THE GENERAL THEORY OF EMPLOYMENT,
INTEREST, & MONEY

by

John Maynard Keynes

Part II: Interest Rates, Aggregate Demand, and the Business Cycle

Page Contents

Keynesian theory

Monetary policy

The business cycle

Fiscal policy

       FUTURECASTS online magazine
www.futurecasts.com
Vol. 6, No. 5, 5/1/04.

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Introduction to Parts I & II

Keynesian theory:

 

 

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  In the source of Keynesian theory, "The General Theory of Employment, Interest, and Money," John Maynard Keynes purports to provide a "general theory" for self-regulating capitalist market systems. He asserts that it is applicable generally in all economic circumstances. Classical concepts, on the other hand, operate only in those rare "special" circumstances where full employment is possible.
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With disconcerting frequency, Marxian stupidities were invoked with approval, although in only one instance explicitly crediting Marx.

  However, it is Keynes' theory that - if applicable at all - is applicable only in very narrow circumstances - like the "special" circumstances of the depths of the Great Depression where political leaders proved incapable of reforming the fundamental policy stupidities that prevented recovery.
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  Keynes nevertheless successfully convinced multitudes of supposedly knowledgeable economists to accept a series of black-is-white arguments. Savings became bad and deficits became good, and the prudent accumulation of reserves for foreseeable and unforeseeable contingencies was imprudently responsible for disastrous consequences. The accumulation of capital assets becomes an economic obstacle rather than an economic advantage. Investment and employment is stimulated by inflation and hindered by price declines. Market liquidity becomes more of a problem than an advantage.
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  Free trade has disadvantages and closed economic systems have advantages because of the greater ease of manipulating the latter. With disconcerting frequency, Marxian stupidities were invoked with approval, although in only one instance explicitly crediting Marx.
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  Although controversy over war debts and other international debts and trade war protectionism was raging around him, Keynes has not a word to offer about the obvious roles of such government policies in the business cycle in general and the Great Depression in particular. See Great Depression Chronology Series, beginning with "The Great Depression: The Crash of '29."
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Keynes provides a rationale for pursuing short term relief from economic problems by means of budgetary deficits and monetary inflation - palliatives that must  ultimately just make matters considerably worse.

  Over a century of capitalist economic history was thus ignored, as were all arguments to the contrary, until Keynesian theories were put to the test in the 1970s - and predictably failed miserably wherever pursued.
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  Nevertheless, Keynesian concepts are once again popular and in use today - especially in the United States under the Bush (II) administration. They remain very popular with political leaders, since they provide intellectual cover for doing what political leaders have always done when seeking to put off confronting the real problems that afflict an economy. Keynes provides a rationale for pursuing short term relief from those problems by means of budgetary deficits and monetary inflation - palliatives that must  ultimately just make matters considerably worse.
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The influence of Marx:

 

 

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 It is evident that Keynes rejected much of the worst of Marxian doctrine. Keynes relies on competitive markets to allocate resources where Marx naÔvely relies on socialist directives. Keynes uses market exchange values instead of Marx's impractical concept of industrial labor use-values. Keynes had infinite faith in paper money managed by governments - Marx had none. (Both are wrong on this last one.)
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  Keynes can thus omit all of the twisted indeterminate and nonfunctional definitions and redefinitions of economic terms that Marx relied upon for the defense of his narrow industrial labor use-value concept and for support of his propaganda myth. Profits - frequently referred to as "income" or "yields" - takes its obvious place for Keynes as a determining factor for capitalist economic activity. Although he views capitalism as unable to operate at optimal levels for any length of time, Keynes recognizes - unlike Marx - that capitalism is inherently stable within the parameters of the business cycle.
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  Moreover, Keynes avoids many of the weaknesses of logic that permeate Marx's work. See the series of articles beginning with Karl Marx, "Capital (Das Kapital)" vol. 1 (I), "Value Determined by an Abstract Labor Standard."
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Keynes, like Marx, ignores the particular reasons why particular periods of economic trouble have taken place.

 

Keynes appears totally ignorant of the inherent inefficiency of government management.

  Nevertheless, Marx's "mature capitalism" fallacy - for which Keynes cites Marx with approval - is the central feature of the General Theory, and Keynes relies upon some indeterminate concepts of his own to support his "mature capitalism" theme. In the process, Keynes, like Marx, ignores the particular reasons why particular periods of economic trouble have taken place.  See, Keynes, "The General Theory of Employment, Interest, & Money,"   Part I, "Elements of The General Theory."
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  Like Marx, Keynes believes the ownership interest is not an essential element in capitalist productivity. Stock market investors are "functionless." Ignoring Adam Smith's warnings about the weaknesses inherent in the separation of management from ownership, Keynes agrees with Marx that good management and supervision is always readily available and can be procured simply by offer of a suitable salary.
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  Like Marx and all socialists, Keynes appears totally ignorant of the inherent inefficiency of government management. See, "Government Futurecast," Part II, "Government Management." He has total faith in the capabilities of government and "community" administered economic systems. While Marx offers broad socialist solutions, Keynes offers narrower administered solutions directed at controlling interest rates, directing investment flows, redistributing wealth, and ultimately directing the activities of major business entities.
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  To entice the credulous, Keynes like Marx offers a vision of an impossible utopia. If a capitalist system is resolutely stimulated pursuant to Keynesian policies, it will generate abundant capital assets - "full capitalization" - so that capital assets are no longer scarce. Then, there would no longer be any need for financiers and rentiers. While residual entrepreneurs would continue to be tolerated, Keynes agrees with Marx that the entrepreneur will become unnecessary.
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  Keynes - also like Marx - assumes that the study of economics is a "scientific" endeavor. He thus avails himself - or at least succumbs to - the "science" propaganda ploy that was a central feature in the propaganda myth created by Karl Marx. His followers would ardently continue this propaganda deception until forced to retreat somewhat by their gross failures in the 1970s.
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The savings gap:

 

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  Keynes provides us with psychological propensities to consume and save. He blames the business cycle and involuntary unemployment on the notion that wealthy nations - "mature" capitalist systems - will inevitably save more than can be profitably invested, leading to periods of economic decline - if not chronic economic decline.  Like Marx's concepts, none of this can be measured, and in fact all the evidence is exactly the opposite.
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As assets accumulate, people and businesses can - and observably do - rely more on their asset wealth than on monetary savings.

 

The decline in savings rates in the U.S. in recent prosperous times has been notorious for decades.

  Mature - wealthy -  capitalist systems require and have lower rates of savings - not higher. As assets accumulate, people and businesses can - and observably do - rely more on their asset wealth than on monetary savings. Their asset wealth supports vast increases in the purchasing power of credit, naturally stimulating both consumption and investment, with profit rates and interest rates sensitively adjusting these flows except when other factors undermine the pertinent markets.
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  Except during the depths of already developed severe depressions, financial intermediaries and the money markets have no trouble instantly putting all savings to work in commerce. As is repeatedly pointed out throughout the articles on Marx, "Das Kapital," and Keynes, "The General Theory," there is absolutely no evidence that excess savings play any role in initiating periods of economic distress.
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  In fact, savings declined substantially in the last full year before the Great Depression - the first decline since WW-I - accompanied by a substantial decline in the number of savings accounts. The decline in savings rates in the U.S. in recent prosperous times has been notorious for decades.
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Considering the extent and nature of man's weaknesses - and the stubbornness with which policy stupidities are frequently maintained, it is astounding that capitalism can function as well as it does.

