You read that correctly. Provided that the government supplies an inexhaustible well of capital – Keynes seems to assume that it can, but provides not the slightest reason why anybody else should believe it – borrowers should not have to pay interest and businesses should not have to pay dividends! Do you think I jest, or that I misrepresent Keynes?

[Our] aim (there being nothing in this which is unattainable) … [should be] an increase in the volume of capital until it ceases to be scarce, so that the [owner of savings] will no longer receive a bonus.

The … owner of capital [is] functionless … He can obtain interest because capital is scarce. But … there can be no intrinsic reason for the scarcity of capital [since government can always print and distribute more of it] … [Making capital freely available] may be the most sensible way of gradually getting rid of many of the objectionable features of capitalism. The rentier [that is, landlord or investor] would disappear … and [so would] the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital (TGT, p. 376, 221 and 376).

          Truly, Keynesianism is the economics of the magic wand and the magic pudding. Should the government ever reverse course and deliberately raise rates of interest? Of course not! Keynes thought it “extraordinary” that such a thing would ever enter anybody’s head (TGT, p. 322n). Instead,

The remedy for the boom is not a higher rate of interest, but a lower rate of interest! For that may enable the boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom (TGT, p. 322).

          The fear of the boom, said Keynes, led the U.S. Federal Reserve to raise the already-too-high rates of interest in the late 1920s. This led directly to the Great Depression. “I attribute the [economic] slump of 1930 primarily to the … effects … of dear money which preceded the stock market collapse [of 1929], and only secondarily to the [financial] collapse itself” (ATM, p. 176).

          Booms, says Keynes, should be embraced and not feared. To think otherwise is a “serious error” (TGT, p. 320-322). The problem with most booms is that businessmen succumb to “overoptimism” – and proceed, given the “excessively high rate of interest,” to make unprofitable investments (TGT, p. 322). But if “we” lower the rate of interest, then these same investments will earn a satisfactory rate of return. And since humanity is still poor, “we” should encourage rather than discourage investment. Because people will always make mistakes, there will always be some “misdirected investment;” but this “happens … even when there is no boom” (TGT, p. 321). To Keynes, the conclusion is self-evident: “we should avoid [high rates of interest] … as we would hell-fire.”(4)

          If at first you don’t succeed, Keynes urges, keep trying. In particular, if the government prints a great deal of new money and injects it into the banking system, then rates of interest should fall. But if they don’t fall far enough or quickly enough to the “optimum level” – namely zero – then the state must undertake “other measures” in order to boost investment (TGT, p. 164, 243). “Wealth-owners” whom the state has not yet completely displaced as lenders and who will likely find low rates “unacceptable” might be able to block them. If so, then “the State, which is in a position to calculate … on long views and on the basis of general social advantage … [will have to] directly organise investment” (TGT, p. 164).

          For now, national governments must take all necessary steps to suppress rates of interest and to maintain them at a suitably low level. Eventually, however, global institutions should undertake and co-ordinate this task. In particular, Keynes hoped that what has become known as the International Monetary Fund (he helped to establish it) would act as a global central bank. If given the power to print unlimited amounts of money and inject it into the global economic system, it could reduce interest rates around the world, maintain them at a very low level and create a worldwide quasi-boom (see, for example, Skidelsky, John Maynard Keynes, vol. 3, p. 227, 247, 255 and 302-303).

          Finally, we should pay our respects to the “army of heretics and cranks” (ATM, p. 193) who in earlier periods agitated for lower interest rates. In TGT (p. 340), Keynes openly acknowledged that he was refurbishing and updating “sixteenth and seventeenth century … [economic writers generally known as] Mercantilists.” This, to put it mildly, was ironic. Keynes’s teachers – and Keynes himself earlier in his career – correctly regarded Mercantilism as a “fallacy” that had “long since been exploded” (TGT, p. 334). But by the 1930s, Keynes saw an

element of scientific truth in Mercantilist doctrine, [especially in the Mercantilists’ view] that an unduly high rate of interest was the main obstacle to the growth of wealth [and in their] preoccupation … [to] increase … the quantity of money [in order to] diminish the rate of interest (TGT, p. 335, 341).(5)

          Throughout TGT, Keynes defines his terms ambiguously, contradictorily or not at all. When he asserts (p. 351) that “the rate of interest is not self-adjusting at a level best suited to the social advantage but constantly tends to rise too high,” he doesn’t tell us what the “social advantage” is, or what rate is most socially advantageous. About one thing he is, however, crystal clear: he doesn’t trust the price system.

