00:09:00.340 --> 00:09:16.340 We have been accustomed in explaining the crisis, he writes, to lay stress on the rising tendency of the rate of interest under the influence of the increased demand for money both for trade and speculative purposes. 84 00:09:16.340 --> 00:09:24.340 At times this factor may certainly play an aggravating and occasionally perhaps an initiating part. 85 00:09:24.340 --> 00:09:26.340 Page 315 86 00:09:26.340 --> 00:09:38.340 But when this happens, he neglects to point out, or perhaps does not understand, that it is precisely because the rate of interest had previously been kept too low, 87 00:09:38.340 --> 00:09:51.340 and credit had been freely extended to marginal and other dubious projects incapable of earning a realistic rate of interest or surviving, except under conditions of inflation. 88 00:09:51.340 --> 00:10:05.340 The high rate of interest then gets the blame for the collapse of the marginal or unsound projects that were launched only under the illusions created by the preceding inflationary low rate of interest. 89 00:10:05.340 --> 00:10:15.340 Insofar as Keynes presents any clear theory of the trade cycle whatever, it is the theory that the economy cannot be trusted to private hands, 90 00:10:15.340 --> 00:10:45.340 It is of the nature of organized investment markets under the influence of 91 00:10:45.340 --> 00:10:50.880 of purchasers, largely ignorant of what they are buying and of speculators who are more 92 00:10:50.880 --> 00:10:56.320 concerned with forecasting the next shift of market sentiment than with a reasonable 93 00:10:56.320 --> 00:11:03.620 estimate of the future yield of capital assets that, when disillusion falls upon an over-optimistic 94 00:11:03.620 --> 00:11:09.900 and over-bought market, it should fall with sudden and even catastrophic force. 95 00:11:09.900 --> 00:11:14.460 pages 315 through 316. 96 00:11:14.460 --> 00:11:22.460 It is not so easy to revive the marginal efficiency of capital, determined as it is, by the uncontrollable 97 00:11:22.460 --> 00:11:26.440 and disobedient psychology of the business world. 98 00:11:26.440 --> 00:11:32.540 It is the return of confidence to speak an ordinary language which is so insusceptible 99 00:11:32.540 --> 00:11:37.900 to control an economy of individualistic capitalism. 100 00:11:37.900 --> 00:11:43.540 Page 317 One incidental point brought out in this passage 101 00:11:43.540 --> 00:11:49.100 is that it extends the phrase the marginal efficiency of capital to the point where it 102 00:11:49.100 --> 00:11:53.380 means in ordinary language merely confidence. 103 00:11:53.380 --> 00:11:59.540 But what the passage reveals most of all in the words I have italicized is the essentially 104 00:11:59.540 --> 00:12:03.100 authoritarian nature of Keynes's thought. 105 00:12:03.100 --> 00:12:08.300 In free markets, purchasers are largely ignorant of what they are buying. 106 00:12:08.300 --> 00:12:13.860 The business world is uncontrollable and disobedient, like a naughty child. 107 00:12:13.860 --> 00:12:20.660 Obviously, in such a world, investors cannot be trusted to invest their own money, or entrepreneurs 108 00:12:20.660 --> 00:12:23.300 to make their own decisions. 109 00:12:23.300 --> 00:12:27.540 Keynes does not flinch from drawing the logical conclusion. 110 00:12:27.540 --> 00:12:34.220 I conclude that the duty of ordering the current volume of investment cannot safely be left 111 00:12:34.220 --> 00:12:36.220 in private hands. 112 00:12:36.220 --> 00:12:41.400 Page 320 Whoever controls investment controls the direction 113 00:12:41.400 --> 00:12:47.500 and nature of production, decides what is to be made and sold and what is not, what 114 00:12:47.500 --> 00:12:53.420 consumers are to be permitted to have and in what volume, and Keynes does not shrink 115 00:12:53.420 --> 00:12:59.820 from this corollary either, except for a certain lack of clarity and candor, but begins to 116 00:12:59.820 --> 00:13:07.260 talk lightly of supporting all sorts of policies for increasing the propensity to consume, 117 00:13:07.260 --> 00:13:12.140 page 325, and redistributing the wealth. 118 00:13:12.140 --> 00:13:18.120 In existing conditions where the volume of investment is unplanned and uncontrolled, subject 119 00:13:18.120 --> 00:13:24.080 to the vagaries of the marginal efficiency of capital as determined by the private judgment 120 00:13:24.080 --> 00:13:31.640 of individuals ignorant or speculative, the least he would support is, a socially controlled 121 00:13:31.640 --> 00:13:37.440 rate of investment, pages 324-325. 