  The roots of the business cycle are to be found in the multitude of pertinent weaknesses of man - NOT in weaknesses alleged in capitalism. Indeed, considering the extent and nature of man's weaknesses - both in the private sector and government sector - and the stubbornness with which policy stupidities are frequently maintained, it is astounding that capitalism can function as well as it does.
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  It is always the nitty-gritty of analyzing particular factors involved in particular periods of economic distress that is required for an understanding of the business cycle. Economists who are too lazy or inept for this task - or unwilling to offend political patrons or private employers - have nothing to tell us. No simplistic "General Theory" will suffice.

Interest Rates

The impacts of interest rates:

 

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  Interest rates play a major role in the investment demand-schedule. Keynes advocates government "monetary policy directed at influencing the rate of interest." However, he believes that the other factors that influence the investment demand-schedule are too powerful for such "monetary policy" alone to achieve levels of investment sufficient to maintain full employment.
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Keynes argues that it is impossible to determine the rate of interest just from investment demand and savings supply.

  There is a well recognized relationship between investment demand and interest rates. According to classical economic theory, interest rates sensitively adjust to allocate all available funds for investment purposes. 

  With the growth of consumer credit - already a recognized factor in the 1920s - investment demand is not the only major use of funds available for loans. The fact that interest rates allocate available funds not just for various investment purposes but for consumption purposes as well is omitted by Keynes. The availability at low interest rates of abundant funds has to influence the propensity to consume.

  Keynes attacks the classical view. He argues that it is impossible to determine the rate of interest just from investment demand and savings supply.
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Keynes assumes that people part from their savings only if offered an interest return. Thus, the interest offered counters a "liquidity preference" to hold wealth in the form of immediately usable but sterile cash.

  Keynes uses the term "liquidity preference" for those who prefer to keep significant sums in the sterile form of cash. Keynes assumes that people part from their savings only if offered an interest return. Thus, the interest offered counters a "liquidity preference" to hold wealth in the form of immediately usable but sterile cash.

  "Thus, the rate of interest at any time, being the reward for parting with liquidity, is a measure of the unwillingness of those who possess money to part with their liquid control over it. The rate of interest is not the 'price' which brings into equilibrium the demand for resources to invest with the readiness to abstain from present consumption."

  This is, in fact, a correct view of matters where financial intermediaries are unavailable or unreliable - as in undeveloped nations or -  during the Great Depression - even in the U.S. It is also true when - for any reason - profits are so scarce that there is no inducement to borrow at any interest rate - as during the Great Depression.
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  However, in developed nations with reliable banking systems, Keynes' "liquidity preference" disappears. It is then safer and more convenient to deposit cash in banks than in mattresses, even with little or no interest on offer. Except during the depths of already existing depressions, banks and other financial intermediaries have no trouble immediately circulating ALL savings through the money markets if not through direct lending.
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  In developed nations, idle hoards don't cause depressions. Depressions cause idle hoards.
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  However, interest rates WILL determine - along with various risk factors - whether funds available for loan will be drawn into domestic markets from abroad - or will flow abroad to take advantage of better opportunities in foreign markets. Artificially low interest rates will cause capital flight.
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Keynes provides some simplistic mathematical equations explaining "liquidity preference" - all of it inapplicable to capitalist economics except when - for other reasons - there has been a breakdown in the financial system. Even then, interest rates won't eliminate or reduce "liquidity preference." Only the elimination of the factors that undermined the reliability of the financial system and the functioning of the economy will reduce or eliminate "liquidity preference." This involves analysis and reform of fundamentals. Government deficits and manipulation of money and interest don't solve fundamental problems.
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    It is to the great credit of Keynes and his followers that - when given the authority and opportunity after WW-II - they took steps needed to end the trade war. With  commendable U.S. leadership, steps were taken to facilitate international trade, and war debts from both world wars were substantially written off. Wouldst that it had all been done two decades earlier.

  There are three general reasons for holding cash identified by Keynes. Cash is held for transactions, safety, and speculation purposes. Monetary expansion may not always reduce interest rates, and interest rate reductions may not always stimulate economic recovery. Keynes recognizes many of the factors that may get in the way.
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  However, Keynes asserts that the level of income is the key factor that determines if savings will equal investment, and that this belief is what separates him from the classical view. Classical theory asserts that interest rates will automatically equate net savings with investment (which except during the depths of depression does indeed happen).
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  Keynes here discusses the supply and demand for savings as if investment returns were the only reason for savings. However, as elsewhere recognized by Keynes, savings depend on many factors other than interest and investment yields. Interest rates - or more precisely, the complex of interest rates - allocate accumulated savings between various investment uses and periods

  Only if banks are less secure than mattresses - and thus themselves constitute an investment risk - are yields essential to draw savings into the financial system.

  Yet, Keynes' whole discussion of "classical theory" assumes that it depends on how interest rates induce savings. (This may have been true when early capitalist economic systems had archaic financial systems, but for economic systems with modern financial systems, it is an obvious straw man - a nonsense theory.) He correctly notes that savings do not in fact necessarily increase when interest rates increase - but the investment demand-schedule does in fact fall. Thus, the two lines need not intersect at all. Some other factors indeed must be involved.
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  Keynes thus easily slays this straw man. He correctly notes that many interrelated factors such as money, incomes, savings rates, and consumption rates, impact interest and investment.

  Keynes is here still theorizing about a closed system - unconcerned with international money flows.

  In the Keynesian world of dysfunctional financial systems (as indeed existed in 1935 in the midst of the Great Depression), reduced spending that increased savings indeed did not reduce interest rates - which were already as low as they could go. In such a world, it did indeed reduce employment instead, since there existed almost no profit-inducement to borrow even at minimal interest rates.
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  It is probably the nature of his times that led Keynes astray, since he clearly understood money - as can be seen from the following paragraph.

  "The strength of all [transactions and reserve motives for holding cash] will depend on the cheapness and the reliability of methods of obtaining cash, when it is required, by some form of temporary borrowing, in particular by overdraft or its equivalent. For there is no necessity to hold idle cash to bridge over intervals if it can be obtained without difficulty at the moment when it is actually required. Their strength will also depend on what we may term the relative cost of holding cash. If the cash can only be retained by forgoing the purchase of  a profitable asset, this increases the cost and thus weakens the motive towards holding a given amount of cash. If deposit interest is earned or if bank charges are avoided by holding cash, this decreases the cost and strengthens the motive. It may be, however, that this is a minor factor except where large changes in the cost of holding cash are in question."

  Clearly, in the midst of the Great Depression, money on deposit in banks is viewed by Keynes as sitting idle - as the equivalent of "holding cash" - since there is little profit inducement for regular or overnight borrowing of such funds. Today, credit cards and lines of credit substitute for cash reserves, large and small.

A relatively small monetary effort may be all that is required to move interest rates up or down as desired, because speculators will quickly enter to move the market in the expected direction, and they will arbitrage subsequent interest rate fluctuations on the basis of the expected rate.

