The wellspring of all Keynesianized economies is hatred of the free market.
As summed up by Lord Keynes himself in 1933, when he declared that,
The decadent international, but individualistic capitalism is not a success.
It is not intelligent, it is not beautiful, it is not just, it is not virtuous, and it does not deliver the goods.
In short, we dislike it and we are beginning to despise it."
He went on to counsel politico-economic experiments
so that each country can find a replacement for laissez-faire to
make our own favorite experiment toward the ideal social republic of the future.
In Keynes's own ideal social republic of the future,
all economic scarcity would be eliminated.
All of our reasonable economic needs, as he put it, would be satisfied.
Freeing us from odious labor and provision of the future to pursue the immediate higher ends of contemplation of beauty and friendship.
In 1931, Keynes said, quote,
A point may soon be reached, much sooner than all of us are aware,
when these needs are satisfied in the sense that we prefer to devote our further energies to non-economic purposes.
In this utopia, the real and permanent problem facing man is, quote,
How to Use His Freedom from Pressing Economic Cares
How to Occupy the Leisure, which Science and Compound Interest will have Won for Him,
to Live Wisely, Agreeably and Well.
For Keynes, social progress depended upon capital accumulation.
As he said in 1931,
From the time of the influx of the precious metals into Spain in the 16th century until today,
the power of accumulation of capital by compound interest,
which seems to have been sleeping for many generations was reborn and renewed its strength.
And the power of compound interest over 200 years as such is to stagger the imagination.
He went on to predict that the capital stock having multiplied a hundred times since the beginning of this process
and raising standards of living roughly four-fold would in the next hundred years
lead to another four to eight-fold increase in standards of living.
However, he did not believe that the free market would be the instrument of this largesse.
The free market itself was insufficient, in Keynes's view, in accumulating capital rapidly enough
to push the economy into his post-scarcity utopia.
That required what he called central controls, or as he put it in a paper in 1925,
It necessitates, quote, the transition from economic anarchy to a regime that deliberately aims at controlling and directing economic forces
in the interest of social justice and social stability.
A year later, he was more specific in a paper entitled The End of Laissez-Faire,
when he called for an agenda of state to bring about, quote, improvements in the technique of modern capitalism by the agency of collective action.
In this paper he elaborated on three policies, the three agendas of state.
The first was, quote, deliberate control of the currency and of credit by a central institution,
coupled with the collection and dissemination on a great scale of data relating to the business situation.
The second policy of state was that the state must render, quote, a coordinated act of intelligent judgment
about how much society should save and how its savings should be allocated to capital projects.
In his great work, The General Theory in 1936, he more succinctly put these two policies into the statement,
quote, that his utopia requires a somewhat comprehensive socialization of investment.
His third policy of state was population control.
After all, capital accumulation would simply be wasted if spread too thinly across too many people and eugenics was part of this policy as well since, after all, the contemplation of beauty and truth is not something that the lesser types in society can accomplish and so in utopia they must be eliminated.
Now, in America, we've suffered through two Keynesian politico-economic experiments
of government central controls to transcend laissez-faire
and arrive at what Keynes called in 1930 our destination of economic bliss.
The first of these is known in the literature as the orthodox Keynesian view.
This is the least similar, the view least similar to Keynes's own views.
Here the ideal was to maximize economic wealth as measured by full employment.
The touchstone of this policy was full employment.
To do this, traditional economic theory or classical economics had to be overthrown
since this theory taught us that it was indeed the free market that maximizes economic wealth,
at least as defined by consumer preference,
and that the free market employs factors efficiently.
The Keynesians claim to the contrary that the central defect of the free market is that total production is determined in the market system by total spending and consumers save too much and spend too little.
And investors are also deficient in their spending and furthermore their spending tends to be volatile.
The policy that the government should employ here is obvious.
Demand management via fiscal policy.
If private spending is deficient, the government should spend more, run budget deficits.
If spending is too great, is excessive, the government should run budget surpluses.
There is some textual justification for this view in Keynes,
But it tends to be centered around Keynes' anti-saving bias.