122 00:13:37.440 --> 00:13:43.400 All this implies, once more, not only that entrepreneurs, businessmen, investors and 123 00:13:43.400 --> 00:13:50.380 and speculators are ignorant, mercurial, and irresponsible, but that there exists a class 124 00:13:50.380 --> 00:13:57.720 of people, perhaps economists very much resembling Lord Keynes, who are completely informed, 125 00:13:57.720 --> 00:14:05.060 rational, balanced, wise, who have means of knowing at all times exactly how much investment 126 00:14:05.060 --> 00:14:12.060 is needed, and in exactly what amounts it should be allocated to exactly which industries 127 00:14:12.060 --> 00:14:18.500 and Projects, and that these managers are above corruption and above any interest in 128 00:14:18.500 --> 00:14:21.700 the outcome of the next election. 129 00:14:21.700 --> 00:14:26.520 Great Britain, unfortunately, decided to try the Keynesian remedy. 130 00:14:26.520 --> 00:14:28.780 The results are now known. 131 00:14:28.780 --> 00:14:35.880 I present herewith an analysis by Professor Eli Devon of the University of Manchester, 132 00:14:35.880 --> 00:14:42.760 which appeared in Lloyd's Bank Review of London, 4 July 1954. 133 00:14:42.760 --> 00:14:48.840 It is now generally acknowledged that there are no objective criteria by which the government 134 00:14:48.840 --> 00:14:55.760 can decide what is the right amount of investment in total, but it is still sometimes argued 135 00:14:55.760 --> 00:15:02.600 that it is possible by statistical analysis to decide on the distribution of investment. 136 00:15:02.600 --> 00:15:09.160 If the government in its control over investment merely wants to imitate market procedure and 137 00:15:09.160 --> 00:15:15.000 to select the right lines of investment that will pay best, then it might try to work out 138 00:15:15.000 --> 00:15:21.220 rates of return on the various projects submitted to it and use such rates as the criteria for 139 00:15:21.220 --> 00:15:24.640 selecting which to approve. 140 00:15:24.640 --> 00:15:30.720 Even on this basis, however, prospective rates of return could be calculated only with very 141 00:16:00.720 --> 00:16:09.720 The controlling authority tries to select on the basis of the public interest or of 142 00:16:09.720 --> 00:16:11.720 social priorities. 143 00:16:11.720 --> 00:16:17.960 It is extremely difficult to see how social priorities or social rates of return can be 144 00:16:17.960 --> 00:16:20.120 measured statistically. 145 00:16:20.120 --> 00:16:26.160 How does one compare statistically the social rate of return from building more houses with 146 00:16:26.160 --> 00:16:31.760 or the social rate of return from more investment on road building and repair, 147 00:16:31.760 --> 00:16:37.280 or compare the social rate of return from additional investment in the coal industry 148 00:16:37.280 --> 00:16:41.480 with investment in engineering or textiles. 149 00:16:41.480 --> 00:16:46.520 Whether or not it is possible to measure social rates of return statistically, 150 00:16:46.520 --> 00:16:52.440 there is in any case little evidence that such calculation ever played an important 151 00:16:52.440 --> 00:16:59.920 rule in the deliberations of the Capital Issues Committee and the Investments Program Committee. 152 00:16:59.920 --> 00:17:04.560 Little has been published about the proceedings of these two important committees and the 153 00:17:04.560 --> 00:17:10.880 criteria which they used in arriving at their decisions, but I suspect that the allocation 154 00:17:10.880 --> 00:17:16.520 of investment is much better thought of as the result of political and administrative 155 00:17:16.520 --> 00:17:22.200 struggles and pressures than as a rational choice determined by the statistical measurement 156 00:17:22.200 --> 00:17:25.160 of Rates of Social Return. 157 00:17:25.160 --> 00:17:31.920 Each industry or line of investment is the administrative responsibility of some government 158 00:17:31.920 --> 00:17:36.920 department, and in the argument about the investment program, each department would 159 00:17:36.920 --> 00:17:41.400 fight for the interests for which it was responsible. 160 00:17:41.400 --> 00:17:46.600 Every argument would, of course, be used to demonstrate that the investment being sponsored 161 00:17:46.600 --> 00:17:53.640 is vital to the economy because it would relieve a potential bottleneck, result in export expansion 162 00:17:53.640 --> 00:17:55.440 or dollar saving. 163 00:17:55.440 --> 00:18:00.580 The strength of this case, the efficiency with which it is presented, the power and 164 00:18:00.580 --> 00:18:07.120 energy of the minister in charge, public pressure and generally accepted but vaguely expressed 165 00:18:07.120 --> 00:18:13.920 ideas of what is essential and inessential, would all go to determine how each particular 166 00:18:13.920 --> 00:18:18.360 The Request for Inclusion in the Investment Program was treated. 