Living in the Age of Keynes

The path to prosperity

In 1935 John Maynard Keynes wrote to his friend George Bernard Shaw: “I believe myself to be writing a book on economic theory which will largely revolutionize, not I suppose at once but in the course of the next ten years – the way the world thinks about economic problems.”

That book, The General Theory of Employment, Interest and Money, published the following year, would go on to fully realise Keynes’s expectations. After World War Two, following Keynes’s analysis, policy makers and economists around the world used fiscal and monetary tools to pursue the goal of ‘full employment’. Keynes gave his name to both the economics and the age itself.

It is conventionally said that this Keynesian Age was brought to an end by the Stagflation of the 1970s. To the extent that responsibility for ‘economic management’ was simply transferred from politicians with primarily fiscal tools to central bankers with monetary tools this can be argued. But there is another sense in which we never left the Age of Keynes.

The first substantive chapter of The General Theory is chapter two, ‘The Postulates of the Classical Economics’. Here Keynes ridicules a set of beliefs which he ascribes to an ill-defined group of ‘Classical economists’. For these Classicals income was either spent on consumption or saved. These savings, as capital, were invested with the two quantities, savings and investment, being equilibrated by the interest rate. As Keynes’s Classical mentor Alfred Marshall put it:

“[I]t is a familiar economic axiom that a man purchases labour and commodities with that portion of his income which he saves just as much as he does with that he is said to spend. He is said to spend when he seeks to obtain present enjoyment from the services and commodities which he purchases. He is said to save when he causes the labour and the commodities which he purchases to be devoted to the production of wealth from which he expects to derive the means of enjoyment in the future.”

Keynes, by contrast, saw no such essential unity between savings and investment. In The General Theory he wrote that the “decisions which determine Saving and Investment respectively are taken by two different sets of people influenced by different sets of motives, each not paying very much attention to the other”.

It was possible, Keynes argued, that investors driven by mercurial “animal spirits” could become so pessimistic that the Marginal Efficiency of Capital (the expected return on their investment) could plunge below the interest rate (the cost of funding that investment) so that no investment would take place. The Marginal Efficiency of Capital could, indeed, sink so low that nominal interest rates couldn’t offset it, giving rise to the ‘liquidity trap’ and monetary impotence. Marshall’s link would be broken and aggregate demand would fall.

For Keynes, the way to guarantee the continued investment which not only guaranteed aggregate demand in the present but also increased prosperity in the future, was for the government to underwrite the profitability of investment by acting as spender of last resort, via fiscal stimulus, to prop up the Marginal Efficiency of Capital.

This was the polar opposite of the Classical view. Whereas Keynes believed that spending made you rich enough to save, the Classicals believed that saving made you rich enough to spend. Though Keynes would have agreed with the father of the Classicals, Adam Smith, that “Consumption is the sole end and purpose of all production”, they took totally different routes to get there.

This stems from a striking difference in attitudes to saving. Adam Smith, anticipating Marshall, wrote, “What is annually saved is as regularly consumed as what is annually spent, and nearly in the same time too; but it is consumed by a different set of people…by labourers, manufacturers, and artificers”. Keynes, by contrast, said that “whenever you save five shillings, you put a man out of work for a day”.

Is it Smith or Keynes’s attitude towards consumption and saving which animates western policymakers today? Since 2008 we are supposed to have seen ‘The Return of the Master’. In truth he never went away. We’ve been living in the Age of Keynes for decades.

This article originally appeared at The Commentator

John Maynard Keynes, in the long run

John Maynard Keynes, 1883 – 1946

“In the long run we are all dead”. So said John Maynard Keynes, born 120 years ago on Wednesday, in one of the most misquoted phrases in economics.

It comes from Keynes’s Tract on Monetary Reform, from 1923, in a discussion about the economic long and short run. If a factory closes you can say that in the long run its workers will find jobs somewhere else but in the short run there may be considerable unemployment and it was this that Keynes was concerned to tackle. Thus, the full quote is: “But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.”

Indeed, Keynes thought much about the long run. One of his most celebrated pieces of writing was an essay titled The Economic Possibilities for Our Grandchildren (1930) and he was one of the architects of the post-World War II Bretton Woods monetary system.

But this isn’t to say that Keynes had any coherent idea about the long run. He didn’t. In The Economic Possibilities for Our Grandchildren he observed that, since the Industrial Revolution, “the average standard of life in Europe and the United States has been raised, I think, about fourfold” and predicted that “the standard of life in progressive countries one hundred years hence will be between four and eight times as high as it is today”. In large part he attributed this, correctly, to “the accumulation of capital which began in the sixteenth century”.