          Perhaps because he doesn’t know it,(6) Keynes doesn’t tell us that rates of interest are prices, and that prices are vital signals to buyers and sellers, producer and consumers, and borrowers and lenders. All prices are ultimately interconnected; but rates of interest directly affect most prices. If rates become corrupted, then they emit misleading and false signals; even worse, bastardised rates rapidly spread misinformation throughout the economy. Intervention by governments in credit markets, like other attempts to countermand prices set in free markets with prices set by politicians and bureaucrats, has not – to put it mildly – achieved great success. If the Soviet Union collapsed because it did not allow prices to tell the economic truth, then Keynes’s maniacal desire to suppress rates of interest does not allow rates to tell the truth about borrowing and lending.

          Keynes says “that the world after several millennia of steady individual saving [sic] is so poor … is to be explained … by high rates of interest” (TGT, p. 242). Really? Are high rates truly the heart of the matter? Even Keynes admits that the safety of principal has always been an issue. In other words, historically rates have been high partly because it has not been safe to lend (TGT, p. 351). In most societies throughout history, property rights have been insecure; as a result, it has not been safe to own property, much less to lend it. The best way to safeguard property has often been to hide it. Why invest if somebody else may well steal its fruits? Throughout history, the most significant “somebody” threatening and stealing property has not been the common thief: it has been the Leviathan state.

          Keynes’s policy of creating new money in order to suppress rates of interest, and thereby to stimulate investment and economic activity, ultimately backfires. First, “the creation of new money by the central bank” and “inflation” are synonyms. Yes, inflation may well initially place downward pressure upon rates. The trouble is that as soon as somebody borrows the new money, he will spend it. And that spending – people who hold “old” money haven’t changed their behaviour – places upward pressure upon the prices of goods and services.

          What will happen to rates once prices begin to rise? Lenders will notice that the money returned to them at a loan’s conclusion will not buy as much as it did at the loan’s commencement. How do lenders protect themselves against the gradual destruction of their purchasing power? Either they will lend less or they will charge more per dollar lent. Either way, their reaction to inflation will place upward pressure upon rates of interest. Hence an unintended consequence of Keynesianism: policies which intend to reduce rates of interest eventually raise them. The Swedish economist Knut Wicksell (1851-1926) initially developed this point, and Ludwig von Mises (1881-1973), Friedrich von Hayek (1891-1991) and Murray Rothbard (1926-1995) extended and elaborated it. Nobody – neither Keynes nor any of his followers – has ever refuted it.

          Do the years since the 1990s, when inflation has raged but the Consumer Price Index and various Producer Price Indices have been quiescent, vindicate Keynes? In these years Keynesianism begat inflation, and inflation fomented bubbles and crashes. After the recession of the early 1980s, governments once again began to print money. Consumer prices rose, but the rise was mild relative to the 1970s. As a result (virtually everybody mistakenly thinks that “inflation” and “annualised percentage rise of the CPI” are synonyms), in the 1990s and beyond rates of interest did not rise as the pace of the government’s inflation accelerated; on the contrary, rates tended to fall. Given the rising inflation and absent the drag of rising rates or (except in the early 1990s and late 2000s) recession, economic conditions seemed to boom. Contrary to the 1970s, in recent years central banks have injected vast amounts of new money into the economy without triggering sharp rises of consumer prices or rates of interest. Many people have concluded that these developments vindicate Keynes.

          For two reasons, they don’t. First, a rise of consumer prices is one of several possible consequences of inflation. But high inflation need not cause a hefty rise of consumer and producer prices.(7) During some intervals (the 1920s was one, and the past two decades has been another) technological, logistical or other developments boost businesses’ productivity and reduce their costs. In the 1920s, electrification was the key development; in the 1990s, the advent of the Internet and the integration of the Chinese and ex-Soviet economies into the world economy (which placed sharp downward pressure upon the prices of raw materials and labour) were the triggers.

          All else equal, technological, logistical and other productivity-enhancing innovations place downward pressure upon prices. If prices should fall by (say) 3% per year (as they did in the latter half of the 19th century, another period of strong technological and logistical innovation) but actually rise by 3%, what’s happening? The answer is that the central bank is creating and injecting into the economy enough new money to raise prices (that is, reduce the currency’s purchasing power) by 6%. In short, technological and other developments can mask one of the possible consequences of the government’s policy of inflation.

