The View From 1776
Monday, January 05, 2009
Keynes’s Wrong-Turn Hypothesis
As Keynes observed, people often unknowingly are the prisoners of erroneous doctrine propounded by long dead theoreticians, in this case doctrine of Keynes himself.
I have noted before that Wall Street Journal news reporters often display pervasive, sometimes subtle, liberal-progressive-socialist biases. Unlike the Journal’s editorial board writers, among other things, they still parrot the nonsense popularized by economist John Maynard Keynes during the 1930s Depression.
Since Keynesian economics is the reigning school of thought in socialistic academia, it’s no surprise that Keynesian nostrums are repeated, without evaluation, by today’s reporters.
One example is in the Journal article titled The Doomsayers Who Got It Right.
The Journal reporter writes:
Those who saw the crisis coming, on the other hand, fret that U.S. government spending on bailouts and stimulus plans that preserve failed business models could increase the likelihood of a worse calamity later.
They foresee a long season in which consumers cut their spending, and instead sharply increase the savings rate. That would be healthy for savings-anemic U.S. households, which have spent beyond their means for years, but deeply problematic for a country where consumers drive 70% of all economic activity.
The matter of concern is the statement that increased personal savings would be “deeply problematic for a country where consumers drive 70% of all economic activity.”
Keynes asserted that the root cause of our Depression was excess savings. His thesis was that savings take money out of circulation, thereby reducing consumption and putting ever greater downward pressure on business activity and job creation. The appropriate remedy, in Keynesian doctrine, is endlessly expanded government deficit spending.
This same thesis, needless to say, is widely advocated by Democrat/Socialist and liberal Republican politicians, by Wall Street operatives, and by liberal-progressive-socialist economists. News reporters and commentators, in the main, go along for the ride.
So, what is wrong with the Journal reporter’s statement?
First, is assumes that money placed by individuals in savings accounts will no longer be available in the flow of economic activity, that it will, in effect, be buried in the back yard or under a mattress.
What really happens is that savings, through one channel or another, end up as increased deposit balances on lenders’ balance sheets. Several beneficial effects arise from this.
One is that banks and other financial intermediaries have increased and more stable lendable funds. Consumers with higher savings are more creditworthy and will find it easier to obtain bank loans. Ask yourself why former investment bank titans Goldman Sachs and Morgan Stanley opted to become commercial bank holding companies and compete to get stable bank deposits.
Government stimulus programs, in contrast, produce temporary and therefore unreliable bursts of increased bank deposits, leaving lenders wary of significant increases in lending activity.
Another benefit is that, with balance sheets strengthened by stable savings deposits, financial institutions are less dependent upon Federal largesse and less likely to become ensnared in European-style regulatory management of lending and investment policy. Innovative new businesses and existing small businesses, which create disproportionately more new jobs, will gain additional financial support.
In contrast, as the price of bailout funds government is nudging banks into lending to keep Detroit’s Big Three automakers and the UAW union afloat, and to compel higher investments in the least profitable of auto products: hybrid or battery-driven “green” cars.
The second major problem with the erroneous Keynesian doctrine expressed in the Journal news story is that consumption does not in fact drive the economy. The wages and profits, from which come consumer spending and saving, cannot exist without the long chain of business expenditures for investment in new equipment, new process, and for payments to materials suppliers and workers.
Consumption expenditures are just one of the by-products of business expenditures. Business expenditures are the real drivers of the economy.
Business expenditures for new investment and for production of basic, intermediate, and consumer goods are as large as, generally larger than, consumer expenditures.
The exception is a period like our recent one, in which government deficit spending leads to excessive fiat money creation by the Fed. That impels an unsupportable increase in borrowing, as the value of the dollar declines. Consumer borrowing in this circumstance, as we have witnessed over the last 15 to 20 years, leads to negative savings. Consumer spending was increasingly floated on credit-card and home-equity-loan borrowing. Spending more than we produce does not make a healthy economy. It just booms imports.
Government stimulus programs may be welcomed by businesses and consumers in the vain hope that they will provide relief from a recession. But we know from unvarying experience, beginning here with the Roosevelt New Deal, that government stimulus spending never ends a recession. In fact such spending tends to prolong and to worsen a recession.
One reason for the failure of stimulus programs is that consumers, already fearful of losing jobs, tend to use stimulus payments to reduce debt and to increase savings. Very little of it goes to added consumption goods spending. President Bush’s stimulus program early in 2008 was a flop. President-elect Obama’s will end the same way.
Another and more fundamental reason is that business does not like uncertainty. When the Federal government begins tinkering with the economy, as it did in the Depression and as it is doing now, it creates new layers of bureaucracy to administer new and more restrictive business regulation. Government typically increases business taxes at the same time, while mandating costly new business methods (think of the looming presence of president-elect Obama’s Carol Browner and other other Al Gore environmentalists).
In such times of high costs, low profits, and prospective government experimentation and regimentation, prudent businessmen hesitate to increase production or to make new production investments. And without production increases there will be no increased payments to suppliers and workers and therefore no wage increases or added jobs.
Government stimulus spending financed with more debt adds to inflationary pressures. This is what occurred in the 1970s stagflation. During a high inflation period, which almost certainly will hit us within the next couple of years, people’s nominal incomes increase, but their costs of living rise even faster. Worse, as their nominal income rises, they are pushed up into higher tax brackets.
The final injury of the fiction that consumer spending drives the economy is that the government pays for its ineffective, indeed counterproductive, stimulus programs by stealing consumers’ lifetime savings. By the mid-1980s, when the 1970s stagflation was finally halted by Paul Volcker, the real purchasing power of consumers’ lifetime savings was less than half what it had been before President Johnson’s Great Society welfare-state entitlements set in motion our destructive 1970s inflation.