by Chris Leithner*
return of Keynesianism (Print Version)
Le Québécois Libre, May
15, 2010, No 278.
If an individual, family or business has long lived for the day and
disregarded the morrow, spending more than it earns, buying what it
doesn’t need and can’t afford, making foolish and reckless “investments”
(which are actually consumption) and borrowing more than it can repay,
then it must eventually face a reckoning. When that day arrives, what
must it do? Few people would prescribe more of the same: that’d be like
taking an alcoholic on a pub crawl. Most would agree that a profligate
family or business must ultimately mend its ways. Whether it likes it or
not, it must live within its means.
Mainstream economists would likely agree – but also hasten to add that
societies are another matter altogether. If a spendthrift family or
business tightens its financial belt, then that’s good. But if everybody
suddenly does so, they allege, that’s bad. In July 2008, for example –
just after the “Global Financial Crisis” claimed Bear Stearns as its
first major victim, and shortly before it would take Lehman Bros. as its
biggest scalp to date – Peter Bernstein warned that “a mass effort by
American consumers to save [as little as] 3.9% of their after-tax
incomes would be a disaster for the world economy.”
President George W. Bush seemed to agree. During a news conference on 20
December 2006, by which time it had become clear that air was rapidly
leaking from the housing bubble, he urged Americans to “go shopping
more.” Why? Because, he seemed to say, spending drives the economy and
the more of it the better.
Most economists concur: the more people spend, the wealthier their
society becomes. Conversely, if aggregate expenditure decreases then a
downward spiral ensues; and because (they say) a market economy doesn’t
and cannot self-correct, the tailspin will continue until the government
intervenes and spends on everybody’s behalf. Once this happens, they
assure us, the free-fall ceases, economic conditions stabilise and
everybody can once again borrow, spend and grow rich.
Hence the annoyed response of President Bush, in an interview with
The Washington Times on 12 January 2009, to the miniscule band who
criticised his endless borrowing, spending, intervening and warmongering.
Like Colonel William Calley at My Lai, who destroyed a village in order
to “save” it and massacred ca. 350-500 women, children and elderly
people in order to “protect” them from the Viet Cong, President Bush
said “I’ve abandoned free market principles to save the free market
system … You can sit there and say to yourself ‘well, I’m going to stick
to principle and hope for the best, or I’m going to take the actions
necessary to prevent the worst.’” At times of crisis, he seemed to say,
free market principle must yield to interventionist pragmatism.
Why did Bush believe that this course of action was necessary? Why would
it prevent the worst? How could he be sure that his policies would not
actually make a bad situation even worse? Bush told his interviewer that
he relied upon the advice of Henry Paulson (the Secretary of the
Treasury) and Ben Bernanke (the Chairman of the Board of Governors of
the Federal Reserve System). Paulson’s and Bernanke’s advice, in turn,
faithfully reflected the prejudices of John Maynard Keynes (1st Baron
Keynes of Tilton, CB, 1883-1946).
The 20th century’s most influential economist
Gregory Mankiw, an economist at Harvard University, a former chair of
Bush’s Council of Economic Advisors and the author of one of the world’s
best-selling undergraduate textbooks, told The New York Times (30
November 2008) that
If you [are] going to turn to only one economist to understand
the problems facing the economy, there is little doubt that the
economist would be John Maynard Keynes. Although Keynes died more
than a half-century ago, his diagnosis of recessions and depressions
remains the foundation of modern macroeconomics.
Lord Keynes was undoubtedly the 20th century’s most influential
economist. Today’s academic literature comprises thousands of books and
tens of thousands of articles that, directly or indirectly, extol his
ideas. His principal work, The General Theory of Employment, Interest
and Money (1936, hereafter TGT), is probably the most
influential economics book of the 20th century. It occupies the 43rd
rung on the “List of the 100 Best Non-Fiction Books of the Twentieth
Century” compiled in 2004 by The National Review; and Martin
Seymour-Smith places it 88th in The 100 Most Influential Books Ever
Written: The History of Thought from Ancient Times to Today (Citadel
Press, 1998). The only other work of modern economics that graced this
latter list, An Enquiry Into the Nature and Causes of the Wealth of
Nations (1776) by Adam Smith, ranked 58th. Even Milton Friedman, who
claimed that he was a fierce critic of Keynes, was in most fundamental
respects an orthodox Keynesian.