  Speculation will affect any "monetary policy" that is designed to change or control interest rates. The cash needs for transactions and reserve purposes are fairly constant, but speculation rises and falls like passing waves, in sensitive response to expectations based on a wide variety of factors.
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  Thus, a relatively small monetary effort may be all that is required to move interest rates up or down as desired, because speculators will quickly enter to move the market in the expected direction, and they will arbitrage subsequent interest rate fluctuations on the basis of the expected rate.

  However - in the nature of markets - to maintain a desired level of interest rates below the market rate will inevitably require an increasing rate of monetary expansion over time.
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  Moreover, interest rates are the time cost of money. They dictate investment patterns. They also influence saving and consumption patterns. By fiddling with interest rates, Keynesian "monetary policy" inevitably sends erroneous signals and screws up the economy. A substantial period of artificially low interest rates MUST leave an economic system increasingly unbalanced. Thus, the Keynesian effort to provide short term stability MUST create increasing instability over time. Ultimately, this instability will increase to levels that will prove unmanageable.
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   But these are long run factors, while Keynes is still here analyzing short run phenomena.

  In his usual style, Keynes offers a mathematical model to trace the relationships of monetary policy and expectations. These relationships depend on cash holdings, M, and liquidity preferences, L, for purposes of transactions and reserves, M1, and speculation, M2, and their related liquidity functions, Land L2, which are determined by income, Y, and interest rates, r. Aside from M, none of these factors are precisely determinable, as Keynes candidly notes, (and even M has more than a few ambiguities). Nevertheless, he proceeds to explain the general impacts of monetary policy in these broad, ill defined terms.

  "A change in M [the money supply] can be assumed to operate by changing r [interest rates], and a change in r [interest rates] will lead to a new equilibrium partly by changing  M2 [reserves held for speculation], and partly by changing Y [income] and therefore M1 [transactions and ordinary contingency reserves]."

  A whole variety of factors apply to this calculation, Keynes notes, such as the financial and industrial characteristics of the economy, social habits, income inequality, and " the effective cost of holding cash." However, for short period calculations, they can all be treated as constants.

  This is the key to the Keynesian remedies of monetary expansion and budgetary deficits. By concentrating only on immediate results - and in a system substantially closed to international trade - the fact that these "policies" can be no more than temporary palliatives with inevitable unpleasant long term impacts can be ignored.

If bonds are traded on public markets, market liquidity should reduce long term opportunity risks to a series of short term opportunity risks, and thus facilitate the raising of debt capital.

  The impacts of interest rate changes are perceptively analyzed by Keynes. He especially notes the impacts of interest rates that are artificially pushed below market rates. He calls market rates "safe" rates.
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  Long term interest rates - properly viewed as the most significant for the economy - must offer an adequate return to balance a variety of risks that include opportunity risks as well as risks of default. Something like 2%, then, is viewed as about as low as long term rates can go. However, if the securities are traded on public markets, market liquidity should reduce long term opportunity risks to a series of short term opportunity risks, and thus facilitate the raising of debt capital.
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  The conclusion of this analysis is that short term rates are "easily controlled by the monetary authority" because it is easier to produce a conviction of both policy consistency and success in the short run. Bringing long term rates down below natural market rates will be more difficult - even if market rates are too high to produce full employment.

  By concentrating only on short term impacts, Keynes provides an intellectual excuse for the ancient political vice of monetizing debt. That's why the politicians hire only Keynesian economists - and they become the "authoritative voices" that provide people with authoritative misinformation on economic matters.

Monetizing the debt:

 

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  Interest rates are very psychological. Manipulation of interest rates - by expanding the money supply to buy interest obligations - can only succeed if viewed broadly as "reasonable and practicable and in the public interest, rooted in strong conviction, and promoted by an authority unlikely to be superseded." (Sounds like the rationale for a pyramid scheme.)
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  Keynes sees no reason why long term debts as well as short term obligations shouldn't be monetized to bring interest rates down to levels consistent with full employment. He views the hyperinflation of Central Europe during the 1920s - when monetary expansion resulted in capital flight and breakdown of currencies and credit - "when no one could be induced to retain holdings either of money or of debts on any terms whatever" - as "very abnormal circumstances."

  In the 1970s, lesser but still unbearable levels of breakdown - of stagnant capitalization and in some nations even decapitalization - occurred as a result of Keynesian policies. Such responses to Keynesian policies take some time to develop, but are not "very abnormal" at all.

Savings and capital:

  The dire consequences of savings are emphasized by Keynes.
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  The world had responded to the Great Depression by reducing consumption rates and increasing saving rates, in an environment where there were no investment opportunities for such savings.

  Outside his Great Depression world, Keynes' lament about savings is pure gibberish. Like Marx in the previous century, Keynes during the Great Depression views "mature" capitalist systems as static, rigid systems incapable of generating continuous increases in prosperity and wealth. Once this capacity for continuous growth is acknowledged, the following sentence becomes untenable.

  "Every act of saving involves a 'forced' inevitable transfer of wealth to him who saves, though he in his turn may suffer from the saving of others."

  On the contrary, a constantly - if cyclically - expanding capitalist system will demand a corresponding diet of savings - from abroad if not sufficiently available from domestic sources.

  The impact of interest rates - the "time cost of money" - on capital is discussed by Keynes. Again laboring under a "mature capitalism" concept similar to that of Marx, Keynes speculates on the possibility that capital could become so abundant as to meet all productive needs. So seriously does he take this incredibly stupid concept that he views post WW-I experience as an example of this phenomenon.
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  The 1920s boom produced so much wealth in the U.S. and Great Britain "that its marginal efficiency has fallen more rapidly than the rate of interest can fall in the face of the prevailing institutional and psychological factors" that dictate a minimum long term interest rate of at least approximately 2%. It is this, according to Keynes, that prevents interest rates falling low enough to counter depression levels of unemployment in the face of a superabundance of wealth. It is this that condemns the laissez-faire capitalist states to live in "poverty in the midst of plenty." Indeed, only if consumption and investment are "deliberately controlled in the social interest" can this be avoided.
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  Properly managed, only one generation - about 25 years - would be needed to create a socially managed utopia of abundance, according to Keynes.

  "I should guess that a properly run community equipped with modern technical resources, of which the population is not increasing rapidly, ought to be able to bring down the marginal efficiency of capital in equilibrium approximately to zero within a single generation; so that we should attain the conditions of a quasi-stationary community where change and progress would result only from changes in technique, taste, population and institutions, with the products of capital selling at a price proportioned to the labour, etc., embodied in them on just the same principles as govern the prices of consumption-goods into which capital-charges enter in an insignificant degree."

  From absurd premises come absurd conclusions - even for the "science" of economics. This opinion perhaps most starkly reveals the extent of the absurdity of Keynes' views.

Interest and money:

  The significance of money and the rate of interest in terms of money are perceptively explained by Keynes.
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It is the nature of money that it will not by itself adjust to the factors that cause unemployment. It is those factors that must adjust.

 

The factor that makes money money - its inelasticity of supply - is viewed by Keynes as the fundamental problem causing involuntary unemployment.

  Money is reliably scarce for private purposes because of:

  • Limited elasticity of production.
  • No ability to substitute other cheaper alternatives. It is a "bottomless sink for purchasing power."
  • Low or negligible carrying costs.