But this capital accumulation was simply assumed by Keynes, not analysed. In The General Theory of Employment, Interest and Money (1936) he speculates on the future possibility of “a society which finds itself so well equipped with capital that its marginal efficiency is zero and would be negative with any additional investment”, blithely asserting that it would be “comparatively easy to make capital-goods so abundant that the marginal efficiency of capital is zero”. The Solow growth model theorists are derided for their characterisation of technological change appearing exogenously as “manna from heaven” but that is exactly how Keynes conceptualised the accumulation of capital and capital goods.

In fact financial capital is that part of income not spent on current consumption; saving, in other words. Capital goods have to be produced and maintained. If they had no value, as Keynes posits in his Utopia, they would not be produced. Include the cost of maintaining them and they would be even less likely to be produced.

This lack of understanding of the process of capital accumulation, which he himself put front and centre of his theory of increasing wealth, was a constant in Keynes’s writings. In The Economic Consequences of the Peace (1919) Keynes wrote that, during the 19th century, which he later characterised as an “epoch of enormous economic progress”,

“There grew round the non-consumption of the cake all those instincts of puritanism which in other ages has withdrawn itself from the world and has neglected the arts of production as well as those of enjoyment. And so the cake increased; but to what end was not clearly contemplated. Individuals would be exhorted not so much to abstain as to defer, and to cultivate the pleasures of security and anticipation. Saving was for old age or for your children; but this was only in theory,—the virtue of the cake was that it was never to be consumed, neither by you nor by your children after you.”

This is drivel. The cake was consumed, not least by Keynes himself who wrote of the pre-1914 era that “The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he may see fit, and reasonably expect their early delivery upon his doorstep”. And while Keynes was a-bed, per capita consumption of milk, meat, butter, sugar, and tea all rose between 1860 and 1913. The grandchildren and great grandchildren of those who had flocked to Milton’s “dark, satanic mills” in the early days of the Industrial Revolution were beginning to consume such soon-to-be-household names as Oxo, Lipton, Rowntree, and Pears.

The end, even if Keynes couldn’t see it, was to extend to the inhabitant of Stepney the opportunities enjoyed by the inhabitant of Bloomsbury. This was made possible, as Keynes recognised, by “the accumulation of capital” which came, as Keynes failed to recognise, from saving. Keynes, aping his friend Lytton Strachey, derided the Victorians for not consuming the cake in its entirety but they understood better than Keynes that it was out of those leftovers, those savings, that they would bake a bigger cake tomorrow.

Keynes was concerned about the long run but he had no conception of how we would get there. He simply extrapolated past trends into the future without stopping to consider what factors were at work behind those trends. To paraphrase, economists set themselves too easy, too useless a task if they simply tell us the ocean will be flat tomorrow without checking the forecasts.

By consuming the whole cake today without regard to the provision of tomorrow’s dinner, in Keynes’s long run we’d all be hungry.

This article originally appeared at The Commentator

Ground control to Major Krugman


Paul Krugman was ill/The Day the Earth Stood Still…

One of the standard charges against believers in smaller government is that we are all fans of Ayn Rand and imagine ourselves as John Galt. I get this thrown at me despite the fact that I have never read a single thing Rand wrote.

Indeed, Paul Ryan got a roasting for his admiration of Rand from New York Times columnist Paul Krugman who called Rand “a very unserious, unreasonable novelist”. And maybe Krugman is right? Perhaps basing your political and economic philosophy on an old science fiction novel is the height of weirdness.

But hang on, what’s this? In an article for the Guardian titled ‘Asimov’s Foundation novels grounded my economics‘, Krugman writes, “I grew up wanting to be Hari Seldon, using my understanding of the mathematics of human behaviour to save civilisation.”

It’s worth reading that again and remembering that it’s from the same man who quotes the well-worn joke about Atlas Shrugged and Lord of the Rings; “the unrealistic fantasy world portrayed in one of those books can warp a young man’s character forever; the other book is about orcs.” If nothing else, at least Krugman’s suggestion that a fake alien invasion could rescue the economy makes a little more sense now.

For those who haven’t waded through Isaac Asimov’s several Foundation novels, Krugman explains:

In Foundation, we learn that a small group of mathematicians [including Krugman’s hero Hari Seldon] have developed ‘psychohistory’ (a) rigorous science of society. Applying that science to the all-powerful Galactic Empire in which they live, they discover that it is in fact in terminal decline, and that a 30,000-year era of barbarism will follow its fall. But they also discover that a carefully designed nudge can change that path…The novels follow the unfolding of that plan

There’s only one brief description of a space battle – and the true purpose of the battle, we learn, is not the defeat of an ultimately trivial enemy but the creation of a state of mind that serves the Plan

There are a series of moments in which the fate of the galaxy seems to hang in the balance… Each of these crises is met by the men of the hour, whose bravery and cunning seem to offer the only hope. Each time, the Foundation triumphs. But here’s the trick: after the fact, it becomes clear that bravery and cunning had nothing to do with it, because the Foundation was fated to win thanks to the laws of psychohistory. Each time, just to drive the point home, the image of Hari Seldon, recorded centuries before, appears in the Time Vault to explain to everyone what just happened.