167 00:18:18.360 --> 00:18:23.680 No doubt argument before these committees would be dressed up in statistics, since every 168 00:18:23.680 --> 00:18:30.560 official knows that a statistical case always makes an impression, and, if all those concerned 169 00:18:30.560 --> 00:18:36.360 play the statistical game correctly, especially if they are not sure that they are playing 170 00:18:36.360 --> 00:18:42.880 a game, then an apparent error of deciding the issues rationally in terms of quantitative 171 00:18:42.880 --> 00:18:50.160 Estimates of the results of alternative lines of action may easily be maintained. 172 00:18:50.160 --> 00:18:54.360 The Life of Durable Assets 173 00:18:54.360 --> 00:19:00.800 So much for one of the main economic policies Keynes advocated, now let us return to some 174 00:19:00.800 --> 00:19:07.560 of the technical economic analysis upon which his astonishing conclusion was based. 175 00:19:07.560 --> 00:19:13.960 Keynes, as we have seen, believed in regularity in the duration of the business cycle. 176 00:19:13.960 --> 00:19:20.160 Specifically, he believed that the duration of the downward movement had an order of magnitude 177 00:19:20.160 --> 00:19:26.920 which is not fortuitous, but which shows some regularity of habit between, let us say, three 178 00:19:26.920 --> 00:19:28.960 and five years. 179 00:19:28.960 --> 00:19:30.960 Page 317. 180 00:19:30.960 --> 00:19:37.420 Characteristically, he presents no statistical evidence of this, nor does he refer to any 181 00:19:37.420 --> 00:19:41.200 and a source where the statistical evidence can be found. 182 00:19:41.200 --> 00:19:47.580 The extreme difficulty even of measuring business cycle durations is brought out by Burns and 183 00:19:47.580 --> 00:19:51.400 Mitchell in Measuring Business Cycles. 184 00:19:51.400 --> 00:19:58.540 Table 56 on page 221 of that volume shows that the contraction phase of 15 American 185 00:19:58.540 --> 00:20:07.060 One cycle, as measured by monthly pig-iron production between 1879 and 1933, ranged from 186 00:20:07.060 --> 00:20:13.820 five months to 44 months, as compared with Keynes's three to five years. 187 00:20:13.820 --> 00:20:19.980 Jeffrey H. Moore, continuing the statistical studies of the National Bureau of Economic 188 00:20:19.980 --> 00:20:26.700 Research, finds that the average duration of the downward movement of the 24 cycles 189 00:20:26.700 --> 00:20:33.980 in the period from 1854 to 1954 was just 20 months. 190 00:20:33.980 --> 00:20:38.920 But this statistical average conceals a wide range of duration. 191 00:20:38.920 --> 00:20:45.020 The contraction beginning in August 1918 lasted only 7 months. 192 00:20:45.020 --> 00:20:50.660 That beginning in October 1873 lasted 65 months. 193 00:20:50.660 --> 00:20:56.420 In spite of Keynes's impression of regularity, here is a difference in duration of almost 194 00:20:56.420 --> 00:21:01.060 Just ten times as much in one case as in another. 195 00:21:01.060 --> 00:21:06.220 Had Keynes been discussing the average duration of the whole cycle, instead of merely the 196 00:21:06.220 --> 00:21:10.800 downward phase, his guess would have come near the mark. 197 00:21:10.800 --> 00:21:17.280 The expansion and contraction phase together of the twenty-four cycles add up to just fifty 198 00:21:17.280 --> 00:21:24.980 months or slightly over four years, but this average again conceals wide differences, for 199 00:21:24.980 --> 00:21:35.980 Whereas the average expansion phase of the 24 cycles lasted 30 months, the range was from as low as 10 months to as long as 80 months. 200 00:21:35.980 --> 00:21:47.980 Now Keynes tries to explain his assumed regularity by the influences which govern the recovery of the marginal efficiency of capital, page 317. 201 00:21:47.980 --> 00:21:54.820 But here, he shifts once more from the wider interpretation of that phrase as equivalent 202 00:21:54.820 --> 00:22:01.580 merely to the state of confidence to the narrow interpretation of the specific productivity 203 00:22:01.580 --> 00:22:04.580 of specific capital assets. 204 00:22:04.580 --> 00:22:10.820 He concludes that the duration of the slump has a definite relationship to the length of 205 00:22:10.820 --> 00:22:21.820 of Life of Durable Assets, page 318, and also to The Carrying Costs of Surplus Stocks, page 317. 206 00:22:21.820 --> 00:22:28.820 Here again, no statistical evidence is offered, and it may be questioned whether any is possible. 207 00:22:28.820 --> 00:22:38.820 There is no meaningful average length of life of durable assets, and no meaningful average period of getting rid of surplus stocks. 