  It is the nature of money that it will not by itself adjust to the factors that cause unemployment. It is those factors that must adjust.
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  Indeed, the factor that makes money money - its inelasticity of supply - is viewed by Keynes as the fundamental problem causing involuntary unemployment. He goes into some detail about these familiar characteristics of money. He notes here that expectations of sharp changes in the money supply will rob money of its essential "liquidity" characteristics - an important limitation on Keynesian monetary manipulation.
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  High interest rates - high "liquidity premiums" - are blamed by Keynes for keeping the world relatively poor in the capital assets needed to produce widespread abundance. Again - following Marx - he blasts "usury."

  This is not consistent with his harangues against savings. Savings tend to reduce interest rates. In well run capitalist systems, it is the ongoing processes of depreciation, obsolescence and creative destruction in competitive markets that are the primary factors dictating the relative scarcity and continuing profitability of capital assets.

The Business Cycle

  Variables:

 

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  In criticizing the "Ricardian world," Keynes emphasizes that there are factors that frequently prevent interest rates from settling at a level that assures full employment. (In this, he is surely correct, but not for the reasons he puts forth.)
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  Interest rate fluctuations alone observably cannot assure full employment - and may even be prevented from tending towards such levels for extended periods of time.
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  The primary causes of cyclical shifts in performance in the Keynesian world are his "propensity to consumer, the schedule of the marginal efficiency of capital and the rate of interest." These impact the key dependent variables - "the volume of employment and the national income - or national dividend."
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Three psychological factors - affecting consumption rates, risk assessments, and yield or profit expectations - plus the general wage rate - and the quantity of money - are viewed by Keynes as the "ultimate independent variables" that determine national income and employment at any particular time.

  The supply and demand schedules for labor, products and services all function within parameters dictated by these variables. The complex of factors that create the economic environment are all taken as given - although Keynes recognizes that the marginal efficiency of capital "depends - - - partly on the given factors and partly on the prospective yield of capital-assets of different kinds; whilst the rate of interest depends partly on the state of liquidity-preference - i.e., on the liquidity function - and partly on the quantity of money measured in wage-units."
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  Thus, three psychological factors - affecting consumption rates, risk assessments, and yield or profit expectations - plus the general wage rate - and the quantity of money - are viewed by Keynes as the "ultimate independent variables" that determine national income and employment at any particular time.
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  That these factors themselves are just way-stations along the infinite chains of cause and effect in the economic world is readily admitted by Keynes. These factors are at best inexact simplifications of a complex reality. However, he chooses to emphasize these factors because of their dominant impacts and their key characteristics as factors that "can be deliberately controlled or managed by central authority" in capitalist systems.
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  Keynes also recognizes the complexity of impacts of changes in the various interrelated factors. The task for him is to identify "the factors which it is useful and convenient to isolate."
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Capitalism is observably stable within cyclical parameters.

  While full employment is a "rare and short-lived occurrence," the system is observably stable within cyclical parameters. Employment and pricing shifts tend to run their course and then move in reverse - rather than proceeding to extremes.
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  It is to eliminate or minimize the fluctuations and move them closer to full employment that is the purpose of the theoretical analysis and the policies proposed by Keynes.

  NOTE that this approach totally ignores the roles played by existing government policies in determining economic performance and stability. Heavens forbid that Keynes should have had to confront the political leaders of the 1930s with the essential need to end trade war levels of protectionism and recognize the impossibility of collecting the WW-I war debts. He would have been ignored, and would not have risen to the influence he subsequently enjoyed by offering an intellectual excuse for the monetary expansion and budgetary deficits that the political leadership was anyway employing.

Wages:

 

 

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  The ability to increase employment by aggregate reductions in wage levels is critically analyzed by Keynes in some detail. While wage rate reductions in particular entities or industries will generally be favorable to employment levels in those entities or industries, reductions spread over the entire economic system have impacts on consumption and psychology that present a far more complex picture.
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It is much easier to expand the money supply, which enables political leaders to avoid many of the immediate unpleasant consequences loosed by downward pressures on wages.

  In an open trading system, there are clear advantages for employment from system-wide reductions in wage rates. (Small nations that must trade because they cannot be nearly self-sufficient routinely export their way out of trouble when faced with periods of domestic economic decline.) In a closed system, however, Keynes argues that the advantages and disadvantages are more evenly balanced.
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  In a closed system, the primary stimulus from reduced wages - as from any aggregate decline in costs - is the reduction in interest rates. However, Keynes argues that this same impact can be achieved by keeping wages fixed and increasing the supply of money. ( He discusses only the impact on interest rates from an aggregate decline in costs. He ignores the increased purchasing power of existing money - disparaging such benefits because of the noxious impact on debt.)

  "It follows that wage reductions, as a method of securing full employment, are also subject to the same limitations as the method of increasing the quantity of money. The same reasons as those mentioned above, which limit the efficacy of increases in the quantity of money as a means of increasing investment to the optimum figure, apply mutatis mutandis to wage reductions. Just as a moderate increase in the quantity of money may exert an inadequate influence over the long-term rate of interest, whilst an immoderate increase may offset its other advantages by its disturbing effect on confidence; so a moderate reduction in money-wages may prove inadequate, whilst an immoderate reduction might shatter confidence even if it were practicable.
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  "There is, therefore, no ground for the belief that a flexible wage policy is capable of maintaining a state of continuous full employment; -- any more than for the belief that an open-market monetary policy is capable unaided, of achieving this result. The economic system cannot be made self-adjusting along these lines."

  This applies only in a closed system - a system that doesn't enjoy all the productivity advantages of international trade. Also, it applies only in a system that has relied to a great degree on debt.
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  In an open system, an increase in money supply increases imports and ultimately undermines currency values and purchasing power. Cost reductions - any costs, not just wages - increase exports, reduce imports, boost currency values and purchasing power.
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  Keynes thus draws a broad conclusion based on his very narrow special case. His conclusion applies only for a closed system - thus necessarily hobbled with grossly limited economic productivity and living standards - that determinedly ignores long term implications. Even for closed systems, rigid wage systems must put greater pressures for adjustment on other cost factors - each with their own complex of impacts - that Keynes doesn't consider.

  Keynes correctly notes that the benefits of declining prices can be offset by the increased difficulty of servicing debt. (He does not, however, deign to note that this is a powerful argument against over reliance on debt capital and government budget deficits.) He also correctly notes that it is much easier to expand the money supply, which enables political leaders to avoid many of the immediate unpleasant consequences loosed by downward pressures on wages. An expanding money supply is also favorable for existing debtors - as there are in abundance in a Keynesian system.
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  The government - as the biggest debtor - benefits immediately from the monetization of vast quantities of its debt. The economy as a whole benefits in the short run by the palliative impacts on consumption and investment of an increase in the money supply.

  All of this is nothing new. Inflation is always adopted for its palliative short term impacts - the reasons for the inflation of the money supply for millennia. And the "long run" is not so long in arriving as Keynes assumed - especially for soft currency nations.

  Keynes thus advises rigid wage systems for closed economic systems.

  Both rigid labor markets and closed systems have since proven individually to be serious burdens on both productivity and employment. Something must obviously be wrong with Keynes' analysis. What could it be?