And Keynes held this view that saving was a great evil,
both on personal grounds and on philosophical ones.
As we mentioned, for Keynes the greatest goal, the greatest end one can pursue in life
is these higher mental states of contemplation.
These, quite obviously, are immediate goods.
can only be satisfied with leisure time. In addition, Keynes' personal behavior was what we nicely call in economics subject to high time preference.
In other words, he tended to desire instant gratification and not wish to look at future provision for him and others.
There is then another rhetorical use by Keynes in the general theory that is taken by the
orthodox Keynesians as being important for their view.
And this was Keynes' use of the phrase, or the term, full employment.
Keynes used this phrase though, in my opinion, rhetorically, simply because when he was writing
these works, people were worried about unemployment.
What Keynes was really after, though, was what he more accurately called full investment,
which we'll talk about in the second Keynesian view.
In the general theory, Keynes even went so far as to attempt to show that capital accumulation
did not depend upon saving and future orientation, as the classical economist would argue.
But that saving actually limited capital accumulation.
This is his famous paradox of saving argument and the argument goes this way that when people
wish to save a greater percentage of their income, this causes their spending to go down.
Their reduced spending then reduces production since production simply follows spending and
this lowers their income so even though they're saving a greater percentage of their income,
their total saving is actually reduced.
Banking also retards capital accumulation because reducing consumption reduces demand
for capital and therefore has this effect as well.
In fact, Keynes went on to argue that capital accumulation and the accumulation of wealth
depends only on investment, not on saving it whatsoever, that investment can proceed
without prior saving because any increase in investment will increase spending, production
then will increase, the greater income from this greater production then will provide
In an article in January 1931, Keynes said,
This seems to be based on the mistaken analogy that because the decline in demand for one consumer good
lowers its price and profitability and thus the production of that good, that a decreased demand for all consumer goods would decrease prices and profitability for all goods across the economy.
But as classical economics has taught us, saving is invested. When people don't spend on consumer goods, those funds are provided for spending on capital goods.
And even if this is not the case and these funds are simply held in cash balances, what Keynes called hoarding,
Saving. This act would simply lower prices all around. Factor prices and prices of goods
would be lowered and profitability of production would be maintained as all prices dropped
roughly in proportion. This would then allow the same dollar amount of spending to buy
all goods since the prices of these goods would be lower. Orthodox Keynesians of course
dispute all this and claim that consumer saving will not be invested but hoarded and even
Even that portion that is invested, that is set aside for investment, will not be picked
up by entrepreneurs because their investment expenditure does not correlate to the amount
of saving.
And even if it does, that doesn't work in the long run or in the longer run because
it's volatile.
Moreover, they argue that prices are sticky downward, that they do not adjust downward
However, it was not losing the somewhat arcane debate about these propositions that ended
the orthodox Keynesian experiment, but the policy implications of their theory. Economic
activity and employment are determined by effective demand or spending, according to
this view. When private spending is deficient, as Keynes claimed was the normal condition
in the market, government should increase its spending and run a budget deficit to prevent
Stagflation and Unemployment. When private spending is excessive, if ever, government
should decrease spending and run a budget surplus to prevent price inflation. But clearly
effective demand cannot be both insufficient causing unemployment and excessive causing
price inflation at the same time. Unfortunately for the orthodox Keynesians, this is a rather
and their normal condition of a Keynesianized economy.
Paul Samuelson was the first to recognize this after the somewhat optimistic orthodox Keynesian views of the 30s and the 40s,
typified by Alvin Hansen who seemed to think that the government could simply run deficits right out to the point of full employment
with no price inflation and reach this utopian point.
As mild as they were, Samuelson was forced by these post-war inflationary recessions to embrace the Phillips curve trade-off in an attempt to salvage the orthodox Keynesian paradigm.
This is a rather puzzling thing for Samuelson to do, and I might even assert that if Samuelson had not picked up on the Phillips curve as a trade-off between inflation and unemployment,
that this theory would have sunk into oblivion.
