RUTHFULLY YOURS

The Kamikaze Obamanomics of John Maynard Keynes

History is repeating itself because the Obama administration is repeating failed Keynesian policies.

President Obama revealed the Keynesian underpinnings of his economic policies in his first prime time press conference when he said:

It is only government that can break the vicious cycle where lost jobs lead to people spending less money which leads to even more layoffs. And breaking that cycle is exactly what the plan that’s moving through Congress is designed to do . . .

More than 90% of the jobs created by this plan will be in the private sector. These will not be make-work jobs, but jobs doing the work that America desperately needs done. Jobs rebuilding our crumbling roads and bridges, and repairing our dangerously deficient dams and levees so that we don’t face another Katrina. They will be jobs building the wind turbines and solar panels and fuel-efficient cars that will lower our dependence on foreign oil, and modernizing a costly health care system that will save us billions of dollars and countless lives. They’ll be jobs creating 21st century classrooms, libraries, and labs for millions of children across America. And they’ll be the jobs of firefighters, teachers, and police officers that would otherwise be eliminated if we do not provide states with some relief.

I can tell you with complete confidence that a failure to act will only deepen this crisis as well as the pain felt by millions of Americans. My administration inherited a deficit of over $1 trillion, but because we also inherited the most profound economic emergency since the Great Depression, doing too little or nothing at all will result in an even greater deficit of jobs, incomes; and confidence. That is a deficit that could turn a crisis into a catastrophe.

Economists from the Austrian school argue that not only is government intervention not necessary to stop economic collapse but it actually prevents the economy from healing on its own. Historical evidence supports the Austrian school: there was no U.S. government intervention in the post-World War I recession of 1920 and it ended within 17 months whereas there was massive government intervention in the Great Depression which lasted more than 8 times as long. Obama’s argument that the jobs created by his plan are jobs that desperately need to be done is not true; one example illustrating this was a recent award by the NIH of $1.44 million for a “study of drug and sexual risk among young male sex workers in Hanoi and Ho Chi Minh City, Vietnam.”  Democrat Senator Michael Bennet of Colorado has pointed out that though trillions of dollars of Federal debt has been incurred through spending since he was appointed to the Senate in January of 2009, “we have nothing to show for it”.

The arguments that only government intervention can rescue the economy and that spending money is the way to do so are arguments John Maynard Keynes made in the 1930s. In order to understand what is wrong with the logic underpinning Obama’s policies it is worthwhile to understand the logic or rather illogic behind Keynesian economics.

Keynes wrote an article in 1934 for the popular American magazine Redbook entitled “Can America Spend Its Way into Recovery?” and opened the article with

Why obviously!” . . . Moreover, tax rates should never have to be increased to pay for the new debt. The money borrowed and spent will revive the economy. A revived economy requires less government spending on the dole (unemployment compensation) and generates a stream of new tax revenue. Together, the savings and the new taxes will more than cover the debt service.

This statement illustrates the essence of what is wrong with Keynesian economics. According to this statement a government can borrow and spend all it wants to because increased tax revenues resulting from such stimulation of the economy will more than cover the debt created by borrowing. The economist Henry Hazlitt wrote regarding Keynes’ ideas:

How marvelous is the Keynesian world! The more you spend the more you [have]. The more you eat your cake, the more cake [to eat].

It is the equivalent of proposing that wealth can be created out of nothing.

Another example of such wishful thinking is the Keynesian multiplier. Dr. Robert Schenk explained the multiplier as follows:

Suppose a factory with a payroll of $500,000 locates in a Lemmingville, a typical suburban community. Suppose further that the $500,000 is the only money that the factory spends in the community, that all employees live in Lemmingville, and that each person who lives there spends exactly one-half of his income locally. By how much will the income of Lemmingville rise as a result of the new factory?

The $500,000 will be an addition to Lemmingville income. But the story does not end here because, by assumption, the people who earn the payroll will spend one-half of the payroll, or $250,000, in the community. This $250,000 will become income for the shopkeepers, plumbers, lawyers, teachers, etc. Thus Lemmingville income will rise by at least $750,000. But the story does not end here either. The shopkeepers, plumbers, etc. who received the $250,000 will in turn spend one-half of their new income locally, and this $125,000 will become income for other people in the community. Total Lemmingville income is now $875,000. The process will continue on and on, and as it does, total income will approach $1,000,000.

If we add up the dollars in the town of Lemmingville before and after the factory paid its workers we find that the total dollars in Lemmingville did not go up by $1,000, 000; in fact it did not go up at all! Five hundred thousand dollars simply changed hands from the factory to the workers and there is no net gain in wealth of the town of Lemmingville resulting from that exchange. The real gain in wealth in Lemmingville is equal to the value of the products created by the Lemmingville factory minus the cost of producing them.

If one follows Keynesian logic to its logical conclusion then paying workers to do nothing or to do useless projects will generate wealth because they will spend that money and that spending will lead to more production.  John Maynard Keynes came to this conclusion and wrote:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines 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.

