The
Problem with Keynesianism
By John Mauldin
Let’s
start with a classic definition of Keynesianism
from Wikipedia, so that we can all be comfortable that I’m not coloring the
definition with my own bias (and, yes, I admit I have a bias). (Emphasis mine.)
Keynesian
economics (or Keynesianism) is the view that in the short run, especially
during recessions, economic output is strongly influenced by aggregate demand
(total spending in the economy). In the Keynesian view, aggregate demand does
not necessarily equal the productive capacity of the economy; instead, it is
influenced by a host of factors and sometimes behaves erratically, affecting
production, employment, and inflation.
The
theories forming the basis of Keynesian economics were first presented by the
British economist John Maynard Keynes in his book The General Theory of Employment, Interest and Money,
published in 1936, during the Great Depression. Keynes contrasted his approach
to the aggregate supply-focused “classical” economics that preceded his book.
The interpretations of Keynes that followed are contentious, and several
schools of economic thought claim his legacy.
Keynesian economists often argue that private sector decisions
sometimes lead to inefficient macroeconomic outcomes which require active
policy responses by the public sector, in particular, monetary policy actions
by the central bank and fiscal policy actions by the government, in order to
stabilize output over the business cycle. Keynesian economics advocates a mixed
economy – predominantly private sector, but with a role for government
intervention during recessions.
(Before
I launch into a critique of Keynesianism, let me point out that I find much to
admire in the thinking of John Maynard Keynes. He was a great economist and
taught us a great deal. Further, and
this is important, my critique is simplistic. A proper examination
of the problems with Keynesianism would require a lengthy paper or a book. We
are just skimming along the surface and don’t have time for a deep dive.)
Central
banks around the world and much of academia have been totally captured by
Keynesian thinking. In the current avant-garde world of neo-Keynesianism,
consumer demand –consumption – is everything. Federal Reserve monetary policy
is clearly driven by the desire to stimulate demand through lower interest
rates and easy money.
And
Keynesian economists (of all stripes) want fiscal policy (essentially, the
budgets of governments) to increase consumer demand. If the consumer can’t do
it, the reasoning goes, then the government should step in and fill the breach.
This of course requires deficit spending and the borrowing of money (including
from your local central bank).
Essentially,
when a central bank lowers interest rates, it is trying to make it easier for
banks to lend money to businesses and for consumers to borrow money to spend.
Economists like to see the government commit to fiscal stimulus at the same
time, as well. They point to the numerous recessions that have ended after
fiscal stimulus and lower rates were applied. They see the ending of recessions
as proof that Keynesian doctrine works.
There
are several problems with this line of thinking. First, using leverage
(borrowed money) to stimulate spending today must by definition lower
consumption in the future. Debt
is future consumption denied or future consumption brought forward. Keynesian
economists would argue that if you bring just enough future consumption into
the present to stimulate positive growth, then that present “good” is worth the
future drag on consumption, as long as there is still positive growth. Leverage
just evens out the ups and downs. There is a certain logic to this, of course,
which is why it is such a widespread belief.
Keynes
argued, however, that money borrowed to alleviate recession should be repaid
when growth resumes. My reading of Keynes does not suggest that he believed in
the continual fiscal stimulus encouraged by his disciples and by the cohort
that are called neo-Keynesians.
Secondly,
as has been well documented by Ken Rogoff and Carmen Reinhart, there comes a
point at which too much leverage on both private and government debt becomes
destructive. There is no exact number or way of knowing when that point will be
reached. It arrives when lenders, typically in the private sector, decide that
the borrowers (whether private or government) might have some difficulty in
paying back the debt and therefore begin to ask for more interest to compensate
them for their risks. An overleveraged economy can’t afford the increase in
interest rates, and economic contraction ensues. Sometimes the contraction is
severe, and sometimes it can be absorbed. When it is accompanied by the popping
of an economic bubble, it is particularly disastrous and can take a decade or
longer to work itself out, as the developed world is finding out now.
Every
major “economic miracle” since the end of World War II has been a result of
leverage. Often this leverage has been accompanied by stimulative fiscal and
monetary policies. Every single “miracle” has ended in tears, with the
exception of the current recent runaway expansion in China, which is now being
called into question. (And this is why so many eyes in the investment world are
laser-focused on China. Forget about a hard landing or a recession, a simple
slowdown in China has profound effects on the rest of the world.)
I
would argue (along, I think, with the “Austrian” economist Hayek and other
economic schools) that recessions are not brought on by insufficient
consumption but rather by insufficient
income. Fiscal and monetary policy should aim to grow incomes
over the entire range of the economy, and that is accomplished by increasing
production and making it easier for entrepreneurs and businesspeople to provide
goods and services. When businesses increase production, they hire more workers
and incomes go up.
Without
income there are no tax revenues to redistribute. Without income and
production, nothing of any economic significance happens. Keynes was correct
when he observed that recessions are periods of reduced consumption, but that
is a result and not a cause.
Entrepreneurs
must be willing to create a product or offer a service in the hope that there
will be sufficient demand for their work. There are no guarantees, and they
risk economic peril with their ventures, whether we’re talking about the local
bakery or hairdressing shop or Elon Musk trying to compete with the world’s
largest automakers. If they are hampered in their efforts by government or
central bank policies, then the economy stagnates.
Keynesianism
is favored by politicians and academics because it offers a theory by which
government actions can become the decisive factor in the economy. It offers a
framework whereby governments and central banks can meddle in the economy and
feel justified.
It allows 12 people sitting in a board room in Washington DC to feel that they
are in charge of setting the price of money (interest rates) in a free
marketplace and that they know more than the entrepreneurs and businesspeople
do who are actually in the market risking their own capital every day.
This
is essentially the Platonic philosopher king conceit: the hubristic notion that
there is a small group of wise elites that is capable of directing the economic
actions of a country, no matter how educated or successful the populace has
been on its own. And never mind that the world has multiple clear examples of
how central controls eventually slow growth and make things worse over time. It
is only when free people are allowed to set their own prices as both buyers and
sellers of goods and services and, yes, even interest rates and the price of
money, that valid market-clearing prices can be determined. Trying to control
those prices results in one group being favored over another.
In
today's world, the favored group is almost always bankers and the wealthy
class. Savers and entrepreneurs are left to eat the crumbs that fall from the
plates of the well-connected crony capitalists and to live off the income from
repressed interest rates. The irony of using “cheap money” to try to drive
consumer demand is that retirees and savers get less money to spend, and that
clearly drives down their consumption. Why is the consumption produced by
ballooning debt better than the consumption produced by hard work and savings?
This is trickle-down monetary policy, which ironically favors the very large
banks and institutions. If you ask Keynesian central bankers if they want to be
seen as helping the rich and connected, they will stand back and forcefully
tell you “NO!” But that is what happens when you start down the road of
financial repression. Someone benefits. So far it has not been Main Street.
And,
as we will see as we examine the problems of the economic paper that launched
this essay, Keynesianism has given rise to a philosophical framework that
justifies the seizure of money from one group of people to give to another
group of people. This is a particularly pernicious doctrine, as George Gilder
noted in our opening quote:
Those most acutely threatened by the abuse of American
entrepreneurs are the poor. If the rich are stultified by socialism and crony
capitalism, the lower economic classes will suffer the most as the horizons of
opportunity close. High tax rates and oppressive regulations do not keep anyone
from being rich. They prevent poor people from becoming rich. High tax rates do
not redistribute incomes or wealth; they redistribute taxpayers – out of
productive investment into overseas tax havens and out of offices and factories
into beach resorts and municipal bonds.