It wasn't a widely held theory when Samuelson began to advance it,
and it was not very well empirically verified.
Samuelson did this, of course, because of the evidence facing him
that price inflation and unemployment can rise at the same time.
He recognized that this was a contradiction to his view,
and so he needed to give some sort of an explanation.
His explanation was that capitalism was actually even more wicked than Keynes thought.
Because his fiscal policy pushes the economy towards full employment,
something deep within the capitalist system causes prices to rise.
Sometimes it's labor unions, or sometimes it's monopolists,
or these other ad hoc types of explanations.
So, in post-Samuelson, the Orthodox Keynesians accepted this trade-off,
This limitation to their fiscal policy.
The heyday of the orthodox Keynesian vision and experiment, of course, was the 1960s,
an era of fiscal fine-tuning, with Walter Heller and his associates deftly pulling the
spending taxing levers, moving the economy artfully along the Phillips Curve trade-off
to the socially optimal point, near full employment with a minimum amount of price inflation.
Orthodox Keynesianism died with the advent of the severe inflationary recession of the
mid-1970s. It was no longer possible to deny the contradiction in the theory that rising
rates of inflation and unemployment simultaneously imply both increasing and decreasing demand
and require government budget to be both in deficit and surplus. Even Samuelson himself
could not save the paradigm by calling inflationary recession stagflation and blaming it on the
and the Arabs and big oil companies.
Orthodox Keynesianism died with its silence on the question,
what is the proper fiscal policy during stagflation?
When politicians ask their advisors what should be done,
the one unacceptable answer is, I don't know.
It's safe to say that this type of Keynesianized economy and its policy prescriptions
are not to be found anywhere in the world today.
Nowhere is a budget deficit seen as a powerful tool
government wields to control the dark forces of the market to balance unemployment with inflation.
Instead, it's a social problem to be solved, or it's a criterion to be met to join an economic trading block like EMU, or to receive international subsidies from the IMF.
No government today claims to use the deficit as a policy tool, and no one is predicting massive recession in the face of our current decline in the deficit.
Surplus is a word that's never even mentioned today, unless politicians utter it to refer to a small deficit or to some future event that they don't actually think will ever occur.
Far from ushering in the full employment utopia, the orthodox Keynesian experiment has left us with a specter of an out of control national debt and the possibility of default or hyperinflation.
Now, after a brief interlude in the late 1970s and early 1980s, the second Keynesian experiment began.
And not coincidentally, it coincided roughly with Alan Greenspan's ascendancy to the Chairman of the Board of Governors of the Federal Reserve.
So we might call this Greenspan Keynesianism, or more generally, Central Bank Keynesianism.
I'm even somewhat inclined to call this Wall Street Keynesianism.
This experiment is much more in tune with Keynes's own views.
Here the idea is to maximize economic wealth by capital accumulation.
The classical view in economics, the correct view picked up by the Austrians, is that the
free market gives the optimal amount of capital accumulation as given by consumers' preferences
to save and invest.
The credit markets and stock markets are efficient mechanisms by which these savings are channeled
into various capital projects. To the contrary, Keynes argued that because of precaution and
avarice, precaution is his term for saving, avarice for holding money, consumers hoard
funds instead of providing them for investment. It takes interest to bribe them to part with
without their liquidity, but interest retards investment, keeping capital artificially scarce
because the rate of interest is artificially high because it isn't determined by rational
calculation but by convention and speculation.
The policy of this view is to have the Federal Reserve engage in monetary inflation to expand
credit and lower interest rates.
So in this view, as Keynes put it, society's progress depends on a progressive policy of
Reducing the Rate of Interest by Central Bank Money and Credit Expansion
As I mentioned in his paper in 1926, the end of laissez-faire, this was one of Keynes's policy prescriptions,
deliberate control of the currency and credit by a central institution.
By 1933, Keynes had, quote, become convinced that the retention of the structure of private enterprise
is incompatible with that degree of material well-being to which our technical advancement entitles us.
