Bloody hell, what a bonkers week it’s been. Until this weekend, I’ve literally had no time to do anything this week other than go to work, come home, eat, and sleep- other than a rather enjoyable concert a few days ago, on which more later.

I’ve also had very little time to keep up my usual reading. However, an interesting bit of work by Gonzalo Lira caught my eye recently, in which he smacked around yet another vulgar Keynesian:

This thinking reveals the key blindness of Yglesias and other
Keynesians: They completely misunderstand the economic moment the world
is living in—and are thus oblivious to the rationale and the
consequences of the policy decisions that have been taken up to now.

Let me take a step back and explain.

The reason that the global economy is in the sorry state that it’s in
today is because of overindebtedness that has grown like a cancer since
1987. That year, in response to the ’87 Crash, Alan Greespan instituted
the famed “Greenspan Put” of low-interest rates to prop up the economy
during every downturn.

Disaster in slow motion: The Greenspan Put palliated the periodic
recessions and financial shocks during the period from 1988 through
2005—but in exchange, it created an environment where the markets all
expected low interest rates whenever anything dipped. This low-interest
rate expectation had the dual effect of making people go into even more
debt (since it was so cheap and was guaranteed to remain cheap), and of
asset inflation (since returns on investment were realigned to the
low-interest rate environment). In other words, assets—like houses and
equities—bubbled, while people took on more and more debt that they
would eventually not be able to service.

Good times for the Nineties and half of the Oughts, but it was bound to
end in tears—as it eventually did: By 2006, borrowers got to the point
where they couldn’t service their debts. So they started selling their
assets (or losing them to foreclosure, in the case of housing), and
shuttering businesses, which created huge unemployment. Falling asset
prices and mounting unemployment—which meant less consumption—led to the
very edge of a deflationary spiral.

This cliff-edge of deflation is what led to two key policies: The
Federal government went into massive debt in order to finance massive
spending, including the Obama stimulus package and the military budget,
all carried out to prop up the GDP. And the Federal Reserve essentially
went into money printing by way of the euphemism “Quantitative Easing”,
while carrying out the literally unprecedented Zero Interest Rate Policy
(ZIRP), done in order to make the massive spending programs possible,
while supposedly encouraging more borrowing by consumers and businesses.  

GL is absolutely correct in almost every regard, and his post serves as a very good introduction to the reasons why Keynesian economics is simply unworkable. His arguments do, however, need some addition and expansion.

Let’s go to the very roots of Keynesian thinking. Lord Keynes was, and remains, one of the most important intellectual figures of the 20th, or any, Century, and with good reason. His analysis of the likely effects of the Treaty of Versailles was brilliant, and did much to cement his reputation as an outstanding economist. His subsequent publications demonstrated that he was a man of keen intellect and exceptional rhetorical skill. Unfortunately, during the Great Depression, he published his seminal work, The General Theory of Employment, Interest, and Money in 1936, and forever changed economics for the worse.

There is a lot of debate as to whether Keynes actually meant anything he wrote in that book- he was famous for being slippery as an eel when it came to pinning down his actual views on any given subject in economics. What is indisputable, however, is that Keynes considered the laissez-faire microeconomic analysis of the time to be a sort of “special case” of a more general framework of economics, one that only worked in a world in which wages and prices were free to move about. Keynes wanted to unify the various schools of economics at the time- Marshallian, Austrian, Manchester, London, etc.- into a single “general theory”, in much the same way that Einstein did with his Special and then General Theory of Relativity.

He did not succeed. Unfortunately for the rest of humanity, what he did succeed in doing was to give politicians and free spenders exactly the kind of credentialed, academically verified ammunition that they needed to ram all manner of big-government stupidity down our throats.

The core of Keynesian thinking can be summarised, in layman’s terms at least, as follows:

1. Wages and prices are “sticky”, in that they do not immediately re-adjust themselves quickly, and in such cases government can and should step in to help them adjust
2. For simplicity’s sake, the economy can be considered as a series of “aggregates”, and various modes of consumption are separable into these aggregate categories
3. Investment and saving must by definition be equal to each other “in the long run” (a particularly perfidious notion because no Keynesian has ever really defined what he means by “the long run”, and which completely ignores the undeniably important role of debt and credit in the economy)
4. The appropriate response to a recession is to lower the rate of interest and/or increase government spending, in order to help wages and prices readjust (Keynes was never very clear, at least in his original work, on whether it was monetary or fiscal policy that was more important)
5. By reducing all of the most complex components of an economy to a set of simplified variables, and stripping out all of the “exogeneous variables” (i.e. stuff that governments can’t control), an economy can be managed and fine-tuned at the whim of any economist.

Every single one of these ideas is demonstrably based on bad logic, bad thinking, and bad evidence. Perhaps the most thorough demolition job ever conducted on Keynes’s “masterpiece” was Henry Hazlitt’s outstanding work, The Failure of the New Economics. Hazlitt read through the entirety of Keynes’s General Theory, and in a book that was less than half the length, reduced the entire grand unified theory of Keynesian economics into a gibbering, pathetic wreck. It’s a great read, and I highly recommend it to anyone who wants to truly understand what is wrong with the profession of economics today.