Keynes also believed that any investment is better than no investment and that interest rates should be kept as low as possible in order to encourage investment. The recent collapse of the housing market shows just how wrong Keynes was in his belief that any investment is better than no investment.

How can interest rates be kept low if banks are unwilling to make risky loans with low rates of interest? Keynes advocated that the government print the money and inject it into the loan market. Keynes wrote in 1943 that credit expansion, performs the

miracle . . . of turning a stone into bread.

In the Keynesian world miracles happen! Unfortunately in our world they don’t. Robert Mugabe, the socialist prime minister of Zimbabwe, engaged in two policies that Keynes approved of and that President Obama is engaged in. Prime Minister Mugabe printed and spent money and he redistributed the wealth. He redistributed the wealth by turning the property of white farmers over to members of his ZANU party. Food production collapsed and food exports ceased so to make up for the shortfall in cash Mugabe ordered his finance minister to print money. Instead of a miracle this created so much inflation that by July of 2008 it cost 100 billion Zimbabwean dollars just to buy 3 eggs.

In order to stop inflation Mugabe instituted price controls. Stores were not permitted to charge the billions of Zimbabwean dollars it cost them to buy food with the predictable result that the shelves of the stores were empty of food and many citizens of Zimbabwe starved.

The lesson of Zimbabwe is that printing money combined with reduction of production of goods can be lethal. Just the act of printing money lowers productivity because it shifts wealth away from the businesses that would invest that money to produce goods. The Obama administration has placed a moratorium that has idled oil rigs in the Gulf that is estimated will lead to a loss of $450 million in payroll revenue. The Obama administration along with radical environmentalist activists have blocked development of much of America’s oil resources when oil may be the answer to rescuing the U.S. economy. The magnitude of the loss this creates for the American economy was described by Paul Driessen who wrote:

Developing just our off-limits oil and gas resources in the ANWR, OCS and Rockies could generate over $1.7 trillion in government revenue and create 114,000 new jobs, a recent ICF International study concluded . . . Developing all US oil and natural gas resources on federal lands could generate $4 trillion.

The American Energy Alliance and other experts say the benefits would be even greater. And this is just conventional oil and gas revenue. It does not include trillions more in revenues from oil shale, tar sands, methane hydrates, coal, uranium and other deposits that Congress, bureaucrats, judges and green activists have conspired to put off limits to the American taxpayers and consumers who own them.

It does not consider the regulatory stranglehold on coal and nuclear power plant construction – and thus on jobs and revenues that those projects and their energy would provide . . .

The categorization of carbon dioxide as a pollutant by the Obama administration will make it more costly to produce goods and thereby also reduce American production.

There is one value to inflation and that is when a country owes a tremendous amount of money. If the country prints the money it can pay off its debts. It’s a crooked way of cheating lenders by paying them back in inflated money that is worth a lot less than the money they leant. There are several downsides to this behavior. The lenders are unlikely to ever lend again, and are likely to demand more compensation, people become impoverished as the currency loses value and it becomes harder to grow the economy in order to pay off the debts.

When jobs are scarce and people reduce spending, stores lower their prices with the result that dollars can buy more and actually gain in value. This is known as deflation. In this case the lenders are now owed more than they leant because the dollar is worth more. This is one reason that Keynesian economist Paul Krugman said that inflation is not what we should be concerned about and that:

the real threat is deflation.

The problem with this statement is that deflation does not prevent hyperinflation. Eric deCarbonnel explained:

In 1920, Germany experienced a deflationary collapse, with the average citizen finding it harder and harder to get enough money for necessities. Banks, short of money, could not honor checks, and businesses were strapped for cash to buy materials and meet payroll. Fearing a collapse that would throw millions of workers out on the street, the German government desperately printed money in an attempt to re-inflate the economy. During this period, despite the government’s money printing, the mark actually gained in value against foreign currencies, so that prices of imported goods fell by some 50%.

Eventually, as a result of the money supply’s rapid expansion, the nation’s massive foreign debt, and the shrinking economy, German citizens lost all confidence in their currency, and the Weimar Republic experienced one of the worst cases of hyperinflation in modern economic history. Billions of hoarded marks came out of hiding and entered the marketplace.

George Goodman in his column titled The Money Game, Supermoney, and Paper Money, wrote about how hyperinflation affected life in Germany.

A student at Freiburg University ordered a cup of coffee at a cafe. The price on the menu was 5,000 Marks. He had two cups. When the bill came, it was for 14,000 Marks. “If you want to save money,” he was told, “and you want two cups of coffee, you should order them both at the same time.”

Soon no one could afford a cup of coffee. Friedrich Kessler wrote:

It was horrible. Horrible! Like lightning it struck. No one was prepared. You cannot imagine the rapidity with which the whole thing happened. The shelves in the grocery stores were empty. You could buy nothing with your paper money.

Former West German Chancellor Willy Brandt warned that it could happen here in the United States. Peter Peterson, in his book about the American economy On Borrowed Time, wrote:

I remember well . . . listening to former West German Chancellor Willy Brandt as he described how, as a child, he had to pack his family’s lifetime savings of deutschmarks into bags and take them to the local orphanage. There they were used to start a fire so the children could be kept warm. “You Americans simply have never experienced the hell that can take place in a country if it doesn’t get inflation under control,” Brandt said. “It is what brought us Adolph Hitler. It’s what transformed, in a hideous way, our entire values and society.”