Unless the rate of interest falls to a much lower figure than is likely to come about by natural forces operating on the old lines,
indeed the transformation of society, which I preferrably envision, may require a reduction in the rate of interest towards vanishing point within the next 30 years."
Such a policy, if possible, pushing the rate of interest to zero, would increase capital values towards infinity
and usher in the post-scarcity utopia that Keynes longed to see,
where everyone's reasonable economic needs were met
and their days were filled with leisure to pursue the higher mental states of contemplation, of beauty and friendship.
But as Mises taught us in 1912 and as we are about to learn again,
credit expansion by monetary inflation contains the seeds of its own destruction
and must end in stock market crashes, liquidations, bankruptcies, capital consumption and unemployment.
As the Fed creates new money and uses it to purchase securities from banks, it bids the prices of bonds up and thus interest rates down.
Banks have more funds to lend and entrepreneurs find more capital projects profitable at these lower rates.
Production of capital and durable consumer goods increases in response to the higher profitability and factors of production are reallocated across the production structure.
The boom that Keynes favored thus begins.
Let's begin. In 1931, in a series of lectures, Keynes, 1931 after the Depression had begun,
Keynes was still in support of the inflationary credit boom of the 1920s. And in speaking
of this investment boom, as he called it, from 25 to 29, he said, quote, a very few
more quinquennia of equal activity might indeed have brought us near to the economic El Dorado
where all our reasonable economic needs would be satisfied.
But instead, as Mises demonstrated, the boom must end in bust
because the newly created money cannot be confined to the credit markets
but will instead be spent again and again on consumer goods.
That is, when people receive the newly created money and income payments,
they will not put 100% of it back into the credit markets as the Fed initially did.
The reduction in funds in the credit market, coupled with price inflation,
push interest rates back up.
Capital values then collapse, stock markets crash and the boom comes to an end.
These financial reversals reveal the necessity of dismantling the buildup of the production structure during the boom.
Liquidation, bankruptcy, unemployment.
What can extend the boom and delay this day of reckoning is an increase in money demand.
That is, if someone, instead of spending this newly created money, holds it.
This would allow the interest rate-driven boom to proceed apace without consumer spending or price inflation reversing it.
And in such a case, we would see exactly what we see in today's economy.
We would see the overthrow, the reversal of the Phillips curve.
We would see an economy where unemployment and price inflation fall at the same time.
In our current boom, there are two sources of increased money demand.
One is simply due to our position in the business cycle.
Any time an economy comes out of a recession, inflationary expectations tend to be lowered,
and people in the recovery period tend to then go back to their normal economic activities,
and that includes a normal level of holding money.
The other source of increased money demand is due to our unique status as the world's reserve currency.
It's an increase in the foreign holdings of dollars, especially the stockpiling of dollar reserves by foreign central banks.
According to the recent figures from the IMF, central bank dollar reserves are $423 billion now,
which is about 60% of the total reserves of central banks of $762 billion.
In 1990, dollar reserves were only $50 billion in this total, now they're $60,
And for industrial countries, the percent of total reserves in dollar form rose from 44% to 91% to 56% today.
Whereas non-industrial countries' percentage stayed about the same.
In other words, these dollars are being held by industrial central banks.
Why they're doing this is obvious. Why any country does this is quite apparent.
Central banks stockpile these dollars to defend their domestic currencies in the case of devaluation.
In the most recent currency debacle, several Asian countries had pegged their currencies
to what was essentially the US dollar, which masked their excessive domestic inflation
and made sudden devaluation inevitable. In response, some of these countries began to
use their dollar reserves to buy up their domestic currencies and support their pegs.
To prevent them from disgorging these dollars and having them come home and ignite price
Tax Inflation here in the U.S. The U.S. as they did with Mexico in 1995 arranged bailouts.
More are planned. The IMF revealed plans for its 181 members to increase its capital base
by $285 billion, a 45% increase, for the express purpose of paying for these future bailouts.
The U.S. share of this increase is $14.5 billion, a 40% increase in our contribution.