Paul Samuelson, Keynes’s most influential American advocate, recalled
is badly written [and poorly organised]; any layman who, beguiled
by the author’s previous reputation, bought the book was cheated of
his five shillings. It is not well suited for classroom use. It is
arrogant, bad-tempered, polemical, and not overly-generous in its
acknowledgements. In it the Keynesian system stands out indistinctly,
as if the author were hardly aware of its existence or cognisant of
its properties; and certainly he is at his worst when expounding on
its relations to its predecessors. Flashes of insight and intuition
intersperse tedious algebra. An awkward definition gives way to an
unforgettable cadenza. When it is finally mastered, we find its
analysis to be obvious and at the same time new. In short, it is the
work of genius.
A few of Keynes’ contemporaries viewed him and TGT in a very
different light. To them, Keynes was the consummate politician-economist
who craved and acquired fame and fortune by elevating politicians and
officials to the pinnacle of economic and financial significance. Keynes
exalted the political class as the guardian of employment, growth and
prosperity. He also imputed to it great civic virtue, and blessed it to
do what it does best: favour particular producers, oppress most
consumers and all taxpayers, debase the currency and foment war at home
Keynes cloaked the old – and repeatedly refuted – doctrine that
consumption and inflation beget prosperity in the new and pseudo-sophisticated
garb of mathematical economics. He also purported to discover something
that John Law (1679-1721) first claimed – namely that there exists a
source of allegedly unlimited funds that is outside and above the
process of saving, investment and production, and which is ever-ready to
serve government officials: the government-owned central bank. Echoing
Samuel Johnson’s famous quip, Henry Hazlitt’s line-by-line and equation-by-equation
refutation of TGT, entitled The Failure of the “New Economics”
– An Analysis of Keynesian Fallacies (Van Nostrand, 1959), concluded
“I have been unable to find in it a single important doctrine that is
both true and original. What is original in the book is not true; and
what is true is not original. In fact, even much that is fallacious in
the book is not original, but can be found in a score of previous
Back in fashion
Despite Hazlitt’s thorough demolition of its foundation (see also W. H.
Hutt, The Keynesian Episode: A Reassessment, Liberty Classics,
1979), after three-quarters of a century the superstructure of
Keynesianism continues to reign supreme within government. Indeed, the
Global Financial Crisis has greatly boosted both its prominence and its
reputation. As The Australian Literary Review (3 February 2010)
put it, “it’s hard to think of [an economist other than Keynes] whose
thoughts were so embraced, then rejected, only to be endorsed again.”
In Australia, the Prime Minister (Kevin Rudd) and Treasuer (Wayne Swan)
presented to the Treasury Secretary (Ken Henry) a copy of TGT –
inscribed with their thanks for his faithfully Keynesian response to the
GFC. In most countries during the past several years, politicians and
their advisors, whether of the “left” or the “right,” have fervently
espoused the doctrine that governments must spend their way into massive
deficits (because they “stimulate the economy”) and thereby spend their
way out of recessions. They insist that consumption – whether by
individuals, businesses or the state – causes employment and growth.
Because consumption allegedly begets prosperity, more borrowing and
spending and bigger government is (if they claim they’re “conservative”
they sometimes add the caveat “for the time being”) best.
Yet when we actually read (rather than merely extol) TGT, we find
much that’s puzzling (to put it politely) and even more that’s absurd
(to put it bluntly). A terrific book by Hunter Lewis (Where Keynes
Went Wrong – And Why World Governments Keep Creating Inflation, Bubbles
and Busts, Axios, 2009) helps the general reader to navigate his way
through Keynes’s madness. For example, Keynes said – without any
reasoning, citation or evidence of any kind – that as a rule people save
too much. How to resolve this alleged problem? Through its central bank,
the state should print vast quantities of new money. This newly-minted
money doesn’t just constitute savings: it is “just as genuine as any
other savings” (TGT, p. 82-83).
But conjuring money out of thin air doesn’t sound like saving. Even if
we grant that it is, why aren’t countries like Zimbabwe and Serbia –
which during the past two decades have printed more new money than any
other – awash in savings? More generally, why will a tsunami of new
“savings” alleviate the alleged problem – namely that people already
save too much?