208 00:22:38.820 --> 00:22:45.540 Every capital instrument has a different economic life span, not necessarily coincident with 209 00:22:45.540 --> 00:22:48.380 its physical life span. 210 00:22:48.380 --> 00:22:54.200 Even durable assets of approximately the same life span were bought and installed at 211 00:22:54.200 --> 00:22:59.280 different times, and therefore need replacement at different times. 212 00:22:59.280 --> 00:23:06.380 The average life expectation of a human being is, say, 70 years, but under normal conditions 213 00:23:06.380 --> 00:23:12.700 Canes approximately the same percentage and numbers of men and women die and are replaced 214 00:23:12.700 --> 00:23:15.620 each year at a fairly even rate. 215 00:23:15.620 --> 00:23:21.340 They do not die all at once and get replaced each 70th year. 216 00:23:21.340 --> 00:23:27.620 Canes has not only got his elementary arithmetic mixed up, but has reversed economic cause 217 00:23:27.620 --> 00:23:29.100 and effect. 218 00:23:29.100 --> 00:23:35.020 The amount of new and durable assets or current inventories purchased depends on the state 219 00:23:35.020 --> 00:23:41.020 of Expectations, the state of confidence rather than the other way round. 220 00:23:41.020 --> 00:23:47.660 Whether a manufacturer keeps his old equipment for another year or two or buys new equipment 221 00:23:47.660 --> 00:23:53.580 depends less upon the physical age of his equipment than upon his expectations regarding 222 00:23:53.580 --> 00:23:57.660 the future of sales, costs and prices. 223 00:23:57.660 --> 00:24:03.380 Whether people keep their old automobiles or buy new ones depends more upon their own 224 00:24:03.380 --> 00:24:11.340 on Present Income or Estimate of Future Income than upon the precise age of their old car. 225 00:24:11.340 --> 00:24:17.780 There is no point at which people are compelled to buy new cars or at which a manufacturer 226 00:24:17.780 --> 00:24:21.420 is compelled to buy new equipment. 227 00:24:21.420 --> 00:24:27.140 This depends chiefly upon his estimate of future conditions in his business. 228 00:24:27.140 --> 00:24:31.320 The same reasoning applies even more to inventories. 229 00:24:31.320 --> 00:24:35.920 There is no meaningful average time for getting rid of them. 230 00:24:35.920 --> 00:24:41.160 Nothing is gained by averaging the time it takes a department store to get rid of an 231 00:24:41.160 --> 00:24:47.200 excess inventory of bedsheets with the time it takes a Cadillac dealer to get rid of an 232 00:24:47.200 --> 00:24:49.920 excess stock of cars. 233 00:24:49.920 --> 00:24:55.560 And in any case, each specific time period depends more upon the purchasing power and 234 00:24:55.560 --> 00:25:01.380 and State of Expectations of Buyers and upon the willingness of sellers to cut prices for 235 00:25:01.380 --> 00:25:08.120 clearance, than upon the need of buyers to replace their own stocks. 236 00:25:08.120 --> 00:25:15.400 In brief, while the length of life of durable assets perhaps has some relationship to the 237 00:25:15.400 --> 00:25:22.920 duration of a slump, it is only one of many factors, and seldom the most important. 238 00:25:22.920 --> 00:25:28.960 Nor does there appear to be any statistical way of determining its exact relationship 239 00:25:28.960 --> 00:25:32.440 or relative importance. 240 00:25:32.440 --> 00:25:37.520 A Policy of Perpetual Inflation 241 00:25:37.520 --> 00:25:44.080 Keynes's theory of the crisis, like his theory of so many other things, consists merely in 242 00:25:44.080 --> 00:25:52.020 a contramundum attitude, a denial of nearly every doctrine that is orthodox or established. 243 00:25:52.020 --> 00:25:58.040 If one truth concerning economic crises has been established in recent years, it is that 244 00:25:58.040 --> 00:26:05.100 they are typically brought on by cheap money, i.e. low interest rate policies, that encourage 245 00:26:05.100 --> 00:26:12.300 excessive borrowing, excessive credit expansion, imprudent speculation, and all the distortions 246 00:26:12.300 --> 00:26:17.500 and instabilities in the economy that these finally bring about. 247 00:26:17.500 --> 00:26:23.220 It follows that such crises can be prevented by keeping money sufficiently tight, so that 248 00:26:23.220 --> 00:26:29.540 credit expansion, reckless speculation and harebrained ventures are not encouraged in 249 00:26:29.540 --> 00:26:31.200 the first place. 250 00:26:31.200 --> 00:26:37.500 It follows also that when such symptoms of an inflationary boom appear, a timely increase 251 00:26:37.500 --> 00:26:43.380 in money rates can prevent them from running too far and dampen down the boom before it 252 00:26:43.380 --> 00:26:46.820 has run to excessive lengths. 