You can see how Krugman pictures himself. He is one of a small band of Psychokeynesians who possess an insight, the IS/LM model, which enables them to predict the future of economies and gives them the tools – vast deficits and credit expansion – to steer them.

Anything that supports the Psychokeynesian analysis is evidence; anything that doesn’t is simply a ruse. And when the next bit of corroborating evidence floats along, Hari Krugman emerges from a Time Vault to say “told you so”.

But there’s a problem. It’s true that Krugman spotted the housing bubble in 2005 but then he had been calling for it in 2002. This might lead you to question Krugman’s omnipotence. Or you might want to wait for Hari Krugman to appear and explain how this crafty Knight’s Move is actually part of The Plan.

Hari Krugman celebrates his clairvoyance:

The IS-LM model (don’t ask) told us that under depression-type conditions like those we’re experiencing, some of the usual rules would cease to apply: trillion-dollar budget deficits wouldn’t drive up interest rates, huge increases in the money supply wouldn’t cause runaway inflation. Economists who took that model seriously back in, say, early 2009 were ridiculed and lambasted for making such counterintuitive assertions. But their predictions came true.

But considering that they also predicted that this mountain of debt and avalanche of new money would lead to economic recovery then no, their predictions didn’t come true.

Remember former Chair of the Council of Economic Advisors Christina Romer’s prediction that President Obama’s Keynesian stimulus would see American unemployment peak at 8 percent in late 2009 and fall to a little over 5 percent today? Remember that American unemployment actually peaked at over 10 percent in late 2009 and stands at 7.9 percent today?

This doesn’t worry Hari Krugman a bit. In the course of a spat with economist Robert P. Murphy, Krugman wrote:

[I]t’s really important to distinguish between fundamental predictions of a model and predictions that an economist happens to make that don’t really come from the model… [T]he unfortunate Romer-Bernstein prediction of a fairly rapid bounceback from recession reflected judgements about future private spending that had nothing much to do with Keynesian fundamentals, and therefore sheds no light on whether those fundamentals are correct. In short, some predictions matter more than others.

Quite so Paul. Apparently the predictions that come true matter; those that don’t, don’t.

In his Guardian piece Krugman excitedly writes of “the possibility of a rigorous, mathematical social science that understands society, can predict how it changes, and can be used to shape those changes.” Well, looking at the record it’s clear that Hari Krugman hasn’t found it.

Or maybe he has, and we mere mortals simply need to wait for his shimmering likeness to appear from the Time Vault and say “told you so.”

This article originally appeared at The Commentator

Why do smart people still choose Keynes over Hayek?

The ridiculous and the sublime

On October 17th a group of concerned economists wrote to the Times. The current economic woes, they wrote, were down to insufficient spending/increased saving. “[W]hen a man economizes in consumption”, they argued, “and lets the fruit of his economy pile up in bank balances or even in the purchase of existing securities, the released real resources do not find a new home waiting for them.” Crucially, “In present conditions their entry into investment is blocked by lack of confidence.” The government should step in and spend to make up the shortfall they said.

On October 19th another group of economists replied with their own letter to the Times. They believed that the cause of the economic problems was monetary mismanagement which had created “a deficiency of investment-a depression of the industries making for capital extension, &c., rather than of the industries making directly for consumption.” They argued for the necessity of increased saving to readjust this and explicitly rejected any role for government spending, writing that “many of the troubles of the world at the present time are due to imprudent borrowing and spending on the part of the public authorities.”

But this was October 1932 and the letters were written by John Maynard Keynes and Friedrich von Hayek. It says much about the essentially static nature of economic knowledge that an 80 year old debate remains so compelling today that it continues to inspire radio shows, debates, books, and even rap-offs.

Keynes’s economics, in a nutshell, argues that of the two components of ‘effective demand’, consumption and investment, investment is prone to volatile swings. As Keynes put it, investment spending was reduced when their expected payoff, the Marginal Productivity of Capital, dipped below the cost of financing them, the interest rate.

Why might this happen? “Animal spirits” was Keynes’ answer; “Don’t ask me guv” in other words. Whatever it was that tipped investors from optimism into effective demand-sapping pessimism is exogenous to the model; it cannot be accounted for by it.

Either way, the policy prescriptions of the Keynesian model are obvious. Financing costs must be held down with low interest rates and the Marginal Productivity of Capital must be underwritten by a government guarantee to purchase, with deficit spending if need be, whatever output industry might produce. Low interest rates and deficit spending. That is the Keynesian prescription for prosperity.

