Motly Fool, David in Qutar ~ Money Part VI: Understanding Keynes, from Marx to Krugman Report March 30, 2009

I have wavered back and forth quite a bit over how to continue this series. Up to this point I have focused solely on monetary theory, discussing the history of money and the consequences of paper money. I have shown how inflation is not some mystical result of wayward capitalism, but rather a traditional policy of corrupt governments (hint: all of them) since the dawn of recorded history. Finally, in an effort of fairness, the arguments for unbacked paper money were presented and I spent an entire post arguing that deflation is not only a result of unwelcome government interference, but a refreshing liberation from the tyranny of Keynesianism. But where do I go from here? Well, rather than going where many others have boldly gone before, I’d rather let them do the talking. Links will be provided after my musings on Keynes. I apologize in advance for rambling, but I’ve been pressed for time lately.

What is Keynesianism?

One of the greatest tricks the devil ever pulled was convincing you that he was an angel. Keynes is such a devil, as our his modern day adherents. To truly understand that statement, take a moment to consider the first reaction of the government, experts, media, and economists to our current fiasco. It’s the free market’s fault! And just like that, the debate was snuffed out and an army of charlatans offered solutions. More regulation, more government intervention, more paper money! Let’s not revisit that delusional path once again, but it is important to evaluate the premise.

Keynes passed off his theory as moderated capitalism. Free markets are bad, but markets in general, are necessary. Therefore, they are a necessary evil that must be watched closely by the State. Now, where have we heard such statements before?

So what’s my problem with Keynes? Do I have some psychological obsession with free markets and an anarchical disposition to oppose government in all forms? Maybe, but probably not, since in my younger days I was a steadfast defender of the State. Here’s Keynes in his own words:

Nevertheless the theory of output as a whole, which is what the following book purports to provide, is more easily adapted to the conditions of a totalitarian state, than is the theory of the production and distribution of a given output under conditions of free competition and a large measure of laissez-faire. - John Maynard Keynes (emphasis mine)

That comes from the forward to the German edition of General Theory, his masterpiece. Keynes understood that his ideas would not only lead to a totalitarian state, but that such a state was essential to his system.

So stop scratching your head, wondering how in the heck Geithner, Bernanke, and their Keynesian cheerleaders like Krugman can continue to argue for government intervention that is contradictory to liberty and American traditions. Let’s see what else Keynes has to offer on the subject:

The Infamous Chapter 24 - Concluding Notes on the Social Philosophy towards which the General Theory might lead

http://www.marxfaq.org/reference/subject/economics/keynes......

If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments and the basic rate of reward to those who own them, it will have accomplished all that is necessary. Moreover, the necessary measures of socialisation can be introduced gradually and without a break in the general traditions of society.

Whilst, therefore, the enlargement of the functions of government, involved in the task of adjusting to one another the propensity to consume and the inducement to invest, would seem to a nineteenth-century publicist or to a contemporary American financier to be a terrific encroachment on individualism. I defend it, on the contrary, both as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative.

It’s a not-so-dirty little secret that Keynes had a fondness for the economic policies of the Nazi Socialist Party. In fact, while the American Left rejected Nazi social policies, rightfully so, they have continued to embrace the folly of Nazi economics, particularly the glorious ideal of full employment.

Make no mistake about it. These lunatics have shaped our current economic system for the last seventy years. So why do they keep blaming all of our problems on free markets? The only alternative would be to tell the truth. America is not a capitalist country. It’s a mixed economy, where the government, using Keynesian theory, involves itslef at every opportunity and has done so for decades.

So from where do Keynes’ ideas originate:

Abolition of Private Property - As I’ve already documented, not only is private property held to be inviolabe on Christian ethical grounds, but our current monetary system is indeed a violation of private property.

Heavy Progressive or Gradual Income Tax - Strongly supported by Keynes on the false notion that it stimulates employment. See Chapter 24.

Centralization of Credit in the hands of the State - Keynes’ believed that free market credit was exorbitant, and thus it was up to the State to lower interest rates whenever possible. The Austrian Theory of the Business Cycle explains how this policy is responsible for the boom and bust we are living through.

Equal liability of all to labor - We call this the national debt. As Keynesian economist Abba Lerner once quipped: "We owe it to ourselves."