Aggregate employment:

  To evaluate the changes in employment that will result from changes in other economic factors - and changes in other economic factors from changes in employment - Keynes introduces an "employment function" that he presents in mathematical terms for individual entities or industries or for the economy as a whole.
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Classical concepts unrealistically tie employment to changes in real wages in a way that fails to explain involuntary unemployment.

  Employment N equals the employment function F times effective demand D at the pertinent economic level. Employment is measured in basic "wage-units" based on market wages and calculated in terms of money-wages.
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  Unlike standard supply and demand curves that are generally applicable only to individual entities or industries, Keynes' approach is designed to facilitate analysis of dynamic elements in aggregate economics.

  "Thus we have the advantage that, in these conditions, the individual employment functions are additive in the sense that the employment function for industry as a whole, corresponding to a given level of effective demand, is equal to the sum of the employment functions for each separate industry."

  This facilitates measurement of the elasticity of both employment and output in each industry and for the economy as a whole. Keynes provides the econometric  equations for these calculations. He notes that such calculations have no place in classical concepts, which unrealistically tie employment to changes in real wages in a way that fails to explain involuntary unemployment. The classical assumption is "that in practice it is impossible to increase expenditure in terms of wage units."

  The difference is that - in the classical concepts described by Keynes - price and wage movements in response to changes in money supply are practically instantaneous. Keynes more realistically bases his concepts on the fact that prices and wages respond to changes in money supply with delays that can be quite long - especially for large, wealthy capitalist systems. Indeed, Keynes specifically confines this analysis to that short run period.
 &
  Of course, once inflation achieves real momentum in rising prices and thus becomes a widely recognized factor, prices and wages change very rapidly indeed, and with other factors like capital flight, the collapse of credit, and decapitalization of fixed assets, purchasing power declines much faster than zeroes can be added to the currency.

Income can be spent in many ways - so his suggested calculations must be viewed as just "a first approximation" of pertinent impacts.

 

Real wages will not rise in response to increasing demand as long as there is substantial levels of involuntary unemployment, so price increases from monetary stimulation should be relatively inconsequential.

  Keynes recognizes numerous complications. Unlike Marx, he is no simpleton.
 &
  Income can be spent in many ways - so his suggested calculations must be viewed as just "a first approximation" of pertinent impacts.
 &
  Increases or decreases in income will change "effective demand" in varying ways for various goods and services, and the employment "elasticity" of various industries will vary - providing differing impacts on employment results. A shift in demand among industries may also impact employment without any change in the level of demand. Moreover, there will be varying rates of response to these changes depending on production characteristics - the time it takes for production to respond - the "period of production." The status of existing inventories will also have obvious impacts. Impacts on profits, interest, and rents will further modify results.
 &
  However, real wages will not rise in response to increasing demand as long as there is substantial levels of involuntary unemployment, so price increases from monetary stimulation should be relatively inconsequential. Only with full employment would artificial stimulation of demand be absorbed and rendered futile by price inflation.

  This is all very logical - except for the numerous instances in economic history when monetary expansion not only led to price inflation without full employment, but observably ultimately worsened unemployment. Latin America provides numerous examples. Keynes does not deign to analyze such periods - immersed as he is in the deflationary world of the Great Depression.

Aggregate Demand

Prices:

 

&

  The disconnect between microeconomic and macroeconomic theory in classical economics is emphasized by Keynes. The supply and demand schedules for individual entities and industries do not aggregate.
 &

  Instead, a crude theory of prices and money supply and money volatility is invoked. Keynes' theories bring the two worlds together and facilitate analyses of dynamic factors where there are many variables - as in fact there always are in the real world.
 &
  Aggregate demand is the variable Keynes is most interested in. It is by manipulation of demand that he proposes to favorably impact employment. "It is on the side of demand that we have to introduce quite new ideas when we are dealing with demand as a whole, - - -." The key is to evaluate "the effect of changes in the quantity of money on the price level" to determine the increase in demand from an increase in money supply.
 &
  A simplified analysis would support a conclusion that, as long as labor is "content with the same money-wage so long as there is a surplus of them unemployed - - - an increase in the quantity of money will have no effect whatever on prices - - - and that employment will increase in exact proportion to any [resulting] increase in effective demand."
 &

Keynes emphasizes that analysis of particular factors should not blind us to their complicated interactions, and warns about the tendency of econometric formula to gloss over such complications.

  However, five specific complications are quickly noted by Keynes.

  1. "Effective demand will not change in exact proportion to the quantity of money."
  2. "Since resources are not homogeneous, there will be diminishing, and not constant, returns as employment gradually increases."
  3. "Since resources are not interchangeable, some commodities will reach a condition of inelastic supply whilst there are still unemployed resources available for the production of other commodities."
  4. "The wage unit will tend to rise, before full employment has been reached."
  5. "The remunerations of the factors entering into marginal cost will not all change in the same proportion."

NOTE: Keynes is here again clearly analyzing a closed system. The impacts on foreign trade and payments are ignored.

  Thus, prices will indeed begin rising gradually prior to full employment, absorbing quickly some of the stimulatory impact of an increase in money supply.
 &
  Keynes perceptively analyzes some of the many complicated interactions of these complicating factors. He emphasizes that analysis of particular factors should not blind us to their complicated interactions, and warns about the tendency of econometric formula to gloss over such complications. He thus provides warnings all too often subsequently ignored by Keynesians.

  "It is a great fault of symbolic pseudo-mathematical methods of formalising a system of economic analysis, such as we shall set down in section vi of this chapter, that they expressly assume strict independence between the factors involved and lose all their cogency and authority if this hypothesis is disallowed; whereas, in ordinary discourse, where we are not blindly manipulating but know all the time what we are doing and what the words mean, we can keep 'at the back of our heads' the necessary reserves and qualifications and the adjustments which we shall have to make later on, in a way in which we cannot keep complicated partial differentials 'at the back' of several pages of algebra which assume that they all vanish. Too large a proportion of recent 'mathematical' economics are mere concoctions, as imprecise as the initial assumptions they rest on, which allow the author to lose sight of the complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols."

  All macroeconomic econometric analyses should carry this warning paragraph!

  Keynes goes at some length into impacts on interest rates of changes in the money supply, the resulting impacts on savings and investment, and the impacts of the identified complicating factors. He provides suitable equations - wisely again warning about their inherent limitations.
 &

"The very long-run course of prices has almost always been upwards."

 

Wages had in fact increased during the previous 150 years, but no faster than productivity, so that prices remained stable while the living standards of labor and the general population kept rising.

  Long run implications are finally acknowledged. Keynes accepts that, in the long run, there may indeed be a connection between monetary inflation and price inflation prior to full employment. However, the manner in which he explains this has some defects.
 &
  At some point, an enlarged money supply may drive interest rates near their minimum, increasing effective demand beyond one of those critical bottleneck points where wages and prices spike upwards. Since there is "less friction in the upward than in the downward direction," the political response to periods of deflation is to enlarge the money supply so as to avoid the problems of deflation. "Thus the very long-run course of prices has almost always been upwards."