253 00:26:46.820 --> 00:26:49.700 All this, of course, Keynes rejects. 254 00:26:49.700 --> 00:26:53.860 He treats the whole thing as a strange and perverse theory. 255 00:26:53.860 --> 00:26:59.440 It may appear extraordinary that a school of thought should exist which finds the solution 256 00:26:59.440 --> 00:27:05.940 for the trade cycle in checking the boom in its early stages by a higher rate of interest. 257 00:27:05.940 --> 00:27:08.140 Page 326. 258 00:27:08.140 --> 00:27:13.340 Keynes professes to be totally incapable of understanding the reasoning of this school 259 00:27:13.340 --> 00:27:24.780 The only line of argument along with any justification for this policy can be discovered is that 260 00:27:24.780 --> 00:27:32.580 put forward by Mr. D. H. Robertson, who assumes in effect that full employment is an impracticable 261 00:27:32.580 --> 00:27:38.420 ideal and that the best that we can hope for is a level of employment much more stable 262 00:27:38.420 --> 00:27:46.460 then at present and averaging perhaps a little higher, pages 326 through 327. 263 00:27:46.460 --> 00:27:52.780 Now whether full employment as conceived by the Keynesians is a practicable or even a 264 00:27:52.780 --> 00:27:59.520 definable ideal is a question we shall later examine, and whether or not Keynes correctly 265 00:27:59.520 --> 00:28:05.540 states Robertson's argument is a question with which we are here not concerned. 266 00:28:05.540 --> 00:28:10.580 We need merely point out that this is not the real line of argument for checking the 267 00:28:10.580 --> 00:28:15.560 boom in its early stages by a higher rate of interest. 268 00:28:15.560 --> 00:28:21.500 The real objection to keeping rates of interest too low too long is that they encourage excessive 269 00:28:21.500 --> 00:28:28.020 borrowing, inflationary price and wage rises, speculative projects that cannot pay their 270 00:28:28.020 --> 00:28:34.820 way, and illusions, instabilities and distortions throughout the economy that are bound to lead 271 00:28:34.820 --> 00:28:37.500 eventually to a crash. 272 00:28:37.500 --> 00:28:42.580 But Keynes professes to believe that those who are opposed to inflationary bubbles are 273 00:28:42.580 --> 00:28:45.620 opposed to full employment. 274 00:28:45.620 --> 00:28:51.300 The austere view, which would employ a high rate of interest to check at once any tendency 275 00:28:51.300 --> 00:28:57.620 in the level of employment to rise appreciably above the average of, say, the previous decade, 276 00:28:57.620 --> 00:29:04.420 is, however, more usually supported by arguments which have no foundation at all apart from 277 00:29:04.420 --> 00:29:14.980 from Confusion of Mind, p. 327-328. Now, I know of no one who advocates or ever advocated 278 00:29:14.980 --> 00:29:21.420 raising the rate of interest in order to lower the level of employment. If Keynes knew of 279 00:29:21.420 --> 00:29:26.800 such an economist, he should have quoted him. Economists have advocated raising the 280 00:29:26.800 --> 00:29:32.840 rate of interest in order to slow down or to halt or to prevent in the first place a 281 00:29:32.840 --> 00:29:39.600 a money and credit inflation, with the instabilities and final crisis to which such an inflation 282 00:29:39.600 --> 00:29:41.320 always leads. 283 00:29:41.320 --> 00:29:47.160 They want the rate of interest raised to a non-inflationary level so as not to be confronted 284 00:29:47.160 --> 00:29:52.480 with a crisis and heavy unemployment when the inflationary bubble bursts. 285 00:29:52.480 --> 00:30:00.440 Keynes's economics is the economics of wish-fulfillment, the economics of the land of cocaine, where 286 00:30:00.440 --> 00:30:04.440 Every problem can be solved by a rhetoric. 287 00:30:04.440 --> 00:30:09.440 Thus the remedy for the boom is not a higher rate of interest, but a lower rate of interest, 288 00:30:09.440 --> 00:30:13.440 for that may enable the so-called boom to last. 289 00:30:13.440 --> 00:30:18.440 The right remedy for the trade cycle is not to be found in abolishing booms 290 00:30:18.440 --> 00:30:23.440 and thus keeping us permanently in a semi-slump, but in abolishing slumps 291 00:30:23.440 --> 00:30:40.440 This sounds more like the wind-up speech of a political candidate at the final rally of a campaign than like the statement of a serious economist. 292 00:30:40.440 --> 00:30:49.440 Of course, the economic ideal is to keep maximum production and even full employment sensibly defined all the time. 293 00:30:49.440 --> 00:30:56.100 But Keynes proposes to do this, in effect, by a policy of perpetual inflation, of keeping 294 00:30:56.100 --> 00:31:02.280 the interest rate low by a constant expansion of the money and credit supply, for that is 295 00:31:02.280 --> 00:31:06.140 what a policy of perpetual cheap money means. 