Keynes also famously asserted (TGT, p. 129)
If the Treasury were to fill old bottles with banknotes, bury
them at suitable depths in disused coal mines which are then filled
up to the surface with town rubbish, and leave it to private
enterprise on well-tried principles of laissez-faire to dig the
notes up again (the right to do so being obtained, of course by
tendering for leases of the note-bearing territory), there need be
no more unemployment and with the help of the repercussions, the
real income of the community, and its capital wealth also, would
probably become a good deal greater than it actually is.
But if we can become wealthy simply by collecting boulders, moving
them from A to B and then from B back to A, then why do Bangladesh and
Haiti remain wretchedly poor? What’s most startling, when one actually
reads TGT, is that Keynes offers absolutely no support – whether
logical or empirical – for his manifold claims. He advances many bald
assertions and intuitive hunches; numerous aristocratic witticisms and
much withering sarcasm drip from his tongue; but simply absent are
closely-reasoned chains of logic and reams of corroborating evidence.
When the world’s governments reacted to the Global Financial Crisis by
launching immense economic experiments along Keynesian lines, most
people assumed that these trials were actually tried-and-true policies
and that somebody had long ago demonstrated that they made theoretical
and factual sense. Yet the stark reality remains: a garb of arcane
mathematics obscures the fact that Keynesianism is a ramshackle grab-bag
of interventionist intuitions and prejudices.
What Keynes Said: Suppress Rates of Interest
Without the intervention of government, Keynes asserted, rates of
interest will almost always be too high. “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 said on p. 351 of TGT.
More generally, “rates … have been [too high for] the greater part of
recorded history.” This is why humanity remains mired in poverty.
“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). “High … rates of interest are the outstanding evil, the prime
impediment to the growth of wealth [they discourage borrowing and thus
investment]” (TGT, p. 351).
Never mind that Keynes doesn’t bother to substantiate his claim that
rates have historically been too high. Apparently, it’s self-evident.
The important point, he insists, is that there’s no good reason why
rates should have been so high throughout human history, or why they
should remain so high now. Why do interest rates tend to be higher than
they should be? Keynes beats around the bush. It seems, however, that
- people “hoard” their money out of fear. This creates a shortage
of lendable funds and thus places upward pressure upon rates (TGT,
p. 174, 351).
- it is expensive to “bring … borrowers and lenders together.”
This cost also boosts rates (TGT, p. 208, 309).
- there may be a “wide gap between the ideas of borrowers and
those of lenders;” as a result, “wealth-owners” simply do not
accept lower rates (TGT, p. 309).
What, then, to do? It’s clear to Keynes that the state can and should
reduce rates of interest to a more reasonable level. Specifically, if
“wealth-owners” withhold their funds from the loan market, or refuse to
accept reasonable rates, then the government should reduce rates by
increasing the quantity of lendable funds (TGT, pp. 167-168,
197-199, 268 and 298). How to do this? By printing new money which the
central bank makes available to commercial banks, and which the
commercial banks then lend to individuals and businesses (ATM, chap. 2).
The greater the quantity of money, the more money will be available to
borrowers and the lower the cost of borrowing. “A change in the quantity
of money … is … within the power of most governments … The quantity of
money … in conjunction with [lenders’ willingness to lend] determines
the actual rate of interest” (TGT, pp. 167-168, 267-268). The
greater the quantity of money the government creates, Keynes seems to
imply, the lower the resulting rate of interest, the greater the
incidence of lending and borrowing and the higher the resultant level of
According to Keynes, general fears of government intervention and
specific fears about a government-engineered increase in the amount of
money circulating in the economy are ill-founded. He emphasises that the
new money that the government has printed and injected into the banking
system is “just as genuine as any other savings” (TGT, pp.
82-83). Further, since “there is no special virtue in the pre-existing [high]
rate of interest … [there can be no] evil [in bringing it down by
government intervention]” (TGT, p. 328). Indeed, if the
government reduces rates of interest, then its ultimate target level for
these rates should be zero. “I should guess that a properly run
community … ought to be able to bring down the … [general rate of
business profits and rate of interest] approximately to zero within a
single generation” (TGT, p. 220).
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
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,
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.”
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).
Why Keynes Is Wrong
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, 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. 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.
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
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).
Can we abolish scarcity with new money?
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, 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
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
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
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.”
Leithner grew up in Canada. He is director of Leithner & Co.
Pty. Ltd., a private investment company based in Brisbane,