ECONOMIC MYTHS:

Keynesian Economic Theory Lives On

FUTURECASTS online magazine
www.futurecasts.com
Vol. 3, No. 6, 6/1/01.

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Mistaken prophets:

 

A triumph of dogma over logic
  The belief in "modern economic theory" - derived from the work of John Maynard Keynes - will go down in history as one of the most remarkable triumphs of dogma over logic in the history of man. Until the 1980s, modern economic theory ignored over 2000 years of economic history - and the entire supply side of the supply-and-demand spectrum of economic activity. Four decades of repeated mistakes, failures and frustrations was added to a massive list of weaknesses in basic theory.
 

 The myth concerning the causes of the Great Depression:
   The experience of the Great Depression gave rise to modern economic theory. It seemed evident that capitalism had failed and that some form of government stimulus was needed in response to the apparent inability of the economy to heal itself. In fact, however, the Great Depression was not a failure of private enterprise capitalism. It was the logical result of a variety of government actions that adversely impacted world commerce.
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Massively stupid government policies - not weaknesses in capitalism - caused the Great Depression.

  A more extensive discussion of the causes of the Great Depression is provided in Summaries of Depression Controversies and Facts: The Great Deception, published in the April, 2001, FUTURECASTS issue
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  WW I and its aftermaths - the war debts - reparations - and America's subsidized excess agricultural capacity - among other causative factors, were the result of government - not private - activities. Protectionism - and especially the trade war that was greatly worsened by enactment of the Smoot-Hawley Tariff in 1930 - were also the result of government policy. These and other government activities and policies made economic collapse possible, and then made recovery impossible. Government was not the answer - it was the problem.
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  The stock market speculative boom and crash was undoubtedly a powerful triggering cause for the Depression, but it cannot explain the depths or duration of the crisis.
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  In fact, after the Crash, neither the stock market nor the economy went straight down. During the next six months, there were several surges that carried the stock market considerably more than half way back towards its 1929 highs, and business recovered nicely that spring, reaching levels favorably comparable to any year except the spring of 1929. Interest rates quickly fell to low levels and money was plentiful. The general banking collapse didn't occur until three years after the crash.
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  The most absurd contention is that excess savings are somehow to blame. This is a fundamental element of the economic theories of John Maynard Keynes and his followers. But savings actually declined for the first time in 12 years during the last fiscal year before the Great Depression - a phenomenon that has been noted before many recessions since that time.
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  The Keynesian savings gap myth will be dealt with more at length in "Future Economic Myths," in a coming issue of FUTURECASTS.
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  Indeed, the only economic activity that failed to stage periodic substantial recoveries was international trade - which declined precipitously, month after month, for several years in a row.
 

Thriving on failure:

For six decades, government failed spectacularly at practically every economic chore it undertook.

Government was viewed as the answer to the problems caused by government.
  But it was capitalism that received the blame. It was a characteristic of the six decades before the Reagan administration that - even though the government failed spectacularly at practically every economic chore that it undertook - it was nevertheless able to convince the public that each failure was due to weaknesses in the economy that could only be dealt with by government's assumption of more - and more difficult - economic responsibilities.
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  Government - the problem - was successfully presented as the answer for the economic weaknesses caused by government.
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  The prosperity that followed WW II was the result not only of natural increases in economic productivity, but also the rapid growth in world trade that was permitted by the end of the trade war, and the elimination of much of the noxious financial residue of WW I. It was also due to the inflationary policies pursued by government - for which we paid a heavy price in the 1970s and early 1980s.
 

A record of failed government policies:

The many myths that guide economic policies:
   Even a partial list of the mistakes and failures of our economic authorities since WW II - including only those that are the most notorious - is impressive. The myths that they adhere to, like the validity of government statistics, the macroeconomic definition of "capital," the inappropriate use of mathematical forms of reasoning  for macroeconomic econometric analysis, the definition of inflation, the Keynesian savings gap, the gross national product as the measure of "economic health," and the laissez faire straw man, are or will be covered in other articles.
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The "unlimited financial resources of the federal government" would solve all our problems.

Inflation would be easy to deal with, and can't exist at the same time as unemployment.

Economics is a "science," that can provide a "new economic era" of unlimited prosperity and render obsolete the business cycle.

 

  

The growth of the gross national product supposedly demonstrated the health and strength of the economy.

 

 

The floating of the dollar was supposed to free the economy from money market restraints.

 

The business cycle, stagflation, liquidity traps, and other economic problems perversely refused to disappear as promised by Keynesian myths.