296 00:31:06.140 --> 00:31:10.960 But this would not bring maximum balanced production of the products that consumers 297 00:31:10.960 --> 00:31:14.520 most wanted, nor steady employment. 298 00:31:14.520 --> 00:31:20.620 It is a policy of boom and bust, with the method correctly described. 299 00:31:20.620 --> 00:31:26.120 And Keynes solves the trade cycle problem rhetorically by the simple device of never 300 00:31:26.120 --> 00:31:31.040 once mentioning in this chapter the level of wage rates. 301 00:31:31.040 --> 00:31:36.600 Never once does he ask what would happen if wage rates in this full employment boom started 302 00:31:36.600 --> 00:31:41.120 racing ahead of prices and wiping out profit margins. 303 00:31:41.120 --> 00:31:45.400 Never once does he say what he would do to stop this from happening. 304 00:31:45.400 --> 00:31:50.760 In the Keynesian system, the level of wage rates and their effect on employment is the 305 00:31:50.760 --> 00:31:52.560 great unmentionable. 306 00:31:52.560 --> 00:31:59.120 Keynes's theory of the trade cycle, including his theory of interest rate policy, is crowded 307 00:31:59.120 --> 00:32:01.080 with contradictions. 308 00:32:01.080 --> 00:32:06.600 The rate of interest, according to him, should be low in the depression, low in the boom, 309 00:32:06.600 --> 00:32:08.540 and low in the crisis. 310 00:32:08.540 --> 00:32:15.900 His remedy is to keep the boom going by encouraging overinvestment and malinvestment, and then, 311 00:32:15.900 --> 00:32:21.220 when the boom cracks, to keep it going by lowering the rate of interest still more to 312 00:32:21.220 --> 00:32:26.400 encourage still more overinvestment and malinvestment. 313 00:32:26.400 --> 00:32:31.960 He refused to recognize the rate of interest as a payment for anything real, whether the 314 00:32:31.960 --> 00:32:37.580 productivity or rental value of the capital assets that could be bought with the borrowed 315 00:32:37.580 --> 00:32:42.060 Funds, or the Payment for Generalized Time Usance. 316 00:32:42.060 --> 00:32:48.100 He failed to recognize that the rate of interest is a market phenomenon like any other. 317 00:32:48.100 --> 00:32:53.980 He was opposed to clapping on a high rate of interest, which would probably deter some 318 00:32:53.980 --> 00:32:57.740 useful investments, page 321. 319 00:32:57.740 --> 00:33:03.720 Forgetting that any market price for anything cuts off all the possible purchasers who are 320 00:33:03.720 --> 00:33:10.480 or unwilling or unable to pay that price, but if the total supply is sold, the commodity 321 00:33:10.480 --> 00:33:15.320 nonetheless goes into presumably its most productive uses. 322 00:33:15.320 --> 00:33:21.320 What confused Keynes was the belief that money was not anything real, but merely pieces of 323 00:33:21.320 --> 00:33:25.760 paper that could be turned out at will by the printing press. 324 00:33:25.760 --> 00:33:29.600 He was capable of writing, for example. 325 00:33:29.600 --> 00:33:35.200 For again, the evil is supposed to creep in if the increased investment has been promoted 326 00:33:35.200 --> 00:33:41.460 by a fall in the rate of interest engineered by an increase in the quantity of money. 327 00:33:41.460 --> 00:33:47.300 Yet there is no special virtue in the pre-existing rate of interest, and the new money is not 328 00:33:47.300 --> 00:33:49.620 forced on anyone. 329 00:33:49.620 --> 00:33:52.100 Page 328 330 00:33:52.100 --> 00:33:58.020 Here Keynes clearly acknowledges that he favors artificially cheap money, even if it is brought 331 00:33:58.020 --> 00:34:01.220 What about by direct monetary inflation? 332 00:34:01.220 --> 00:34:06.540 As a matter of fact, this is the only way in which a cheap money policy can be made 333 00:34:06.540 --> 00:34:07.540 effective. 334 00:34:07.540 --> 00:34:13.620 Either the supply of money and or credit has to be increased to keep the interest rate 335 00:34:13.620 --> 00:34:19.980 down or the artificially low interest rate, if it is effective at all, will stimulate 336 00:34:19.980 --> 00:34:25.260 increased borrowing and a consequent increase in the money and credit supply. 337 00:34:25.260 --> 00:34:32.300 True, there is no special virtue in the pre-existing rate of interest, but there is at least a 338 00:34:32.300 --> 00:34:38.260 negative virtue in a rate of interest which is not inflationary. 