The importance of maintaining these dollar reserves explains the recent hysterical attacks
on foreign currency speculators.
You may have read of the Prime Minister of Malaysia calling these speculators rogue speculators
and accusing them of wanting to destroy weak countries.
He even developed a conspiracy theory in which currency trading is a form of imperialism,
whereby developed countries put underdeveloped countries in their place.
And he concluded his tirade with, quote, I am saying that currency trading is unnecessary,
unproductive and immoral.
It should be stopped.
It should be made illegal, close quote.
Expect others to join in his chorus as the European Union tries to implement the euro,
which necessitates fixed exchange rates between each domestic currency and the euro
and thus fixed exchange rates among all the currencies in the EMU.
Without extreme discipline and precise policy convergence, currency speculators
will have a field day reaping profits while destroying the attempt to impose a single fiat paper money in Europe.
And it's not too difficult to predict what will happen in America if the Europeans are forced
and the support of their currency exchange rates to disgorge these dollars.
They'll come home. Price inflation will be reignited, interest rates will skyrocket and the boom will come to an end.
Keynes even recognized this international limitation to domestic credit expansion and since he was so wedded to this policy,
he proposed a single worldwide fiat paper money that he called the banker as a solution to this.
But clearly this will not bring about a more rapid and uninterrupted capital booms as Keynes desired but ever more severe crises and worldwide inflation and recession.
This is why Keynes went on to his third experiment.
This is what we might call a fully Keynesianized economy or the socialization of credit and equity markets.
And since I'm running out of time I'll briefly summarize this.
Keynes argued that stock markets, like credit markets, were inherently irrational,
that stock prices were based solely upon convention,
since the average investor has no knowledge whatsoever of the underlying realities of these capital values.
And the stock market then is a great black hole, we might say, in the economy that sucks money
away from capital projects into the stock market.
It also sucks the effort of professional entrepreneurs
since they now have to deal with the volatility of the stock market
instead of focusing their attentions and energies on their own capital projects.
Let me give you one quote here from Keynes about the stock market.
He's talking about average stock investor's knowledge being nil
of Stocks, and saying then that it must be based on arbitrary convention, which in turn is a product of the state of confidence, as he called it, of the mass of ignorant investors.
Stock markets just limit genuine capital accumulation by diverting funds and efforts into it and away from capital projects.
And they're also the source of the trade cycle, since investors have what he called a disobedient psychology.
and are subject to over-optimism and over-pessimism.
And so he concluded this way, he said, I expect to see the state,
which is in a position to calculate the rate of return on capital goods on long views
and on the basis of a general social advantage,
taking an ever greater responsibility for directly organizing investment
since it seems likely that the fluctuations in the market estimation
of the rate of return on different types of capital
will be too great to be offset by any practical changes in the rate of interest,
or as I mentioned before, what he called a somewhat comprehensive socialization of investment.
Now, I might remark then in closing that there's one more theoretical problem for Keynes
in suggesting that a fully Keynesianized economy should have a socialized stock market and bond market.
That's this, that if one doesn't go on to socialize the rest of the economy, then capital values will still be based upon consumer preferences, as David Gordon mentioned.
These capital projects that Keynes envisions the state engaging in will not have capital value either, since they get their capital value only by consumer demand.
What this necessitates, of course, is going on to socialize consumer demand as well.
And far from shrinking from this, Keynes actually advocates this in the general theory, where he says this disturbing conclusion that capitalism cannot accumulate capital sufficiently depends, of course, on the assumption that the propensity to consume and the rate of investment are not deliberately controlled in the social interest, but are left mainly to the influences of laissez-faire. He goes on then to say, the state will have to exercise a guiding influence on the propensity to consume, partly in its scheme of taxation, partly by fixing
and increasing the rate of interest and partly perhaps in other ways.
It's the other ways of course that scare me.
And surely there can be only one outcome to progressive socialization.
And this is progressive impoverishment. And just as surely it would be folly
for us to repeat the socialist experiments of the 20th century
under the guise of a Keynesianized economy. Thank you.