Hayek’s theory is very different. For Hayek, when low interest rates cause an expansion of credit, this credit flows into some parts of the economy before others. This blows up bubbles in the affected part of the economy, be it in housing, internet stocks, or tulips.

At some point, Hayek argues, the inflationary effect of this credit expansion overwhelms any wealth effect and interest rates begin to rise. With no further credit available to purchase the bubble assets the prices of these assets and their attendant industries collapse. This is the bust.

A major difference between Hayek’s theory and Keynes’s is that for Hayek the bust as well as the boom is endogenous to the model, it is explained by it. The bust isn’t caused by “animal spirits” switching inexplicably out of the clear blue sky, but by the predictable outcome of actions undertaken in the boom.

As Hayek’s model is radically different from Keynes’s, radically different prescriptions follow from it. Viewing the cycle as a whole Hayek believed that preventing a future bust was as important as fighting the current one and he proposed measures to limit the ability of banks to swell credit, his favoured solution being competing currency issue by banks.

More immediately, Hayek argued that as the bubble assets and attendant industries had been pumped up by unsustainable injections of inflationary credit, they could only be liquidated; any attempt to preserve their value would only prolong the bust or, as bad, set another cycle in motion. Sound money and non-intervention was the prescription of Hayek and his fellow Austrian Schoolers.

Looking back over the last few years you have to ask how intelligent people, examining the evidence, can still choose Keynes over Hayek. In both Britain and America we had monetary policy makers working to keep financing costs down with low interest rates. We had governments running budget deficits and applying fiscal stimulus to economies which were already growing. We followed the Keynesian prescription for prosperity and we still ended up with a bust – a bust which Hayekians, with their superior model, saw coming.

The answer lies in the prescriptions. Keynes, with his cheap credit and shower of borrowed money, is a pleasant prospect. Indeed, Paul Krugman, one of the most uncompromising modern Keynesians, believes that “Ending the depression should be incredibly easy”, all we need is cheaper credit and more borrowing. Just, in fact, what we had going into the crisis.

Hayek, on the other hand, offers a more painful prospect. As his mentor Ludwig von Mises put it:

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved”

Which of these vistas would you prefer to gaze upon?

But these theories should be judged not on how warm and fuzzy they make us feel but on how accurate they are. On that score Hayek wins hands down yet some still cling doggedly to Keynes. It’s for the same reason the aunt who gives you chocolates is preferred to the aunt who makes you do your homework.

This article first appeared at The Commentator

Barack Brewster’s Millions

Who ya gonna call in November?

Films have often been vehicles for communicating complex ideas and philosophies in coded parables. The dreary films of Marxist filmmaker Ken Loach aren’t much more fun than ploughing through all three volumes of Das Kapital but they do, at least, take less time.

When, in The Shootist, John Wayne’s character, J B Books, says “I won’t be wronged, I won’t be insulted, and I won’t be laid a hand on. I don’t do these things to other people, and I require the same from them”, he was saying roughly what it took Robert Nozick 300 pages to say in Anarchy, State, and Utopia.

But I wasn’t expecting any such heft when I sat down to watch Brewster’s Millions at the weekend. As a child of the 1980s I might have seen this film around 20 times but this time I noticed something new in it; it is a parable for Keynesian economics.

It tells the story of washed up baseball player, Montgomery Brewster (Richard Pryor), who is left $300 million by an eccentric relative. There is one catch: first he has to spend $30 million in 30 days with absolutely nothing to show for it; “you’re not allowed to own any assets. No houses, no cars, no jewelry. Nothing but the clothes on your back!”

Brewster uses a raft of tricks to spend this money, some of which will be oddly familiar to anyone who has been watching economic policy making over the last few years.

Brewster’s first act is to go on a hiring spree offering vastly inflated wages. No, not public sector employees, but a team of security guards. Later he gets into his very own crackpot environmental, or ‘green tech’, scheme when he buys an iceberg with the aim of floating it to the Middle East to bring relief to supposedly drought stricken Arabian farmers.

“What thirsty Arab farmers?” his friend Spike (John Candy) asks, “There aren’t any, because there aren’t any farmers in the desert!” If only John Candy had been on hand before Barack Obama blew $535 million on Solyndra.

Finally he hosts an expensive exhibition game between his old team, the Hackensack Bulls, and the New York Yankees. The Bulls are kitted out in new uniforms and flown in by helicopter. Brewster should, of course, have re-designated some of the major roads in New York as special lanes for his game; then he could have wasted as much money as the London Olympics.

If it sounds fanciful to see any economics in this flurry of pointless spending, consider the words of John Maynard Keynes himself:

“If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is”

A different attitude to wealth creation is on display in one of the classics of 1980s cinema, Ghostbusters.