  This is factually erroneous. The records on the English commodity exchanges run back to the end of the 16th century. There were indeed many upward surges in prices - usually associated with such things as wars or crop failures - but the vacillations remained within a remarkably level range for the almost 3 1/3 centuries prior to the Great Depression. Keynes himself notes this remarkable price stability between the Napoleonic Wars and WW-I.
 &
  Moreover, the 19th century was a period of persistent price deflation in the U.S. - a period when the U.S. economy prospered and the U.S. became an economic superpower. With the exception of the 1850s and 1860s - the decades of the gold rush and the Civil War - prices declined on average about 1 1/2% per year - reflecting productivity gains and providing the U.S. economy with vast gains in purchasing power.

  Keynes also notes that basic interest rates had not declined, but had remained remarkably steady during the previous 150 years. Long term rates remained at about 5%, with gilts between 3% and 3 1/2%. Wages had in fact increased, but no faster than productivity, so that prices remained stable while the living standards of labor and the general population kept rising. (Marx was totally oblivious to the fact that labor was indeed reaping the benefits of productivity increases.)
 &
  However, Keynes - like Marx - is fixated on the "mature capitalism" fallacy. His perspective dominated by the Great Depression, he insists that declining yields on capital assets are reducing investment rates to a point that makes reasonably high employment rates impossible in the absence of some kind of intervention.
 &
  This also, however, undermines the power of interest rates - and therefore of monetary expansion - "monetary policy" - to assure reasonable employment rates, since long term rates are already at or near their absolute minimum levels. Interest yields are already close to the minimum that people will accept for the risks and inconveniences of permitting others to borrow their savings. Their "liquidity preferences" prevent further interest rate declines sufficient to promote full employment.

 "If a tolerable level of employment requires a rate of interest much below the average rates which ruled in the nineteenth century, it is most doubtful whether it can be achieved merely by manipulating the quantity of money. From the percentage gain, which the schedule of marginal efficiency of capital allows the borrower to expect to earn, there has to be deducted (1) the cost of bringing borrowers and lenders together, (2) income and sur-taxes and (3) the allowance which the lender requires to cover his risk and uncertainty, before we arrive at the net yield available to tempt the wealth-owner to sacrifice his liquidity. If, in conditions of tolerable average employment, this net yield turns out to be infinitesimal, time-honored methods may prove unavailing."

Remedies for the business cycle:

  The schedule of the marginal efficiency of capital is the key factor in the complex mechanism of the business cycle, according to Keynes.
 &

 

 

"The explanation of the time-element in the trade cycle, of the fact that an interval of time of a particular order of magnitude must usually elapse before recovery begins, is to be sought in the influences which govern the recovery of the marginal efficiency of capital."

 

Interest rates are obviously incapable by themselves of preventing the wide swings of the business cycle both as a matter of theory and of observation.

 

Keynes concludes that "the duty of ordering the current volume of investment cannot safely be left in private hands."

 

 

  With optimistic expectations driving investment during prosperous times, capital assets flood into the economy. Suddenly, realization spreads that the high yields optimistically expected cannot be realized. The marginal efficiency of capital is revealed to be much lower than expected.
 &
  Other factors also contribute in a cascade of cause and effect. Fear pushes liquidity preferences - and thus interest rates - higher, contributing to the decline.

  This is factually in error, as previously noted. Keynes should have known this from the financial history of the first year of the Great Depression. The final surge in interest rates typical of the last phase of a bull market always corresponds with a period of irrational exuberance - not "fear." A lack of caution is in fact the predominant characteristic. Fear attacks equities well before it undermines credit.

  Collapsing equity values and levels of confidence cause consumption rates to decline. Eventually, as economic activity declines and reduces demand for funds, interest rates fall.

  During such turning points, interest rates in fact fall immediately with reductions in demand for funds - as occurred steadily and substantially from the beginning of September, 1929.

  However, Keynes correctly notes that interest rate declines are helpless to quickly reverse the cycle until the surplus capital assets and inventories are absorbed "through use, decay and obsolescence," permitting the marginal efficiency of capital to rise to a point that provides sufficient incentives for investment and borrowing at the low interest rates. Inventories are then rebuilt, and consumption levels recover.

  "The explanation of the time-element in the trade cycle, of the fact that an interval of time of a particular order of magnitude must usually elapse before recovery begins, is to be sought in the influences which govern the recovery of the marginal efficiency of capital. There are reasons, given firstly by the length of life of durable assets in relation to the normal rate of growth in a given epoch, and secondly by the carrying-costs of surplus stocks, why the duration of the downward movement should have an order of magnitude which is not fortuitous, which does not fluctuate between, say, one year this time and ten years next time, but which shows some regularity of habit between, let us say, three and five years."

  This explanation is simplistic but tolerable for regular recessions. However, the Great Depression did last a full decade - and the inflationary problems of the 1970s, too, lasted through the decade. What were the specific factors that prevented recovery? Only government is capable of maintaining its policy stupidities stubbornly throughout such long periods of economic dislocation.

  Reliance on interest rates to mitigate - much less avoid - the business cycle is thus misplaced, Keynes correctly emphasizes. Interest rates are obviously incapable by themselves of preventing the wide swings of the business cycle both as a matter of theory and of observation.

  "Thus - - - the market estimation of the marginal efficiency of capital may suffer such enormously wide fluctuations that it cannot be sufficiently offset by corresponding fluctuations in the rate of interest. - - - In conditions of laissez-faire the avoidance of wide fluctuations in employment may, therefore, prove impossible without a far-reaching change in the psychology of investment markets such as there is no reason to expect. I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands."

Raising the rate of interest frequently "cures the disease by killing the patient."

 

The proper remedy may lie in stimulating the propensity to consume "by redistributing  income or otherwise."

 

"The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom."

 

As little as 25 years might be all that is required to reach a true state of "full investment" if only full employment could be maintained for that length of time.

 

It is possible as a matter of public policy to increase "the stock of capital until it ceases to be scarce."

 

The correct answer is to increase consumption so investment retains its profitability.

 

  So, what is to be done? Keynes recognizes that high rates of interest can be effective in limiting the investment excesses of boom periods, so that there will be less of an overhang of capital assets and inventories to work off during recessions. However, this is a crude and destructive weapon, since it inhibits equally all investment - not just that which is excessive. It can also inhibit the propensity to consume. It frequently "cures the disease by killing the patient."
 &
  Thus, "drastic steps" may become advisable. The proper remedy may lie in stimulating the propensity to consume "by redistributing  income or otherwise."
 &
  Fortunately, most cyclical downturns occur before capital assets reach widespread overabundance. They begin while investments can still yield profits - but at much lower rates than previously expected. This causes a substantial decline in both earnings expectations and price-earnings multiples for capital assets.
 &
  At such times, the boom may be extended if interest rates can be pushed sharply lower, restoring positive expectations.

  "The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom."

  Except during war, Keynes finds no instances of "full employment," although shortages of some skills and the development of some production bottlenecks have observably occurred during prosperous times - especially during the 1928-1929 boom.

 "Nor was there over-investment in the sense that the standard and equipment of housing was so high that everyone, assuming full employment, had all he wanted at a rate which would no more than cover the replacement cost, without any allowance for interest, over the life of the house; and that transport, public services and agricultural improvement had been carried to a point where further additions could not reasonably be expected to yield even their replacement cost."

  In short - like Marx - Keynes views the need for profits as the obstacle rather than as the driving force for generating widespread prosperity. By this standard, economic and social "needs" are without practical limit, and are impossible to satisfy. At least Marx honestly limited his utopian promises to mere subsistence.