 

Inflation could - and would - cause increasing unemployment.

   It has been about 4 1/2 decades since a U.S. Secretary of the Treasury first climbed Capitol Hill to assure a credulous Congress that the United States could and would easily resolve its balance of payments problems. This solemn ritual continued for over a decade, with the presentation predictably including references to the nation's strong balance of trade position and the overall strength of the economy. Surely - it was repeatedly asserted - a few billion dollar balance of payments deficit couldn't seriously disturb the nation's huge trillion dollar economy. Unfortunately - for fixed exchange rate monetary systems - balance of payments problems are dangerous.
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  During the Kennedy administration, the president's economic advisers uniformly hailed the glory of modern economic theory. They asserted that government had the ability to fine tune the economy and to eliminate unemployment and the business cycle. This enabled sociologists and economists to appear repeatedly before the television cameras and in the printed media expounding eruditely on how all our social and economic ills could be cured merely by committing "the unlimited financial resources of the federal government" to the solution of the nation's problems.
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  The public was assured that it need not worry about inflation - that inflation could be easily dealt with if it got started - and that it was impossible for inflation to exist during times of substantial unemployment anyway.
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  It was proclaimed that economics had become a "science," and that a "new economic era" of permanent prosperity had begun. The business cycle was "obsolete." Anyone who voiced skepticism was considered a fool, or worse.
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  Even after the balance of trade joined the still-adverse balance of payments in the red ink column during the Johnson administration, government and economic spokesmen assured the public that the dollar was as good as gold if not better than gold, and gave solemn assurances of the government's unquestionable determination to keep the price of gold fixed at $35 per ounce. Similar statements had been made during the Kennedy years about the silver in the coinage.
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  During the Vietnam War, the public was assured that the nation could have both guns and butter. It was argued that the gross national product was several times larger than at the time of WW II, and that this meant that the economy could easily handle the financial and economic burdens of the relatively minor conflict in Southeast Asia.
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  "We are all Keynesians now!" Thus did President Nixon proclaim the complete acceptance in official circles of the policies of modern economic theory.
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  The Nixon administration presented the devaluation of the dollar as a triumph of economic policy and a solution to growing economic problems. Now that the nation no longer had the burden of maintaining any particular artificial value for its currency, the government's economists and economic policy makers would be free to deal with and resolve the economy's basic problems.
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  However, the nation's economic problems perversely refused to conform to these economic myths. During the 1970s, economic problems became too serious and too repetitive to ignore. It became obvious that the nation had jumped out of the frying pan of the gold standard, only to land in the vicious fires of the international money markets. Gold had actually provided a temporary shield from those fires - and now that shield was gone.
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  Inflation reached intolerable levels and - as always in economic history - quickly demonstrated that it could - and would - exist side-by-side with growing unemployment. The business cycle grew increasingly vicious, with a recession in 1974, a depression in 1980 and a recession in 1990, despite rates of inflation that rose at one point  into double digit levels and generally stubbornly remained around 4%.
 

  
The "Golden Straight Jacket:"
  As the limitations of government economic policy became distressingly evident, the nation's economic spokesmen began to speak with a refreshing degree of humility about their past failures. Most now admit that economics is not a science, and that massive government deficits and monetary expansion ultimately cause inflation, and bring on problems such as stagflation or liquidity traps. They no longer ignore the problems of the supply side of the supply-and-demand spectrum of economic activity.
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 Keynesian economists await only the inevitable onset of the next recession to reassert their myths
  International money markets force governments to maintain a stable currency and a relatively balanced budget if they want to maintain economic prosperity and growth. It has become increasingly evident to economists around the world that government policy must accept the restraints of the "golden straight jacket." These, of course, are the same restraints that would make a success of the gold standard.
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  While the standard Keynesian policies of massive governmental deficits and monetary expansion were admittedly proven disastrous by the events of the 1970s, there are still an amazingly large number of economists, such as Professors Paul Krugman and John Kenneth Galbraith, who still assert the basic validity of the economic theories that justify those policies.
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  Academic economists have been working strenuously in their efforts to overcome the obvious theoretical shortcomings of modern economic theory. Indeed, they have actually made some real headway in dealing with some of the most obvious defects in their theoretical concepts. They anxiously await only the inevitable onset of the next recession to crawl out of the academic woodwork. Thus, we can expect to have to deal with these concepts well into the 21st century.

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 Copyright 2001 Daniel Blatt