Three government employees spend their days trying to seduce their students with phony experiments and running away from ghosts. When this dismal level of productivity proves too low even for the public sector they are sacked and go private, though not without misgivings.

As Ray Stanz (Dan Aykroyd) warns Peter Venkman (Bill Murray), “Personally, I liked the university. They gave us money and facilities. We didn’t have to produce anything! You’ve never been out of college. You don’t know what it’s like out there. I’ve worked in the private sector. They expect results.”

Spotting a gap in the market (“We are on the threshold of establishing the indispensable defense science of the next decade. Professional paranormal investigations and eliminations. The franchise rights alone will make us rich beyond our wildest dreams”) the three borrow some money and set up the Ghostbusters.

Soon they are raking in $5,000 a night, getting coverage from Larry King and Time magazine, and taking on a black member of staff, no affirmative action needed.

Then up pops Walter Peck of the Environmental Protection Agency. “I want to know more about what you do here” he demands. “Frankly, there have been a lot of wild stories in the media and we want to assess for any possible environmental impact from your operation, for instance, the presence of noxious, possibly hazardous waste chemicals in your basement. Now you either show me what’s down there or I come back with a court order!”

With Venkman an unlikely John Galt the government steps in, shuts down the thriving private sector enterprise, and the town is flooded with ghosts.

Where Brewster’s Millions is an object lesson in the wasteful uselessness of Keynesian economics, Ghostbusters is one of the most pro free market films ever made, a hymn to the genius of capitalism and the clumsy damage wrought by government.

Or, to quote another economist, Milton Friedman, “If you put the federal government in charge of the Sahara Desert, in five years there’d be a shortage of sand”

These differing attitudes are on display in the US Presidential election. With the American economy slowing to stall speedthe question each of the candidates must answer is “Where is the growth going to come from?”

With his background in law and ‘community organising’ it’s no surprise that Barack ‘Brewster’ Obama doesn’t know, pinning his hopes on ever more government spending of the Solyndra sort.

Mitt ‘Venkman’ Romney, by contrast, is at least paying lip service to private sector led growth of the Bain Capital sort. The difference is that Bain made money and Solyndra went bust. Do Americans want their economy run by Monty Brewster or the Ghostbusters? That will be the question this November

This article originally appeared at The Commentator

Time for an economic Nuremberg for the last Labour government

The guilty men

ike an iceberg, the extent of the damage wrought by the last Labour government is still becoming apparent.

One of the wheezes Labour used to camouflage its vast spending spree was the Private Finance Initiative. These had been brought in by John Major’s Conservatives (to criticism from the then Labour opposition) and involved a private sector entity building something and then selling it or leasing back to the government over a number of years, usually decades.

Upon winning the election in 1997 however, Labour performed a volte face and embraced PFIs. They appealed to Gordon Brown because the liabilities taken on under PFIs would not show up on the government’s balance sheet. In other words, they wouldn’t be included in the national debt figure.

Labour signed up to an estimated £229 billion of PFI projects. That’s almost two and a half times the entire projected budget deficit for 2012 – 2013, or 16 percent of GDP.

And all of it was off the books. This enables Labour supporters to argue that “Public sector net debt (as a percentage of GDP) FELL from the start of Labour’s time in government until the beginning of the global financial crisis”. But, if you include the PFI liabilities the Labour government signed us up to, any fiscal improvement during their time in office vanishes and this already thin argument does likewise.

Perhaps Brown was stupid and/or hubristic enough to believe he really had banished “Tory boom and bust”. Perhaps he calculated that he would be long gone before the bills for PFI landed on the mat. Either way, while in the long run Brown is (thankfully) politically dead, we taxpayers are not.

Last week it emerged that six NHS trusts were facing bankruptcy thanks to the PFI deals struck by the Labour government. As the Telegraph reported

The total value of the NHS buildings built by Labour under the scheme is £11.4bn. But the bill, which will also include fees for maintenance, cleaning and portering, will come to more than £70bn on current projections and will not be paid off until 2049…Some trusts are spending up to a fifth of their budget servicing the mortgages…Across the public sector, taxpayers are committed to paying £229bn for hospitals, schools, roads and other projects with a capital value of £56bn”

Indeed, like the cat who leaves little ‘presents’ around the house for you to discover when you return from holiday, the Labour government of 1997 to 2010 is the gift that keeps on crapping on your carpet. We will be discovering fiscal turds left by Labour for literally decades to come.

If you were being charitable you would ascribe the fiscal incontinence of the Blair/Brown governments to some sort of Keynesian economic theory, though that fails to explain why they applied fiscal ‘stimulus’ for seven years to an already growing economy.