  Again, Keynes offers the preposterous opinion that as little as 25 years might be all that is required to reach a true state of such "full investment" if only full employment could be maintained for that length of time. Moreover, even if it is not possible to sustain investment at full employment levels, the answer is not to reduce investments through higher interest rates, but to increase consumption so investment retains its profitability.
 &
  Keynes believes it is possible as a matter of public policy to increase "the stock of capital until it ceases to be scarce." This can be achieved if public policy is designed to stimulate both investment and consumption.

  "Whilst aiming at a socially controlled rate of investment with a view to a progressive decline in the marginal efficiency of capital, I should support at the same time all sorts of policies for increasing the propensity to consume. For it is unlikely that full employment can be maintained, whatever we may do about investment, with the existing propensity to consume."

  What could be more obvious? What could possibly go wrong with such a well meaning policy?
 &
  Not until the world had experienced the gross ineptness of government management in socialist and in other administered systems - and in administered segments of capitalist systems - would the answer become clear enough to counter such facile policy suggestions.

  Particular private sector causes of cyclical downturns are noted just once by Keynes. He offers some brief thoughts on the impacts of inventory and agricultural crop fluctuations. Incredibly - considering the experience of the previous half dozen years - he downplays their significance for recent events.

  Unfortunately, he totally ignores the impacts of the huge agricultural crop carryovers from the record and near record crops of 1928, 1930 and 1931, and the disruption of world agricultural markets early in 1930 and thereafter by the cumulative impacts of a decade of trade war protectionism. Agricultural trade - a huge percentage of the market for U.S. crops - had totally disappeared, and would not even begin to revive for four more years. See, "Great Depression Chronology, The Collapse of Agriculture."

Trade Policy

Mercantilism:

 

&

  International trade is left for last by Keynes. He never directly faces the fact that his policy prescriptions MUST have adverse impacts on international trade and payments flows, but he provides strong indications that he knew this to be the case.
 &

Under laissez-faire capitalism, "all measures helpful to a state of chronic or intermittent under employment were ruled out, except measures to improve the balance of trade on income account."

  Keynes clearly has a Marxist perspective on foreign trade. The ultimate limitations on mature domestic capitalist markets require that capitalist systems seek investment opportunities and markets abroad. Under laissez-faire capitalism, "all measures helpful to a state of chronic or intermittent under employment were ruled out, except measures to improve the balance of trade on income account."

  This assertion is patently false. A wide variety of government policies designed to facilitate commerce are available - and indeed are essential - to improve economic results. In fact, such government policies have always been a vital part of every successful capitalist system. While governments vary in the particular policies they implement or reject, none has ever depended on a general laissez-faire economic policy. See, "Government Futurecast," Part I, "Economic virtues of the U.S. political system."

A modestly favorable balance of trade is thus vital for capitalist nations under traditional laissez-faire interest rate policies.

 

There are numerous ways in which mercantilist trade restrictions result in unfavorable trade balances instead of favorable balances.

 

"A policy of trade restrictions is a treacherous instrument even for the attainment of its ostensible object, since private interest, administrative incompetence and the intrinsic difficulty of the task may divert it into producing results directly opposite to those intended."

  A favorable balance of trade is essential to directly fund foreign investments and indirectly increase monetary metals. The increase in monetary metals is essential to keep interest rates low enough to keep domestic investment levels high. A modestly favorable balance of trade is thus vital for capitalist nations under traditional laissez-faire interest rate policies. "An unfavorable balance of trade may soon produce a state of persistent depression." (Keynesian policies ALWAYS adversely impact the balance of trade.)
 &
  Mercantilist objectives are thus correct, even if their policies generally have adverse unintended consequence. However, protection of infant industries and efforts to improve the terms of trade are realistic objectives for national policy, according to Keynes, even when they are disadvantageous for the world as a whole. (But see, Irwin, "Free Trade Under Fire.")
 &
  While many of their practices were self-defeating, the overall objectives of the mercantilists were correct, according to Keynes.

  "There was wisdom in their intense preoccupation with keeping down the rate of interest by means of usury laws - - -, by maintaining the domestic stock of money and by discouraging rises in the wage-unit; and in their readiness in the last resort to restore the stock of money by devaluation, if it had become plainly deficient through an unavoidable foreign drain, a rise in the wage-unit, or any other cause."

  The "any other cause" almost always involves government overspending and debt - often but not always as an essential response to military conflicts. Monetary devaluation - clipping the coins or running the printing presses - is a form of general taxation - appropriating the produce of the public for government purposes. That's the real reason all modern governments want as much inflation as they can get away with without causing observable economic harm. This generally includes about 2% price inflation in addition to the inflation which eats up productivity gains. Today, in the U.S., these two together generate additional revenue equivalents in excess of 5% of GDP.
 &
  International markets tend to be broadly self-correcting - in ways similar to those of domestic markets. Flexible exchange rates permit smoother adjustments, while fixed exchange rates generally require financial earthquakes to achieve any major adjustments that may be needed.
 &
  When not justified by productivity gains, lower domestic interest rates and higher domestic rates of investment and consumption will draw in additional imports and have similar equilibrating impacts on the balance of payments. Keynes recognizes such impacts - but discusses them only after they have proceeded sufficiently to increase domestic costs or to shift investment flows towards higher interest opportunities abroad.

  Keynes is cognizant of the numerous ways in which mercantilist trade restrictions result in unfavorable trade balances instead of favorable balances. He notes that England enjoyed a favorable balance in the 19th century while operating essentially an open - free trade - economic system.

  "There are  strong presumptions of a general character against trade restrictions unless they can be justified on special grounds. The advantages of the international division of labour are real and substantial, even though the classical school greatly overstressed them. The fact that the advantage which our own country gains from a favorable balance is liable to involve an equal disadvantage to some other country - a point to which the mercantilists were fully alive - means not only that great moderation is necessary, so that a country secures for itself no larger a share of the stock of the precious metals than is fair and reasonable, but also that an immoderate policy may lead to a senseless international competition for a favourable balance which injures all alike. And finally, a policy of trade restrictions is a treacherous instrument even for the attainment of its ostensible object, since private interest, administrative incompetence and the intrinsic difficulty of the task may divert it into producing results directly opposite to those intended."

The only means of correcting trade and payments imbalances while still maintaining the currency peg was to raise domestic interest rates sufficiently to slow down the entire economy.

  The gold-based fixed exchange rate system prior to the Great Depression created dangerous conditions. The only means of correcting trade and payments imbalances while still maintaining the currency peg was to raise domestic interest rates sufficiently to slow down the entire economy. This reduced imports, drove costs down, and improved international competitiveness - but at the cost of domestic depression.

  "[Thus], the objective of maintaining a domestic rate of interest consistent with full employment was wholly ruled out. Since, in practice, it is impossible to neglect the balance of payments, a means of controlling it was evolved which, instead of protecting the domestic rate of interest, sacrificed it to the operation of blind forces."

  Heavens forbid that anyone suggest the productivity improvements always possible by the removal of government obstacles to and burdens on commerce.

  With the advent of the Great Depression, such practices were abandoned by Great Britain and in many other nations in favor of more flexible practices, Keynes notes with approval.

  Such flexible practices failed to protect the pound during the last half of the 20th century. Nor did they assure full employment or prevent the fluctuations of the business cycle.

