Keynesian Nostrums Still Plague the US Economy
That Keynesianism is still the prevailing orthodoxy among the economic commentariat is plain to see. What is not so plain is the consequences of this thinking. Paul Krugman's name usually springs to mind when conservatives think of Keynesian commentators. But Krugman is merely one among an army of such economists who dominate economic thinking in Western universities.
James K. Galbraith, that's Galbraith Jr in case you're wondering, is a typical example of what I mean. It's important to reflect on what the likes of Galbraith are teaching because it eventually turns up in the media and the political arena.
Several years ago Junior did us the favour of publicly revealing what he is teaching his students about the US economy (So, what happened to the New Paradigm?, The Australian Financial Review, 15/2/2002), that's Galbraith Jr in case you're wondering. Far be it for me to prejudge, but I did anyway.
Galbraith argued that the "New Economy began to expire with the NASDAQ's collapse in April 2000". I hate to tell you that I told you so (just kidding) but I was writing in 1999 that the economy was showing signs of severe imbalances and that real depressionary forces were emerging. I also stressed on numerous occasions that manufacturing feels the impact first, not the share market.
He claimed that it pained him to point out that the roots of the recession go back to the Clinton administration. It pains me even more to contradict Galbraith on this point. The roots of the recession go back to Lord Maynard Keynes and not Clinton or any other president. He gave the following three reasons why the prosperity of the 1990s, which he called real, was unsustainable:
1. The techno-boom was mainly a financial bubble largely financed after 1997 by capital inflows. The situation was made worse by the Fed's failure to curb margin lending. (The Galbraiths have got a thing about margin lending, a bit like arachnophobia I suppose).
2. Federal surpluses were dangerous because raising taxes in excess of public spending puts a strain on business and obliges it and consumers to turn to debt in order to support growth. When the borrowing stopped this caused GDP to drop.
3. Monetary policy could only support growth so long as business and consumers were willing to borrow. Once business and consumers become debt shy interest rate cuts only have the effect of relieving debt repayments. "Nor will lower interest rates induce households to buy new durable goods..."
These three reasons basically sum up the Keynesian argument. He later remarked that it takes time for debts to become sufficiently low for consumers and business to start borrowing again and for banks to start lending. (This is always the case during a recession). His comment that it also takes time for investors to discover new things is not, so to speak, part of the equation.
Having first told us what was wrong Galbraith then told us what needed to be done. But before I go on to his solution I think it's necessary to deal with his three reasons for the recession:
1. The boom was caused by loose monetary policy, the Keynesian policy of forcing interest rates below their market levels. This caused credit to explode. As for so-called excessive margin lending, this is always caused by excess credit expansion by the banking system. Where does he think the damn credit came from in the first place?
That business and consumers turned to borrowing was also a product of credit expansion. Without the expansion borrowing would have been severely curbed. Moreover, the idea of lowering interest rates is to get people, especially business, to borrow. It's called Keynesianism.
2. The surpluses were not dangerous even though they were the product of fiscal drag and higher tax rates. Once again, it was credit expansion (monetary expansion) generated the surpluses by flooding the economy with 'cheap' credit. Business activity rises, the market booms, nominal incomes increase and as a result so do federal revenues.
3. The idea that monetary policy supports growth is a fallacy. Once again: savings fuel growth and entrepreneurship drives it. What monetary expansion, credit expansion, does is to distort the pattern of production, waste capital and increase debt. It does not generate growth.
For a start, at the time that Galbraith wrote his article US consumer spending was still racing ahead with retail sales rising by 1.2 per cent in January 2002. What's more, I explained a number of times how the recession would first begin in manufacturing and work its way down to consumption, and that consumption would still remain high relative to manufacturing. (Regardless of what some economic commentators think, manufacturing does matter).
This is exactly what happened. Furthermore, if Keynesians were right then the recession would have started with falling consumption followed by falling output. The real idea behind forcing interest rates down is not basically to get consumers to borrow for big ticket items but to get business to invest by supplying it with cheap capital. Unfortunately, cheap credit does not equal capital. If it did we could all live like Bill Gates, or even the Galbraith family.
Now Galbraith is against tax cuts, surprise, surprise, because most of it will be saved. But this is exactly what every country needs: more savings. After all, to save is to spend, but someone else is doing the spending. Without savings Americans cannot invest and without investment living standards will fall. If Americans increased their savings rate this would drive down the rate of interest the natural way and so supply entrepreneurs with real capital that in turn will raise real incomes by raising the productivity of labour.
Anyone acquainted with economics will, of course, now know what Galbraith's solution to the recession is. Spend! Spend! And Spend! Except that it will be government at all levels doing the spending. Hospitals, schools, drug benefits, urban amenities, public parks, etc.
And who will provide the money for all of this expenditure? The Feds, of course. And where will Washington get all this money? Well, Galbraith the Younger is a little coy on that question so I'll tell you: from the printing press. That's the Keynesians real solution: print money and throw it around until something happens. Talk about never learning from history. (This is also Krugman's economic solution for the Japanese economy).
We've already seen that consumption spending is not the problem. Consumption is never a problem. The problem is and always has been production. We never have enough. Now by directing spending towards consumption you are directing resources away from the higher stages of production. If left unchecked this process would eventually lower productivity and hence real wages.
If people have any doubts about what I've said they should direct their attention to Argentina where large-scale government intervention, not to mention corruption, combined with the inflationary policy that Galbraith should love wrecked the economy.
Keynes got so carried away with his ancient fallacies that he once suggested paying people to bury bottles filled with pound notes and then paying other people to dig them up. In case you think he was joking, he also said, in all seriousness, that artificially lowering interest rates was the equivalent of "turning stone into bread" (Paper of the British Experts, 8 April 1943). At the end of the day, what did Keynes really leave us? The likes of Galbraith and Krugman.