If you were being slightly less charitable you might ascribe it to incompetence of a quite staggering degree. The last Labour government, after all, were probably the biggest set of mediocre idiots ever to govern this country.

And, if you were being even less charitable, you might ascribe it to something more sinister – Brown poisoning the wells when he heard opposition tanks at the end of his strasse.

The architects of this national disaster have moved on. Blair is swanning around the globe earning millions. Brown is off brooding somewhere and probably enjoying it. Ed Balls, Brown’s right hand man through all this, is now, incredibly, Labour’s shadow minister for the economy!

We will have to live with the consequences of their mismanagement for years, why should they get away scot free? When we look at the continuing harm the Blair/Brown governments did to Britain shouldn’t we consider some sort of economic Nuremberg for these people? To punish them, Blair, Brown, and Balls, for the harm they have done to the British public?

Of course, you could argue that the electorate is responsible for electing these dangerous cretins. After all, every single majority Labour government in history has left office (in 1931, 1951, 1970, 1979, and 2010) with the economy in meltdown. Assuming that Labour voters aren’t so stupid that they don’t know this you have to conclude that they simply don’t care if the economy collapses.

In the wake of the Barclays rate fixing scandal, Ed Miliband has called for a full public inquiry into the banking industry, saying, “If you go out and nick £50 from Tesco, you are punished, at least we hope that you are punished – if you fiddle, lie, cheat to the tune of millions of pounds, you should also have the full force of the law brought against you.”

As Britain’s economy continues to smoulder isn’t it time for Miliband’s former colleagues in the wretched Labour government of 1997 to 2010, Tony Blair, Gordon Brown, and Ed Balls, to face a reckoning for the continuing damage they wrought upon the nation?


Overrated: Paul Krugman

“Snake oil, £14.99!”

When Friedrich von Hayek became a Nobel Laureate in economics in 1974 he said: “The Nobel Prize confers on an individual an authority which in economics no man ought to possess.” The truth of this is demonstrated daily by the case of Paul Krugman.

Krugman and his supporters whip out his Nobel Memorial Prize in Economic Sciences like a Top Trump of Diego Maradona. It is awarded annually — so why the special fuss about a prize Krugman won four years ago? His Nobel is being used to intimidate opponents. Any opposition to Krugman with his Nobel Prize is opposition to science itself.

Why Krugman generates so much opposition isn’t hard to fathom. From his perch in the New York Times he says one ridiculous thing after another. In the British context Krugman’s risible thesis is that the economy is struggling because the government isn’t spending enough money, that austerity is driving us back into recession, and that the solution to our debt crisis is to borrow and spend even more money.

But there is no austerity. British government spending has fallen from record highs by only about 1 per cent since the coalition took office. This has tipped us back into recession? Most private sector companies could save that by switching to cheaper copier paper.

Krugman argues that we need vast government spending to get us out of the recession. But Britain is running a budget deficit of more than 8 per cent of GDP, one of the highest in the developed world. The government is spending more than 400 million borrowed pounds every day; the national debt is increasing by more than £5,000 every second.

And yet, with all this extra borrowing and all this spending Britain’s economy is still tanking. Perhaps this suggests that massive deficit spending isn’t the answer. That’s one interpretation. Not for Krugman. To him the problem is that even the record levels of borrowing which will see Britain’s national debt increase by 60 per cent, from £1 trillion to £1.6 trillion, by the next election, are not enough. We need to borrow more. That, he claims, would solve our debt crisis.

Krugman’s new book (its recommended retail price an aggregate demand boosting £14.99) is called End This Depression Now! (Norton) as though that hadn’t previously occurred to anyone else. Indeed, it’s possible that if George Osborne decided to increase borrowing to 10 or 12 per cent of GDP we might have a quarter or two of growth. Labour managed to boost GDP growth to 1 per cent by dumping £160 billion of borrowed money into the economy.

But after that? Don’t ask Krugman. He follows John Maynard Keynes who, accurately but none too helpfully, observed: “In the long run we are all dead.” Actually, if you did ask Krugman, you might get a response like the one he gave when the dot com bubble burst: “To fight this recession the Fed needs . . . soaring household spending to offset moribund business investment . . . Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.”

That worked out fine, didn’t it? Well yes, in Krugman’s terms it did. Sure, we are now living with the effects of the bursting of that bubble but we did get a few good years of rocketing property prices which made us all feel as though we were getting richer just by sitting in our homes. And now that bubble has burst we just inflate a new one somewhere else. And when that bursts we inflate a new one. And when that bursts . . .

This is where the Keynesian ignorance of the long run demonstrated by Krugman leads you: lurching from one catastrophe to the next with a series of increasingly expensive quick fixes of ever shorter duration which do nothing to address the underlying problems.