          Secondly, the new money ginned by the central bank doesn’t flow solely into markets for consumer goods and services. Since the mid-1990s, and unlike the 1970s, the effects of governments’ inflation haven’t, by and large, appeared in workers’ pay packets and in supermarkets. Instead, during the past 20 years the new money has flowed disproportionately into stocks, bonds and real estate. To use the common (and imprecise) parlance, if the 1970s was a period of high “consumer price inflation” then “asset price inflation” has plagued more recent years.

          The problem is that inflation (whose consequences technological developments have masked) and rising prices of assets conspire to create asset price bubbles. What looks like a moderate CPI reassures lenders and thereby helps to restrain the rates of interest they charge. This, in turn, makes it easy for people to borrow ever greater sums in order to buy stocks, bonds and real estate. The demand for these assets created by the borrowed money puts upward pressure upon these assets’ prices; as their prices rise, lenders are increasingly willing to lend; and borrowers, observing the steadily rise of prices, are increasingly willing to borrow. Eventually, the new money channelled into these assets creates bubbles.

          Newly “printed” money, injected into the economy through the banking system by government, is inflation – properly defined and understood. But the river of inflation follows different courses during different eras. If the funny-money congregates in stocks, bonds and real estate, then bubbles inflate. Notice, then, that the boom that precedes the bust is not a creature of the free market; both are monsters created by government’s central bank. Mises, Keynes’s most systematic and devastating critic, put it this way:

The cyclical fluctuations of business are not an occurrence originating in the sphere of the unhampered market, but [are products] of government interference with business conditions designed to lower the rate of interest below the height at which the free market would have fixed it.(8)

          This means that, contra Keynes, artificially-low rates of interest will in the long run lead not to a quasi-permanent boom but to a cycle of boom and bust (although the path of bust may lead either through “consumer price inflation” or “asset price inflation”).

          Mises exposed many of Keynes’s other misconceptions about interest. Perhaps most notably, it’s downright Orwellian to refer to newly-printed government money as savings. Money created ex nihilo by the government isn’t savings; indeed, this funny-money destroys savings. Whatever the merits or demerits of the monetary printing press, or its electronic equivalent, it isn’t and it doesn’t produce savings. The word “savings” describes income that has been earned but not consumed; rather, it’s set aside for investment or a rainy day.

          It takes much self-control to save, but the government requires absolutely no self-discipline to inflate. Quite the opposite: inflation is the indicator par excellence of governments’ profligacy. Nor should anybody imagine that, as Keynes insisted, the government’s newly-created money will augment or “top off” traditional savings. Instead, the inflation will ultimately erode the purchasing power of real savings and thus injure the saver (especially the saver of modest means).

          In the wake of the bursting of the Dot Com Bubble, the Federal Reserve (headed by Alan Greenspan) slashed the federal funds rate to 1%; and in the wake of the Panic of 2007, the Fed (headed by Ben Bernanke) slashed it to 0.25%. Keynes advocated something much more extreme: nominal rates of interest at 0%. Yet he seemed utterly oblivious to the fact that if the borrower can borrow money for free, then the lender must logically regard the money as valueless. If so, then why would the lender want the borrower to return the money, and why should the lender care if the borrower doesn’t? Mises explained how utterly nonsensical this is:

There cannot be any question of abolishing interest by any institutions, laws or devices of bank manipulation [such as the government injecting new money into the economy through commercial banks]. He who wants to “abolish” interest will have to induce people to value an apple available in a hundred years [at a price that is] no less than a present apple (Human Action, p. 529).

          Can the Keynesian program of creating vast amounts of money and suppressing rates of interest abolish scarcity? Consider two views about the causes of poverty:

1. Billions of people live in poverty because food, clothing, shelter and amenities are scarce (and hence expensive for the poor). In order to help the poor escape poverty, all of us must live within our means, save and invest. Only by these means can more and better goods and services be produced more cheaply, so that the poor can better afford them and thereby raise their standard of living.

2. The problem isn’t that goods and services are scarce: it’s that money is scarce. Government should therefore create so much new money that everybody has enough of it.

          Clearly, view #2 is fallacious. It hasn’t worked in the past (if it had, there would be no poverty today) and there’s no reason to believe that it will in the future. Even if the central bank gave $1 million of new money per year to every poor person, it would avail the poor nothing: there would be much more money in the world, but no more food, shelter, clothing, etc. The torrent of new money would simply place tremendous upward pressure upon prices. People who were poor on $10,000 per year would therefore be poor on $1 million per year – and, it’s vital to add, people who hitherto weren’t poor on $150,000 per year would now be destitute. Inflation, in other words, doesn’t alleviate poverty: it creates it. Ask the middle-class Germans of the 1920s, Argentines of the 1970s or Zimbabweans of today.