Where have you heard these ideas before?

A note on the Federal Reserve

Cute play on words there, but seriously, there are some tremendous misconceptions about the Federal Reserve that seem to befuddle even the sharpest minds.

The Federal Reserve is not a bank. A bank handles money. It exchanges money, holds money, loans money, etc.. In other words, a bank deals with money. The Federal Reserve is a money producer. It creates money. It is simply the modern form of the mint. Instead of minting coins, it mints paper, which is tremendously cheaper. It’s a business with a legal monopoly privilege.

It’s also not Federal, in that it is a private for-profit business entity (wouldn’t you like to buy shares in this company!?) But it has an ad hoc relationship with the government, each using the other to further its own interests when necessary, both certain to suffer a loss power from a collapse of the other. And both rather treasonous to the Constitution and the American People. I would surmise that most central bankers and politicians will eventually by lynched by armed mobs but it might take a few trillion more in theft.

The Silence of Socialists

Funny isn’t it? The same yahoos that rail against monopoly wholeheartedly support a legalized monopoly when it serves their interest. I was told by my Socialist friends that monopolies are a product of the free market. Well, for the economically illiterate, the difference between a free market monopoly and a legal monopoly is barrier to entry. In the free market, the aspiring entrepreneur is not legally barred from entering into competition with the current monopoly. In other words, he/she can take their chances. Maybe they’ll get slaughtered. Maybe they won’t. No one, however, may enter into the minting business today. That’s the opposite of Capitalism. That’s totalitarianism. Why don’t the Socialists oppose this monopoly privilege? Oh yeah, because it makes the Welfare State possible. So much for principles.

The Silence of Christians

Here’s one I really don’t get. Maybe it’s because they’re caught up in neo-con driven messianic conquests overseas, but I just don’t understand why Christians can sit idly by while America sweeps toward tyranny. I’ve only skimmed the surface of Christian theology that stands in direct opposition to Keynes and Central Banking. What happened to the Church? I realize that the "butts in the pews" business mentality of some churches may lead to an appeal to populism at the expense of orthodoxy, but that doesn’t explain the absence of Christian leaders from mainstream economic debate. Have they been silenced or are they simply silent? I don’t have the answer for this. But make no mistake, Christian theologians have long been exemplary scholars on monetary policy and classical economics. In fact, here is an area that Christians and rational Atheists (rational in the Objectivist sense, not as a back-handed compliment) have a great deal of common ground. Maybe that’s why the State often pits them against each other. Divide and conquer, friends.

Calculation Problems

As has been pointed out before, Socialism has a big problem. If all assets and resources are controlled by the State, prices are no longer determined by aggregate processes. This is called Capital Theory. Keynes, like Marx, rejects Capital Theory on the grounds that prices appear to be random since there is so much subjectivity in price decisions. This rejection is also the justification for every price control and trade restriction in recorded history. I’ll assume that you’ll read further on this subject if you are interested and go straight to the conclusions for now. I’m rambling and running out of space. Without a pricing mechanism there is no way to determine how resources should be distributed. The end result is a monstrous State bureaucracy with everything at its disposal and no clue how to dispose of it (see: Geithner). The rejection of Capital Theory becomes more evident with every misguided bailout and government program. It’s the destruction of the market economy and a step towards chaos and tyranny.

The All Powerful Shareholder

Another fallacy of modern Keynesian philosophy that dates back to Marx is that the shareholder in a joint stock company directs operations. It is true that some modern corporations, in fact, hold shareholder opiinion as more important than other business matters. However, efficient companies, do not. The company run by the entrepreneur acts in the interest of the consumer, because in the end it is the consumer’s decision to purchase his/her products and services that determines the profitability of the operation (unless you’re an automaker or an insurance giant). The general shareholder’s responsibility is to ascertain the results of these efforts to determine whether or not the company is worth investment.

But alas, the power of debt! In a paper money world, easy credit means that larger operations cease to be run by independent entrepreneurs, which is exactly the outcome that Marx had hoped for. A business manager with a 1% stake and 99% debt is no longer the steward of his/her own fortunes, soley. Instead, he/she becomes a manager of other people’s money. He becomes a bureaucrat, answering to bankers and shareholders that have capitalized his operations. This is how the market economy gets transformed into something that resembles kleptocracy.