The economic problems of Greece, Spain, and Britain are not that the deficits of 7 per cent, 7 per cent and 8 per cent their governments are respectively running are not high enough. Greek labour costs are higher than elsewhere and Greece doesn’t export very much. Spain has unemployment of 24 per cent thanks to a labour market which makes job creation almost impossible. Britain is  already one of the most indebted nations on the planet.

These fundamental problems are ignored by Krugman and his followers. In his 1994 book Peddling Prosperity Krugman accused the supply-side economists of the 1980s of being “cranks” selling “snake oil” because, he said, they offered politically expedient economic non-remedies with no   basis in fact. Hypocrisy, thy name is Krugman.

As for that Nobel Prize, Paul Krugman won it for his work on international trade patterns, not his crackpot Keynesianism. Sir Paul McCartney won an Ivor Novello award for writing “Yesterday”. That doesn’t mean sentimental schlock like “Mull of Kintyre” is worth listening to.

This article originally appeared in Standpoint

The euthanasia of the rentier: Why the assault on savers must end


Take that thrift!

With the British economy flat lining, America’s stumbling, and Europe’s in a nosedive, the clamour is growing for policymakers to ‘do something’. The Bank of England is, once again, being urged to deploy the weapon of Quantitative Easing – the spending of newly created money on long term assets.

Would this do any good? It hasn’t so far. The truth is that money is not wealth, goods and services are, and a central bank simply producing more money does not make us wealthier. But if central banks can’t create more wealth by creating more money they can redistribute the wealth there is.

This has been happening in Britain for nearly four years. Between October 2008 and March 2009 the Bank of England slashed interest rates from 5 percent to the historic low of 0.5 percent. When this failed to reignite economic growth the Bank resorted to £325 billion worth of QE. Whereas the Bank usually works on the short term end of the Yield Curve when setting the base rate, with QE it set out to pull down the long term end.

The stated aim was to put money into banks to get them lending again. I’ll leave it to you to judge how far the programme has succeeded in that aim, but one predictable side effect has been to lower returns all along the curve.

And this matters. With policymakers pulling every trick to keep interest rates everywhere as low as possible, Britain’s savers are being ravaged. On one estimate they are being robbed of £18 billion per year. Simon Rose, of pressure group Save Our Savers, puts the figure savers have been stripped of at £100 billion since the start of the crisis, “a staggering amount of money” he says “given that it would pay for the Olympics ten times over.”

The Bank’s monetary shenanigans haven’t boosted growth (cheerleaders have fallen back on the old argument that they have, at least, staved off catastrophe – again, I’ll let you be the judge). They have caused a vast transfer of wealth away from Britain’s savers and towards debtors and zombie banks and this is bad economic policy for reasons of growth and stability.

An entrepreneur with an idea must spend money on premises, wages, and all kinds of other possible outlays before seeing a single penny in revenue. The only way the entrepreneur can fund this outlay is from savings, either their own or other people’s channeled through a financial institution.

An increase in saving allows this period between embarking on production and sale of the product to lengthen (or fund other production periods for other goods). The lengthening of the production period, in turn, permits more stages of production,increasing ‘roundaboutness’ as the Austrian economist Eugen von Böhm-Bawerk put it.

Take shelter, a basic human need. Without the savings to sustain us over a prolonged production period, the period between embarking on production and using the shelter must be short, perhaps as long as it takes us to find a cardboard box. But with savings we can extend the production period and introduce many more intermediate stages. We can purchase land, draw up plans, purchase materials, hire labour etc.

The story of human material progress can be characterized as the lengthening of production processes enabling ever more intermediate steps. In short, savers are the difference between a three bed terrace and a cardboard box.

This much is not controversial; almost all economists agree that saving is an indispensable ingredient of increasing wealth. But the attack on savings risks shorter term instability too.

Lowering the base rate and QE works the same way, just on different ends of the Yield Curve; assets are purchased from banks with money newly created by the Bank of England.  From the point of view of a bank there is no difference between money deposited with it by savers and money it receives from the Bank of England in return for financial assets; it can lend out and earn profits on both.

But from the point of view of the wider economy there is a huge difference between the two types of ‘savings’. When savers deposit their funds with a bank they are doing so because they wish to withdraw this money in the future to fund consumption then. The resultant fall in interest rates, which makes it possible for firms to borrow to invest in the means to supply this future consumption, represents the actual time preferences of economic agents.

The ‘fake savings’ of Bank of England deposits, however, represent no such thing. While they can be lent and borrowed to fund investment projects with longer production periods there has been no change in the time preference of economic agents. There will be no real savings to purchase the output of these enterprises in the future.

When this is revealed these unprofitable enterprises will be liquidated causing recession. It is, thus, only the deposits of savers which can provide the capital which allows for longer production processes and increasing wealth on a stable and sustainable basis.