          Consider now a third alternative:

3. The problem isn’t that goods are scarce: it’s that lendable funds are scarce. If the government provided unlimited funds to borrowers, they could use those funds to build new factories and businesses, and within a generation nothing would be scarce.

          This is Keynes’s view,(9) and it’s just as fallacious as #2 (to which it is closely related). Printing money and lending it to people will have exactly the same result as printing money and giving it to people. Either it will make existing goods and services cost more, or it will make assets cost more. Both will cause rather than resolve problems.

 

1. See in particular Roger Garrison, “Is Milton Friedman a Keynesian?” in Mark Skousen, ed., Dissent on Keynes: A Critical Appraisal of Keynesian Economics (Praeger Publishers, 1992).
2. John Maynard Keynes, Collected Writings, vol. 20, Activities 1929-31: Rethinking Employment and Unemployment Policies (London, Macmillan, 1981), p. 273.
3. John Maynard Keynes, Collected Writings, vol. 6, A Treatise on Money (London, Macmillan, 1971), p. 339. (Hereafter referred to as “ATM”).
4. Robert Skidelsky, John Maynard Keynes, vol. 3, Fighting for Britain: 1937-1946 (London, Macmillan 2000), p. 281.
5. Lest anyone think that Paul Krugman of Princeton University is a real economist (instead of a Keynesian political operative), read his blog (entitled “The Conscience of a Liberal”) which appears on the web site of The New York Times. In his post of 17 March 2010 (“How Much Of The World Is In a Liquidity Trap?”) he states: "As I’ve written many times in various contexts since the crisis began, being in a liquidity trap reverses many of the usual rules of economic policy. Virtue becomes vice: attempts to save more actually make us poorer, in both the short and the long run. Prudence becomes folly: a stern determination to balance budgets and avoid any risk of inflation is the road to disaster. Mercantilism works: countries that subsidize exports and restrict imports actually do gain at their trading partners’ expense. For the moment – or more likely for the next several years – we’re living in a world in which none of what you learned in Econ 101 applies [italics added].”
6. In an unfettered market (i. e., in the absence of a central bank), interest responds to the laws of supply and demand. In a free market, in other words, interest smoothly co-ordinates the actions of borrowers and lenders. Alas, Keynes and his followers indignantly reject the very possibility that interest might co-ordinate the activities of borrowers and lenders. They therefore deny that interest can equilibrate the desire for jam today versus more jam in the future. Keynes said “classical economists” (a phrase he used mischievously to tar most of the economists who preceded him) “are fallaciously supposing that there is a nexus which unites decisions to abstain from current consumption with decisions to provide for future consumption” (TGT, p. 266). This rejection has fundamental implications. As Roger Garrison ("Ditch the Keynesians: Why Policy-Infected Rates Must Go," Barron’s, 2 September 2002) put it, “Keynes’s verdict of ‘no nexus’ left interest rates up for grabs. And if they weren’t doing [any useful job], maybe they could be used for macro-management.”
7. An increase in the prices of consumer goods and services as measured by the CPI is not a definition or synonym of inflation: it is one of several possible consequences of inflation. Others include bubbles in stock, bond and real estate markets, rising interest rates and (in extreme cases) collapses of the currency. Inflation, as British classical school and Austrian School economists define it, is (stripped to its essentials) an increase in the supply of money not backed by a corresponding demand for money (i. e., savings). In an age of fiat money (that is, money whose definition is decreed by government rather than agreed in a free market, and whose regulation the state monopolises), only one entity can create inflation. No person or business or other private organisation (such as a trade union) can inflate the supply of money: only the central bank (using commercial banks as its agent) can. Ludwig von Mises introduced this insight in The Theory of Money and Credit (1912), and extended and elaborated it in Human Action (1949).
8. Ludwig von Mises, Human Action: A Treatise on Economics (Fox & Wilkes, 1966), p. 562.
9. And Keynes was merely the latest in a line (the first was John Law’s Money and Trade Considered: With a Proposal for Supplying the Nation with Money, Edinburgh, 1705) of writers who attempted to give a veneer of respectability to the always-fallacious and perpetually-popular idea that the growth of the quantity of money in circulation stimulates economic activity. Law attributed Scotland’s poverty to the “reduced” money supply and thus carries mercantilist ideas to their logical conclusion. In his own words: “The quantity of money in a state must be adjusted to the number of its inhabitants … One million [pounds sterling] can create employment for only a limited number of persons … A larger amount of money can create employment for more people than a smaller amount, and each reduction in the money supply lowers the employment level to some extent.”