Conclusions

I regret having to heap so much information in such a small space, but unless a book deal is forthcoming I don’t have the resources available to paint a comprehensive picture. Besides, many others have already presented tremendous cases for economic liberty. I am only trying to bring my own style to the intellectual debate. The answer is of course, freedom. Freedom to mint your own money. There is no reason, ethical or practical, to prevent aspiring entrepreneurs from producing their own money to be used in a dynamic economy. The gold-exchange standard, sadly, is flawed, though not as horribly flawed as a paper standard. It’s flawed by fiat law and monopoly privilege. In my final essay, I will present the system by which a free market money supply would operate. I’ll get into the details, moving from the theoretical to the practical. It is not simply be a fancy idea, rather it will be shown to be a practical and ethical solution.

Money Part IV - The Prosecution Rests. Fiat Paper Money Calls Its First Three Witnesses

Report March 17, 2009 - Comments (7)

"Woe to those who call good evil, and evil good." - Isaiah 5:20

I start this blog with the same quote which I ended the last. You are about to bear witness to its importance. In this tour de force series on the roots of Money Production and, as you will see, the roots of our current and future financial problems, it is time to hear the other side’s case. I have taken the hammer to fiat paper money, attempting to show the reader just how unethical and impractical unbacked paper money is as a long term monetary solution. Now it’s time to hear from the defenders of fiat money. First, let’s review where we are at.

Part 1 - The origins of money were discussed. It was shown that natural money (gold, silver, copper, etc) always arose without government decree in market economies. The theory of monetary and nonmonetary value was presented to teach about the difference between metals and paper as a means of indirect exchange. We looked at possible reasons why governments would outlaw metals, or certificates redeemable in metal, as currency and replace them with unbacked paper.

Part 2 - An argument was made the unbacked paper money and property rights are mutually exclusive. Christian scholars presented the case that property rights are absolutely sacred as the best means for improving the lives of the masses. Therefore, from a Christian perspective, unbacked paper money is unethical.

Part 3 - In this study on Inflation, or monetary base expansion, I demonstrated the purpose of currency distortion - to benefit government and politically connected businessmen and bankers at the expense of the poor and middle class. We covered the various forms of inflation and how they came into existence. Finally, we explained how excessive monetary base expansion, through fractional reserve lending and central bank inflationary policy, causes the booms and busts that are so frequently confused with unfettered capitalism.

Now it wouldn’t be fair or ethical if I didn’t present the arguments for paper money, and I will do that here. I have selected the most common arguments, with a nod to Jorg Hulsmann’s great book The Ethics of Money Production and Murray Rothbard’s What Has Government Done to My Money?, but I don’t wish to attack a strawman. If you find any problems with my presentation, please let me know. The point of this entire lengthy exercise is to share knowledge. After all, in order to endorse paper money it must have significant advantages. One could not argue that freedom of association, civil liberties, and the use of monies that have been in circulation since at least biblical times should be outlawed unless they had a very good reason, right? Here in Part 4 of our study of money we will examine three common arguments for paper money. We will finish the paper defense by looking at three more in Part 5 due to character limits and limitations on my time.

THERE IS NOT ENOUGH GOLD OR SILVER TO MAKE OUR DYNAMIC ECONOMY WORK.

Fiat paper argument: Suppose the economy grows at a rapid rate, let’s say 8% per year. In order to maintain that growth, the monetary base must be expanded at an equal rate. This is clearly impossible with gold or silver, at least certainly in the long run. Without a corresponding growth in the money supply, the economy will contract and the subsequent bust will wipe out businesses, investors, and lead to a depression. This is often refereed to as the Assignment Theory of Value, first developed by John Law, and later expressed in more detail by Schumpeter and Wieser.

Counter argument: Monetary growth and economic growth need not be dependent. In the above example, should the economy grow by 8% and monetary growth stagnate, the economic growth would mean a reduction in prices with no change in "real" wealth. There would be 8% more goods and services, but on average all goods and services would decrease by 8%. In fact, during the period of 1871-1900, both the American and Germany economies grew at high rates despite monetary supply decreases! (A Monetary History of the United States, Milton Friedman).