If all nations abandoned fixed exchange rates and pursued Keynesian policies for achieving full employment, then all would benefit and international competition for precious metals would end.

  The gold standard - a fixed exchange rate standard - was at the heart of the problem prior to the Great Depression, Keynes asserts. This sets every nation in competition over flows of precious metal that alone can dictate prosperity or decline.

  Competition is good for national economic policies as well as for so much else. It imposes discipline on political leaders that they hate. It forces them to strive to provide the most favorable commercial environment possible for the prosperity of their people, and bluntly punishes political excess and irresponsibility - at cost to the citizenry as well as the politicians.
 &
  Where governments have sources of wealth that do not depend on the prosperity of the people - as where there are abundant oil or diamond resources in small nations - such wealth can prove a curse for the people. Then, political leaders need not give a damn for the commercial environment and the economic well being of the people.
 &
  Access to the monetary printing presses is conducive to similar disregard for the public well-being. The inability to print money is a major reason why individual states in the U.S. concentrate so hard on facilitating commerce within their borders. Small nations with soft currencies and little mineral wealth operate under similar imperatives.

  Keynes provides some interesting background on early mercantilist thought, but basically provides a simplistic - partial explanation of the problems of the gold standard and fixed exchange rates in the 1920s and before. He concludes that, if all nations abandoned fixed exchange rates and pursued Keynesian policies for achieving full employment, then all would benefit and international competition for precious metals would end.

  "It is the policy of the autonomous rate of interest, unimpeded by international preoccupations, and of a national investment programme directed to an optimum level of domestic employment which is twice blessed in the sense that it helps ourselves and our neighbors at the same time. And it is the simultaneous pursuit of these policies by all countries together which is capable of restoring economic health and strength internationally, whether we measure it by the level of domestic employment or by the volume of international trade."

  This is a typical assertion of many utopians - and all pyramid schemes. If only everybody would believe in the scheme and act on that belief, it would be sure of success and never break down. That Keynes would write such a paragraph is a strong indication that he knew and feared the impacts on international trade and payments balances that his policies would have for any particular nations that adopted them.
 &
  It is not fixed exchange rates and free trade that are the problems. Although financial excesses in the private economy can also play a role, always - and for any system - especially Keynesian systems - it is irresponsible government policies and government profligacy - and monetary expansion - that cause problems.
 &
  In fact, fixed exchange rates offer many benefits. See, "The determinants of purchasing power" in "Capital as Purchasing Power."
 &
  The politicians - and the Keynesian economists who provide them with intellectual support for irresponsible policies - rage against natural limitations - natural disciplines - that block their desire for unlimited expenditures and the easy solutions of the printing presses. They seek out scapegoats to divert blame from themselves, and blame capitalism and the disciplines of capitalist processes for the consequences of their own mismanagement.

   Thus, Keynes had to assume that floating exchange rates imposed no similar disciplines. He even looked with some sympathy on closed systems.

  The 1970s would prove Keynes' view to be disastrously in error. It was then demonstrated that gold reserves and monetary pegs in fact offered some temporary shelter from the merciless judgments of international money markets. For the U.S. after WW-II - with its then vast gold holdings - this temporary shelter extended for two decades.
 &
  Without gold or hard currencies to expend in support of a national currency, adverse currency movements quickly and ruthlessly punish government profligacy - especially in soft currency nations.

  The relationship between interest rates and prosperity has been obvious for millennia, Keynes notes. Efforts of all kinds have been directed at the problem. "Provisions against usury are amongst the most ancient economic practices of which we have record." That interest rates tend to rise "too high" - above "a level best suited to the social advantage" - is a view that Keynes strongly supports. (Even Adam Smith viewed usury laws with some sympathy.)

  There is a vast difference between - on the one hand - administratively attempting to set low interest rates - and - on the other hand - encouraging lower interest rates by improvements in the general commercial environment that reduce the risks of both the lender and the borrowing entrepreneur. Administered rates - like any other administered prices - MUST prove counterproductive. Ultimately, the market always wins.

  Schemes for artificially dealing with liquidity preference or hoarding problems have historically been quite common. Keynes notes one - advocated by Silvio Gesell - for imposing a carrying cost on money by requiring that money be stamped each month, with a charge somewhat less than 6% on an annual basis. Keynes correctly notes that this would just chase people into other stores of value - art, gold bars, jewelry, etc. 

  In fact, this is exactly what inflation does - with the same impacts and defects. A 6% charge on money is like a 6% rate of price inflation - a rate that already inflicts so much distress as to prove intolerable wherever it has been experienced.

Utopia

The virtues and vices of savings:

  Excess savings and inadequate rates of consumption are concepts at the heart of Keynes' "General Theory." At the end of the book, Keynes notes with approval views that attack excessive savings as an economic sin. He does not include Marx, here, since Marx viewed all savings as "hoarding."

  Savings in excess of investment needs - "excess" or "undue" saving - is a straw man. It is an analysis of problems of economic distress that starts too late in the infinite chains of economic cause and effect.
 &
  Of course, with perfect price flexibility, there truly cannot be insufficient money in circulation, since prices would simply adjust to the money available - just as Adam Smith explains. Of course, there can never be anything near perfect price flexibility - so monetary fluctuations matter. Nevertheless, policies that facilitate price flexibility will improve economic performance, while those that inhibit price flexibility must make problems worse.
 &
  In the private sector - where the prospect of commercial death serves to concentrate minds - the process of policy reform occurs naturally. However, stupidities in government policies periodically pose far more intractable problems. 
 &
  It is not "undue savings" - but the reasons why savings become "undue" - that must be addressed.

A promise of utopia:

 

&

  A final note that is pure Marxist ideology concludes this work. Keynes finds "no intrinsic reason for the scarcity of capital." He, like Marx, has total confidence in the ability of government - of "the community" - to administer economic markets and manage economic activities.
 &

  Keynesian policies vigorously applied for about 25 years would produce full capitalization sufficient to make the roles of financiers, rentiers and "the functionless investor" superfluous. Indeed, their interest rates and rents are obstacles to progress.
 &
  The achievement of this noble goal would involve some "comprehensive socialization of investment." Systems of taxation and administration would have to more nearly equalize results and assure adequate levels of consumption and investment. The costs of capital assets would then need to cover only obsolescence, risks and the costs of skill and supervision - costs sufficiently low to dispense with profits. The needed skills and supervision could be acquired by means of suitable salary.
 &
  However, this is an administered utopia - not a socialist utopia. Unlike the Marxian utopia, market mechanisms would still be employed in the Keynesian utopia to allocate resources.

  Like socialist utopias, Keynes' administered utopia is static and contemplates little further progress. We might as well close the patent office. It is based - like all socialist utopias - on total ignorance of the inherent ineptness of government management and administered systems. See, Government Futurecast," Part II, "Government management."
 &
  It ignores the obvious reality that his objective is in any event impossible to even temporarily reach. Capital may be fungible, but capital assets are not. As profits decline arithmetically, the pressures of creative destruction increase exponentially - rendering efforts to reach such an objective ludicrous. Capital assets thus must always be scarce - offering adequate profits for efficient enterprise.

  See, Keynes, "The General Theory of Employment, Interest, & Money,"   Part I, "Elements of The General Theory."

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