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Keynesian Policies: Half a Century of Failure

The glorified European currency union that was to fix all that was wrong with Europe is falling apart. The patchwork bailout schemes introduced month by month delay the collapse. But the time between fixes is growing shorter and shorter.

And the only real fix of dramatic spending cuts, sound money and banking, deregulation, debt repudiation, and liquidation are politically unviable. That’s because the political elites would not benefit from such policies, and their interests are not aligned with those of the people.

In the United States, the combination of stagnant labor markets and struggling stock markets has cast a spell of doom over nearly everyone. For most American observers who look only at superficial signs of economic health, this is a perfect storm. So long as stocks are rising, even a real zombie apocalypse wouldn’t be noted. But if stocks are struggling, everything seems wrong with the world.

For those of us who have been watching the unfolding folly since 2008, it’s very difficult to take any of the current panic too seriously. What else should we expect from Keynesian policies after half a century of failure? And you don’t even have to know the history to know that the path of spending, money growth and interest-rate manipulation is going to prove fruitless. You need to know only that government has no power to create bread from stones.

It’s a tossup as to which aspect of Keynesian policy is silliest. Maybe it is this idea that government can ramp up spending and that this spending can be a viable proxy for private-sector investment. Where does government get its money? From the private sector. Draining resources by force from one sector to be spent by another creates no new wealth. It destroys wealth, because you are throwing good money after bad.

Or maybe it is this idea that a sector can be rescued from deleveraging pressures with enough infusions of newly created government money. In this case, it was mainly the housing sector that was the target. If the bust were the correction of the error, why would you want to throw resources at re-creating the error? In any case, it didn’t work. The tailspin continued, despite the interventions.

Or maybe it is this idea that we can push interest rates to zero and thereby inspire people to stop saving and go out and borrow and spend. But interest rates are prices that imply a meeting of minds. Subsidizing one side of the transaction, the borrowers, penalizes the other side of the transaction, namely the lenders. And even if people can make deals under these conditions, they won’t be economically wise.

Even aside from the goofy logic of this policy, didn’t Japan already try this approach all throughout the 1990s? Yes, this very thing happened. Interest rates were pushed to zero in an effort to give the economy a jolt after the asset bubble collapsed. Now these years are typically referred to as “the lost decade.” One might suppose that if a decade is lost, people might blame the bad policies that caused it to happen.

But that’s just the problem. It is a matter of establishing cause and effect. The people who defend Japan’s policy say that had it not been for this policy, Japan would have collapsed into economic disaster. See? You can always say that. It’s impossible to prove these people wrong based on the facts alone.

Let me try an analogy. Someone is sick with the flu, the doctor prescribes injections of more flu virus and the patient gets worse. People denounce him, but the doctor explains that the patient would have been even sicker were it not for the treatment. The doctor is regarded as crazy because of the implicit assumption of cause and effect: The flu virus makes you sick.

The problem with economic theory today is precisely the absence of a consensus of cause and effect. One group of economists says that the economy fell into recessions in response to an artificial boom created by cheap money, debt, subsidies and a moral hazard. Fixing the problem requires getting rid of those policies. But the other group — now just as in the 1930s — ascribes the problem to the unleashing of capitalism and its inevitably attendant instability.

This is why reading Paul Krugman can sometimes seem as if you are reading letters from the loony bin. He says that the problem is that Keynesian theory has not been tried enough, or even at all. He blasts the Fed for insufficient action. He attacks Congress for its cutbacks. He flails away at the Obama administration for its do-nothing policies. He lashes out at regulators for failing to kick people around more. And then he suggests hyperinflation and the looter state as great solutions.

I’m reminded of 1989, when socialism collapsed all over the Soviet Union and Eastern Europe. I figured that the socialists would all hang their heads low and admit that their crazy scheme to impose collective ownership of capital had flopped horribly. Far from it! They said that the problem with the Soviet Union and Eastern Europe was that they hadn’t actually tried socialism; the system they had was rather a Stalinized and bureaucratized regime of regimentation that merely replaced one ruling class with another.

Believe it or not, they have a point, but it is not the one they think they are making. Socialism is actually impossible in the real world. There is no such thing as collective ownership of scarce goods. The attempt ends up empowering elite rulers who make rules about how property is used. What they end up doing is abolishing markets, which robs society of the profit and loss signals needed for rational economic decision making.

They are pursuing a pipe dream. But it is not different from the Keynesian dream in this respect. Keynesianism imagines that the economy can be managed by scientific elites who make decisions according to an objective standard of economic efficiency. In reality, it ends up putting politicians, bureaucrats and central bankers in the position of overruling the rational decisions of property owners. The Krugman view of the world is as far-flung as the socialist one.

But we wouldn’t know this without some clear sense of cause and effect in economic world. That comes only from reflecting on the logic of human action in a world of scarce resources. Doing that is as easy as picking up a copy of Henry Hazlitt’s Economics in One Lesson.

Yet the Keynesians still dominate the punditocracy. Amazing? Not really. The Centers for Disease Control and Prevention recently had to issue an announcement that there is no Zombie Apocalypse in the making. The actual text: “CDC does not know of a virus or condition that would reanimate the dead (or one that would present zombielike symptoms).”

We do not know of any government policy that will reanimate a zombie-like economy following an artificial boom. Our best hope is to free the markets and let entrepreneurs and capitalists raise this economy from the dead. We should do this before the dead start coming after us.

Regards,

Jeffrey Tucker
for The Daily Reckoning Australia

From the Archives…

When Capital Comes A Knocking
2012-06-01 – Greg Canavan

When the Pain From Spain Moves Across the Plain
2012-05-31 – Greg Canavan

Greek Game Theory: Default, Devaluation, Austerity, Deliverance?
2012-05-30 – Nick Hubble

Desperate Stock Market Traders Waiting To Be Made Whole
2012-05-29 – Murray Dawes

Greek Elections: The Fear of Uncertainty
2012-04-28 – Dan Denning

The Daily Reckoning
The Daily Reckoning offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, The Daily Reckoning delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, The Daily Reckoning is published in 7 countries with a worldwide readership of almost 1 million people.
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