Fiat paper argument: Even if monetary and economic growth are independent, enough growth would be render coins useless as they would have to shrink to ridiculous sizes to make small purchases possible. This would be insanely impractical. It is especially true in the case of gold.

Counter argument: In every market in history, lower valued coins were introduced to satisfy this need. The monetary supply market has always adjusted and there is no reason to think it won’t continue. Silver became the most prevelant money for precisely this reason. No government intervention was ever necessary. Furthermore, silver or gold backed paper (or electronic) money has also fulfilled this need.

Fiat paper argument: Even so, the reduction in prices due to this disjointed growth will lead to bankruptcies as entreprenuers are forced to sell items at lower prices than initially calculated before the economic expansion.

Counter argument: Entrepreneurs are not machines. They can easily adjust and anticipate future reductions of the selling prices of their products. They can even thrive in a declining price environment by properly reducing operating and supply costs as prices drop. The most astute entrepreneurs will propser in a declining price environment.

Bottom line: The idea that there is not enough gold or silver to go around, or to support economic growth, doesn’t hold water. Let’s see what else fiat money can offer in its defense.

NATURAL MONEY LED TO HOARDING

Fiat paper argument: An economy can only operate efficiently when money is moving through it. In the old days, people hoarded money, limiting economic growth. Hoarding becomes excessive and reduces the amount of money available for everyone else, thus depriving them of the resources necessary to improve their livelihood. Only the forceable expropriation of the money, or a willful increase in the money supply can alleviate the danger of hoarding. That willful increase can only come about with unbacked paper money. Case closed.

Counter argument: Not so fast, big guy. You may have overstated your case. Hoarding money is a pathological problem and a very rare one at that, Holding money is something quite different indeed. A person can have a virtually limitless number of excellent reasons to hold money. Perhaps they wish to hold excess cash for emergency rainy day funds. Is that excessive? Certainly not, so why punish them with inflation simply to prevent hoarding? Seems a bit unethical. What about the entrepreneur accumulating capital for expansion of his/her current operation? Or the retiree that withdraws a portion of his retirement fund from stocks or bonds he deems too risky? Are these people hoarding money? What measurement will you use to determine what is excess hoading? The fact is that hoarding is a rare phenomenon. Please show me the billionaires that hoard cash. I see them spending massive amounts constantly. The only people I see doing the hoarding are central bankers, who now control nearly all of the world’s gold. Now, that’s hoarding!

Bottom line: The effects of hoarding are negligible in any economy, but especially in a dynamic one. Any decrease in money supply is immaterial anyway as shown above precisely by the fact that monetary supply and economic growth are independent factors anyway.

THESE PRICES ARE STICKY! YUCK!

Fiat paper argument: Suppose a situation arises where unions successfully negotiate significant wage increases. The subsequent fallout, should the success be widespead, could lead to very high unemployment should entrepreneurs be unable to support labor at their new costs. If these entrepreneurs can not raise prices on the goods they must either go out of business or lay off substantial amounts of the labor force. Either way, the resulting spiral will lead to economic contraction and possibly a depression. By manipulating the money supply, artificially increasing the amount of money in circulation, we can eliminate this sticky price of labor. The increase in money will lead to an increase in the amount that entrepreneurs can charge for goods, thus allowing them to reintegrate the unemployed labor force. Voila! This is clearly impossible on a gold or silver standard.

Counter argument: Sounds simple enough, but I need to ask you something: How many times do you think you can outsmart the labor unions? The first time you pull this off, don’t you think labor leaders will realize that any gains they received in negotiation were wiped out by your inflationary policies? Do you think they are that dumb? In response to your monetary machinations, labor unions just factored in their reduction in purchasing power in their next round of negotiations, thus demanding even higher wages, leading to more unemployment. And the cycle goes on.

Bottome line: Sticky Price theory was surprisingly prevalant in Europe after WWII and, predictably, led to higher unemployment and constantly larger wage demands from labor unions.

Up next: In Part 5 we will continue to examine arguments for paper money. I think we’ll continue to see they don’t hold water.

"Paper money eventually returns to its intrinsic value -- zero" - Voltaire

David in Qatar