There are two serious core problems with Keynesian economics.

First, Keynesian thinking seeks to do away with the concept of opportunity cost– also known as scarcity. This is the single most important concept in economics. The idea is logically sound and absolutely empirically true: we have nearly unlimited wants and needs, and only limited resources with which we can address them. Without this concept, there would not even be any need for economics. If we all lived in the Star Trek universe, where universal replicator machines are freely available and can construct anything we want from the very carbon and helium atoms that surround us, then concepts like “money” and “trade” and “saving” would be completely irrelevant. That, however, is not the universe we live in. By trying to get rid of opportunity cost- the cost that comes with the decisions that you make every day regarding how you will spend your finite time and finite resources- Keynesians try to live in a fantasy world in which money and credit are endlessly available, inflation is a Good Thing, and economies can be regulated without thought of consequences.

Second, Keynesians try to lump everything into “aggregates”, without for one moment stopping to think about those aggregates themselves. Keynesians try to separate production and consumption, without bothering to realise that producers are consumers and consumers are producers. Think about it. When you go to the grocer’s to buy vegetables, you aren’t giving him money in return for his product. You are trading your own skills, time, and product for his skills, time, and product. Whatever you do for a living produces something of value to someone else- just as he does by selling you vegetables and milk. The money that you give him in return for those items is just the medium of exchange, nothing more. It holds no intrinsic value in and of itself unless you have done something to earn it. There is no point in trying to arbitrarily separate production and consumption.

These two basic and very severe failures of logic and evidence are what allow Keynesians to construct beautifully tortured mathematical equations that make perfect sense in an abstract world of algebraic constructs and multi-dimensional derivatives- and absolutely zero sense in the real world. I should know. I used to study this stuff. I’m still pretty decent with abstract mathematics, which I loved studying in university and which helped me get to where I am today. Economics is not about mathematics, it is a study of human action in the face of incentives. The basic concepts of economics are, as always, scarcity and production- the incentives that each of us face every day.

It is because of these failures to understand the concepts of scarcity and production that Keynesians advocate inflation in response to a deflationary spiral, without for one moment recognising that it was inflation that created the spiral in the first place, and that the deflation is absolutely necessary to cleanse the system of all of the poor decisions, wasted resources, and malinvestments that created the original problem. It is because Keynesians do not understand the basic mechanisms of the market that they delude themselves that any group of technocrats can possibly manage millions of people making thousands of economic decisions every single day. No computer on Earth is powerful enough to model chaotic and unpredictable human interactions the way Keynesians would like, and none ever will be- because humans do not follow neat mathematical models.

All of which leads back to GL’s strongly worded, and entirely appropriate, criticism of Brad Yglesias’s particular brand of stupidity. Yglesias, like Krugman, Brad DeLong, and Lord only knows how many other misguided vulgar Keynesians, argues that the path back to prosperity is more of the same things that got us INTO this mess. That their ideas have been proven wrong time and again, throughout 40 centuries of wage and price controls and inflation followed by catastrophic depression, completely escapes them because they remain utterly ignorant of economic history. Keynesians succeeded in rewriting the narrative of the Great Depression as some sort of great victory for government action, when in reality, the reason that the Depression endured as long as it did was because of government action.

The appropriate thing for governments to do in the face of a massive recession is precisely 100% of nothing. Government bureaucrats cannot manage the economy any better than you or I can. They have not the clairvoyance to see what will come next, nor the omniscience required to incorporate all possible information into their decision-making models. They do not have the wisdom to understand the consequences of their actions, and they do not have the constraints that the rest of us face in pursuing our own individual actions. Worst of all, they have nearly unlimited power to spend and debase the currency, whereas you and I are limited to our own ability to provide useful skills to others in exchange for payment.

Governments cannot stop the pain that inevitably comes with a severe recession. All they can do is ensure that the next time around, the same mistakes will not be repeated. Unfortunately, we now are witnessing the 6th year of an effectively zero-interest-rate policy (ZIRP), and it’s not bloody working. Yes, American high-tech manufacturing is making a comeback- but how much of that is real and how much is due to America’s increasingly worthless currency? Yes, America’s corporate profits have never been higher- but how much of that is due to actual production and not financial engineering on the balance sheets, or greatly-depreciated production costs due again to a debased currency? Yes, the S&P 500 breached 1,500 recently- but the P/E ratio of the S&P is still well above its historical averages, indicating that stock prices are not good indicators of the true underlying value of the goods and services provided by the companies of the index.

Ultimately, Keynesian economics will collapse in on itself, but that day will be a very long time in coming. Keynesianism is a morally and intellectually bankrupt system, but because it allows governments to spend and inflate at will, and provides theoretical support for fiat money in place of real money, it will endure until the day that the concept of fiat money itself is destroyed- which will probably be the same day that the US dollar finally loses its status as the global reserve currency, and this nation’s economy finally collapses in on itself. And make no mistake- when, not if, that day comes, it will come as a direct result of the consistent insanity preached by Keynesians around the world.