In his ‘General Theory’ in 1936, John Maynard Keynes looked forward to “the euthanasia of the rentier” when interest rates would be driven to zero and capital would be free and abundant. This nonsense, as much as anything else he said, represents a threat to our economic growth and stability. The assault on savers must end.

This article originally appeared at The Commentator

Why the euro is working

It’s just misunderstood

The euro is a disaster. The single currency is falling apart because it does not have a central fiscal authority or a central bank capable of acting as lender of last resort standing behind it. Because of this it was doomed from the start and everybody knew it.

This line of thinking, stretching from the pages of the Telegraph to the New York Times, is so widespread that it might seem ridiculous to challenge it. Indeed, I subscribed to it myself. But lately I’ve been having second thoughts. Is it, in fact, possible that the euro is working in exactly the way it ought to be?

Let’s go back to basics and look at what we want our money to do. As I wrote recently

“The textbook functions of ‘money’ are familiar to anyone with a smattering of economics; a medium of exchange, a store of value, and a unit of account. But each of these functions is entirely dependent upon money maintaining its value. If the value of the pound fluctuates it is no more useful as a unit of account or measure than a twelve inch ruler which kept changing length. Money which declines in value is a poor store of value.

Historically, when its value declines beyond a certain point people stop storing their wealth in money and trade it for commodities as quickly as possible. This acceleration in velocity of circulation exacerbates the decline in value and can trigger hyperinflation. And money which is rapidly losing value can cease to fulfil the function of medium of exchange if people refuse to accept it, legal tender laws or not.

So the value of money must be maintained for it to serve its functions and value is determined by supply and demand. Money is demanded for transactions, buying and selling. A few coin collectors aside, people do not demand money for its own sake but because they wish, at some point in the future, to exchange it for goods or services.”

So what is the greatest threat to this maintenance of purchasing power which we desire from our money? Historically it has come from currency issuers, almost always governments, who have issued excess amounts of currency to pay their bills and caused a decline in the purchasing power of everyone else’s money in the process.

In the last century this was taken to lamentable extremes. John Maynard Keynes wrote in 1931 that “A preference for a gold currency (which could not be produced at will by monetary authorities) is no longer more than a relic of a time when governments were less trustworthy in these matters than they are now”

The following decades proved Keynes’s faith in politicians to be grossly misplaced. We’ve all heard of the Weimar inflation but over the twentieth century the dollar and the pound lost about 90 percent of their value. This didn’t happen smoothly. As D R Myddelton writes, during the Keynesian golden age “The pound’s purchasing power halved between 1945 and 1965; it halved again between 1965 and 1975; and it halved again between 1975 and 1980. Thus the historical ‘half-life’ of the pound was twenty years in 1965, ten years in 1975 and a mere five years in 1980”

As a result of such monetary mismanagement many countries sought a way to get their politicians’ hands off the printing press. No one was willing to go the whole hog and reintroduce the gold standard (which had tied the issue of currency to the amount of gold the issuer held) but the German model, with the Bundesbank independent from the government, was widely copied.

The whole point, to repeat, was to remove from government the power to print excessive amounts of money to cover their own expenses and, in doing so, ruin everyone else’s money. That considered, the euro is actually performing well.

Given the dire state of several eurozone economies, this may seem a bizarre thing to say. But can Spain’s horrific unemployment really be blamed on the euro when it hasn’t been under 8 percent since 1979? Is it really the fault of the euro that the Greeks chose to pay their pastry chefs, radio announcers, hairdressers, and steam bath masseurs (among 600 other “arduous and perilous” professions) a state pension of 95 percent of their final salary when they retire at 50?

Spain’s unemployment predates the euro and won’t be solved until a labour market which makes it practically impossible to hire and fire is reformed. Greece’s politicians have to stop promising Greeks that they can spend one third of their life retired, living on money borrowed from the Germans. ‘Reforming’ the euro can’t help with either of these. Indeed, by forcing governments to address these structural issues the euro could be seen to be doing them a service.

But these steps will have to be taken against the backdrop of a debt crisis. This is where calls for the European Central Bank to act as lender of last resort or for fiscal union to match monetary union are heard. The fatal flaw of the euro, these people say, is that it cannot be produced at will by governments to pay their bills.

But then, that is, and always was, the whole point. If a given country cannot pay its bills, is the solution for it to run the printing press and devalue everyone’s money or is it for that government to stop making spending commitments it can’t keep?

Countries like Greece are faced with massive borrowings in a currency which they cannot produce at will. Those who argue that this represents a fatal cleavage between monetary and fiscal policy and that a single fiscal policy must stand behind a single currency to bridge it are arguing that the solution is to put the power to make spending commitments in the same hands as the power to print money. The lessons of history are that this does not end well.

This article originally appeared at The Commentator