339 00:34:38.260 --> 00:34:42.660 More Carts Before Horses 340 00:34:42.660 --> 00:34:49.740 There are some incidental fallacies in section 6 of chapter 22 that are worth noticing cheatfully 341 00:34:49.740 --> 00:35:18.320 The Theory of Money and Credit This is disingenuous, not only because Keynes 342 00:35:18.320 --> 00:35:25.080 Mises himself defined investment and savings in this special sense in his treatise on money, 343 00:35:25.080 --> 00:35:31.440 but because notwithstanding his formal definitions of saving and investment in section two of 344 00:35:31.440 --> 00:35:38.000 chapter six, according to which they must always be equal, the whole thesis of the general 345 00:35:38.000 --> 00:35:45.760 theory which makes saving sinful and investment virtuous depends constantly on the tacit assumption 346 00:35:45.760 --> 00:35:53.020 that one can, in fact, occur without the automatic occurrence of an equal amount of the other. 347 00:35:53.020 --> 00:36:00.600 The truth, as we saw in our Chapter 16, is that in a boom, monetary investment can outrun 348 00:36:00.600 --> 00:36:08.000 previous genuine saving, provided new money or bank credit has been meanwhile created, 349 00:36:08.000 --> 00:36:11.720 provided in other words, there is monetary inflation. 350 00:36:11.720 --> 00:36:18.080 Again, Keynes makes some astonishing statements on page 328. 351 00:36:18.080 --> 00:36:24.120 In the short period, supply price usually increases with increasing output, on account 352 00:36:24.120 --> 00:36:29.520 either of the physical fact of diminishing return or of the tendency of the cost unit 353 00:36:29.520 --> 00:36:34.360 to rise in terms of money when output increases. 354 00:36:34.360 --> 00:36:41.600 But in the typical Keynesian situation, after there has been unemployment and unused capacity, 355 00:36:41.600 --> 00:36:48.080 Unit costs of production fall when output increases because of the reduction of unit 356 00:36:48.080 --> 00:36:50.800 overhead costs. 357 00:36:50.800 --> 00:36:56.560 The rise of prices is merely a by-product of the increased output. 358 00:36:56.560 --> 00:37:04.160 But increased output, demand remaining unchanged, means a fall of prices. 359 00:37:04.160 --> 00:37:09.740 No one has a legitimate vested interest in being able to buy at prices which are only 360 00:37:09.740 --> 00:37:22.740 This is a reversal of cause and effect. When output is low, it is usually because prices are low, because demand is low. 361 00:37:22.740 --> 00:37:37.740 When statements about elementary economic relationships are so slovenly and confused, it is hardly surprising that we should encounter so much confusion and fallacy in the discussion of more complicated problems. 362 00:37:37.740 --> 00:37:42.740 Sunspots Before the Eyes 363 00:37:42.740 --> 00:37:50.740 The final section of Chapter 22 on the supposed connection of the size of crops with the business cycle 364 00:37:50.740 --> 00:37:57.740 is irrelevant to the main themes of the general theory and need detain us only as a further illustration 365 00:37:57.740 --> 00:38:04.740 of the slipshod and offhand theorizing that Keynes seems to think good enough for economics. 366 00:38:04.740 --> 00:38:12.980 Keynes takes off from the theory of W. Stanley Jevons, presented in 1878, that the trade 367 00:38:12.980 --> 00:38:18.820 cycle was primarily due to the fluctuations in the bounty of the harvest, and these in 368 00:38:18.820 --> 00:38:21.500 turn to a sunspot cycle. 369 00:38:21.500 --> 00:38:26.180 Keynes restates and defends the theory in this form. 370 00:38:26.180 --> 00:38:32.020 When an exceptionally large harvest is gathered in, an important addition is usually made 371 00:38:32.020 --> 00:38:35.740 to the quantity carried over into later years. 372 00:38:35.740 --> 00:38:40.860 The proceeds of this addition are added to the current incomes of the farmers and are 373 00:38:40.860 --> 00:38:47.060 treated by them as income, whereas the increased carryover involves no drain on the income 374 00:38:47.060 --> 00:38:53.260 expenditure of other sections of the community, but is financed out of savings. 375 00:38:53.260 --> 00:38:59.000 That is to say, the addition to the carryover is an addition to current investment. 376 00:38:59.000 --> 00:39:03.840 This conclusion is not invalidated even if prices fall sharply. 377 00:39:03.840 --> 00:39:09.400 Thus, it is natural that we should find the upward turning point to be marked by bountiful 378 00:39:09.400 --> 00:39:14.400 harvests and the downward turning point by deficient harvests. 379 00:39:14.400 --> 00:39:20.040 Pages 329 through 330 Now, such a theory, to be even superficially 380 00:39:20.040 --> 00:39:25.760 plausible, calls first of all for an inductive or statistical support. 