Ben Bernanke said he will rein in inflation when it comes by raising interest rates. Federal Reserve Chairman Paul Volcker had to raise interest rates to 21.5% to get inflation under control during the 1980s. If the Federal Reserve had to raise interest rates to 21.5% once again just the interest on the national debt would be over 2.4 trillion dollars.

Why does the Keynesian beast never die? That question was the topic of a lecture by Peter Klein at the Mises Institute. Dr. Klein quoted the University of Chicago economist Luigi Zingalis explanation as follows:

Keynesianism has conquered the hearts of minds of politicians and ordinary people alike because it provides a theoretical justification for irresponsible behavior . . .

Politicians like to play Santa Claus. What better way to get votes than to give money away? Keynesian economics says go ahead spend, it’s good for the economy.  Prescribing Keynesianism to some politicians has been described as prescribing crack to a coke addict. Dr. Klein said in his lecture that:

They (Keynesian economists) tell politicians who are addicted to spending our money that government expenditures are good . . . In economics it gets you a job in Washington.

In other words if you tell government what it wants to hear you rise to the top and become more influential. It is no coincidence that the man who holds the most powerful position in economics in the United States, the chairman of the Federal Reserve, Ben Bernanke, is a Keynesian economist.

John Cochrane, professor at the University of Chicago Business School wrote:

The idea that [government] spending can spur the economy was discredited decades ago . . . It is very comforting in times of stress to go back to the fairy tales we heard as children but it doesn’t make them less false.

There is another appeal to Keynesian economics to socialist idealists like President Obama. Keynesian economics encourages the government to print money.  Printing money is a form of stealth wealth redistribution because it causes the purchasing power of dollars to decrease and shifts that purchasing power to the owner of the newly printed money. It is a way to redistribute wealth to the government. If the government spends some of that money on programs for lower income people that is a form of socialist wealth redistribution that buys votes.

It is no coincidence that Keynesian economics appeals to socialist idealists. Keynes was a socialist idealist. In chapter 24 of his book The General Theory of Employment, Interest and Money, Keynes revealed his socialist leanings when he argued for a “somewhat comprehensive socialization of investment” and a redistribution of British income in the desirable direction of diminished inequality. Keynes argued that wages should be set based on what is “fair” and “reasonable” instead of by the free market.  Keynes wrote:

I want to mold a society in which most of the existing inequalities and causes of inequality are removed.

A common argument for the Keynesian prescription of spending to stimulate the economy is that the enormous amount of spending by the U.S. government during World War II was followed by an economic boom. Paul Krugman explained:

From an economic point of view World War II was, above all, a burst of deficit-financed government spending, on a scale that would never have been approved otherwise. Over the course of the war the federal government borrowed an amount equal to roughly twice the value of G.D.P. in 1940 – the equivalent of roughly $30 trillion today.

Had anyone proposed spending even a fraction that much before the war, people would have said the same things they’re saying today. They would have warned about crushing debt and runaway inflation. They would also have said, rightly, that the Depression was in large part caused by excess debt – and then have declared that it was impossible to fix this problem by issuing even more debt.

But guess what? Deficit spending created an economic boom – and the boom laid the foundation for long-run prosperity.

Peter Schiff, one of the few economists who predicted the current economic collapse, pointed out that if spending on war is what will save the economy then we should all fight a huge pretend war in which we don’t kill anybody in order to revive the economy. Even Paul Krugman doesn’t buy his own argument. In September 2003, Dr. Krugman published a collection of his columns under the title, The Great Unraveling, in which he said that the money spent on the Iraq war was harmful to the economy. Apparently from Krugman’s point of view, war is not good for the economy if the politicians to blame are Republican.

There are alternative explanations for the economic boom that followed World War II. One alternative explanation is that Federal spending delayed economic recovery until the war ended when the spending was sharply reduced and production could be converted back to non-military uses.

It is important to note that massive government spending did not begin with World War II but earlier with the Great Depression and it did not work then either. FDR’s Treasury Secretary, Henry Morgenthau wrote in his diary:

We have tried spending money. We are spending more than we have ever spent before and it does not work . . . We have never made good on our promises . . . I say after eight years of this Administration we have just as much unemployment as when we started . . . and an enormous debt to boot!

History is repeating itself because the Obama administration is repeating failed Keynesian policies. We can only hope that American economic policies change before the history of Zimbabwe repeats itself in the United States. Mark Hendrickson in his article The Keynesian Stimulus Dogma warned:

We are already in great economic danger from deficit spending. A policy to plunge us even deeper into the debt abyss is kamikaze economics.

We need to step back from the abyss before it’s too late.

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Acknowledgements: I wish to thank: Dr. Robert Schenk, Professor Emeritus of St. Josephs College-Indiana and Dr. Peter Klein, Associate Professor at the University of Missouri for their helpful comments.