381 00:39:25.760 --> 00:39:34.120 It would be necessary to show a direct correspondence or at least a positive correlation, simultaneous 382 00:39:34.120 --> 00:39:41.240 or lagging, between the size of crops and the degree of prosperity, at least an approximate 383 00:39:41.240 --> 00:39:48.680 correspondence between the total size of crops and the size of the carryover from them, at 384 00:39:48.680 --> 00:39:54.400 least an approximate correspondence between the total size of a crop and the volume of 385 00:39:54.400 --> 00:40:01.240 of Bank Loans for Carrying the Carryover, and 4, a correlation between the annual changes 386 00:40:01.240 --> 00:40:07.920 in the volume of agricultural loans for carrying crops and the annual changes in the total 387 00:40:07.920 --> 00:40:12.080 volume of bank loans for all purposes. 388 00:40:12.080 --> 00:40:17.360 Not one of these statistical comparisons is made by Keynes or even suggested. 389 00:40:17.360 --> 00:40:23.920 Yet, these statistics are all easily available, at least on a national scale, and some of 390 00:40:23.920 --> 00:40:39.920 The total monetary value of a crop, and there is no other practicable way of measuring the value except in monetary terms, bears no direct correspondence with the size of the crop. 391 00:40:39.920 --> 00:40:46.920 Thus, in the decade 1876 to 1885, to take figures from Jevons Owen period, 392 00:40:46.920 --> 00:40:57.440 period. The annual production of wheat in the United States averaged 448,337,000 bushels, 393 00:40:57.440 --> 00:41:10.520 and the annual farm value averaged $413,730,000. But in the decade 1886 through 1895, the annual 394 00:41:10.520 --> 00:41:18.960 The annual average production of wheat in the U.S. rose to 526,076,000 bushels, whereas 395 00:41:18.960 --> 00:41:27.720 the annual average farm value fell to $356,288,000. 396 00:41:27.720 --> 00:41:34.360 I could cite any number of similar falls in total farm value of crops when the crops themselves 397 00:41:34.360 --> 00:41:35.600 increased. 398 00:41:35.600 --> 00:41:42.260 Speaking broadly, in fact, the farmer's total income from crops does not vary either directly 399 00:41:42.260 --> 00:41:46.540 or inversely with the total size of the crops. 400 00:41:46.540 --> 00:41:53.180 The conditions of demand in any year and changes in the value of the monetary unit itself are 401 00:41:53.180 --> 00:41:57.580 just as important as changes in crop supply. 402 00:41:57.580 --> 00:42:04.580 Secondly, there is no necessary correspondence between the total size of a crop and the size 403 00:42:04.580 --> 00:42:11.580 The Theory of Money and Credit The Theory of Money and Credit 404 00:42:34.580 --> 00:42:51.580 The American wheat crop rose to 1,184,749,000 bushels and the average size of the carryover fell to 281,603,000 bushels. 405 00:42:51.580 --> 00:43:07.300 In 1948, the new wheat crop was 1,294,911,000 bushels and the carryover 307,285,000 bushels. 406 00:43:07.300 --> 00:43:23.420 In 1949, the new crop fell to 1,098,415,000 bushels, but the carryover rose to 424,714,000 bushels. 407 00:43:23.420 --> 00:43:29.860 I need not go on to show the lack of correspondence between the total size of crops or carryovers 408 00:43:29.860 --> 00:43:32.940 with total bank loans year by year. 409 00:43:32.940 --> 00:43:38.700 After all, it is the business of the propounder of a theory to present at least the prima 410 00:43:38.700 --> 00:43:45.180 facie reasons that make it seem plausible before it becomes incumbent on anybody else 411 00:43:45.180 --> 00:43:49.180 to present an elaborate disprove. 412 00:43:49.180 --> 00:43:55.180 Keynes's deductive argument for his modernized version of the Javonian trade cycle theory 413 00:43:55.180 --> 00:44:00.220 is implausible even in the absence of statistical disprove. 414 00:44:00.220 --> 00:44:07.120 It is based on the tacit assumptions, never spelled out, that large crops lead to a corresponding 415 00:44:07.120 --> 00:44:13.860 automatic increase in the volume of bank loans, that this increase adds to the volume of monetary 416 00:44:13.860 --> 00:44:19.720 purchasing power, and also that, for some mysterious reason, none of this purchasing 417 00:44:19.720 --> 00:44:24.480 power is ever tied up by the holding of the crops themselves. 418 00:44:24.480 --> 00:44:31.600 In fact, Keynes contends that the reduction of redundant stocks to a normal level actually 419 00:44:31.600 --> 00:44:35.800 has a deflationary effect, page 331. 420 00:44:35.800 --> 00:44:43.160 It is, on the contrary, surplus stocks hanging over the market that have the deflationary 421 00:44:43.160 --> 00:44:44.720 effect. 422 00:44:44.720 --> 00:44:50.580 Prices of any commodity tend to rise as such surplus stocks are worked off. 423 00:44:50.580 --> 00:44:57.140 These are facts known to every informed speculator or businessman, but they were apparently never 424 00:44:57.140 --> 00:44:59.540 called to Lord Keynes's attention.