Skousen The Big Three in Economics - Smith, Marx, Keynes (Sharpe, 2007)

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gridge 1992, 470; Skidelsky 1992, 519; 2003, 514–18). Following a trip to Russia in 1925, Keynes wrote three articles for the Nation, debunking the Soviet “religion” as “unscrupulous,” “ruthless,” and “contrary to human nature.” There was none of that naïve “I’ve seen the future” optimism for Keynes. Individual freedom and a liberal open society meant too much to him. “For me, brought up in a free air undarkened by the horrors of religion, with nothing to be afraid of, Red Russia holds too much which is detestable.” He added, “How can I adopt a creed which, preferring the mud to the fish, exalts the boorish proletariat above the bourgeois and the intelligentsia who, with whatever faults, are the quality in life and surely carry the seeds of all human achievement? . . . We have everything to lose by the methods of violent change. In Western industrial conditions the tactics of Red Revolution would throw the whole population into a pit of poverty and death” (1951 [1931], 306). He lambasted Marx’s magnum opus, Capital, as “an obsolete economic textbook” that was “scientifically erroneous” and “without interest or application for the modern world” (298–300).

In the middle of the Great Depression, the best and the brightest intellectuals embraced Marxism, but not Keynes. At a dinner among friends in 1934, Keynes said that, of all the “isms,” Marxism was “the worst of all & founded on a silly mistake of old Mr Ricardo’s [labor theory of value]” (Skidelsky 2003, 515). In a letter to playwright George Bernard Shaw, Keynes labeled Das Kapital “dreary, out- of-date, academic controversialising.” He compared it to the Koran. “How could either of these books carry fire and sword round half the world? It beats me.” In a second letter to Shaw dated January 1, 1935, Keynes complained of Marx’s “vile manner of writing” (Skidelsky 1992, 520; 2003, 517).7

7. Marxists, in turn, have disdained the bourgeois Keynes and Keynesian economics. “Such a theory is a serious danger to the working class,” wrote Marxist John Eaton in his little book, Marx Against Keynes (1951:12). According to Eaton, Keynesianism defends “wage slavery” and “policies of imperialism” (75). Eaton accused Keynes of not having “ever read and understood Marx’s profoundly scientific analysis” in Capital (33). In short, Keynesian economics is the “vulgar economy of monopoly capitalism in crisis and decay” (85), according to Eaton, and thus is doomed to fail.

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Keynes’s Critique of Adam Smith and His Invisible

Hand Doctrine

Keynes has been lauded as the savior of capitalism, but his model and policy recommendations were in many ways a direct repudiation and assault on Adam Smith’s laissez-faire system. In the New Era twenties he wrote, “It is not true that individuals possess a prescriptive ‘natural liberty’ in their economic activities. . . . Nor is it true that self-interest generally is enlightened. . . . Experience does not show that individuals, when they make up a social unit, are always less clear-sighted than when they act separately” (Keynes 1951 [1931], 312). This speech, appropriately titled, “The End of Laissez-Faire,” was given in 1926, a full decade before The General Theory was written. It was a clear attack on Adam Smith’s system of natural liberty.

In the early 1930s, Keynes became increasingly disillusioned with capitalism, both morally and aesthetically. The ideas of Sigmund Freud were fashionable at the time, and Keynes adopted the Freudian thesis that moneymaking was a neurosis, “a somewhat disgusting morbidity, one of the semi-criminal, semi-pathological propensities which one hands over with a shudder to specialists in mental disease” (1951 [1931], 369). Later, in 1933, he indicted the capitalist system: “The decadent international but individualistic capitalism, in the hands of which we found ourselves after the war, is not a success. It is not intelligent, it is not beautiful, it is not just, it is not virtuous—and it doesn’t deliver the goods. In short, we dislike it and are beginning to despise it. But when we wonder what to put in its place, we are perplexed” (Hession 1984, 258). This is a far cry from Adam Smith!

Keynes, the Heretic, Turns Classical Economics

Upside Down

The General Theory did not aim to rebuild the classical model; it aimed to replace it with elaborate unconventional concepts and a new Weltanschauung. Until the 1930s, the economics profession had largely sanctioned the basic premises of the classical model ofAdam Smith—the virtues of thrift, balanced budgets, free trade, low taxes,

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the gold standard, and Say’s law. But Keynes turned the classical model upside down.

Instead of Smith’s classical system being considered the general or universal model, Keynes relegated it to a “special case,” applicable onlyintimesoffullemployment.Hisowngeneraltheoryof“aggregate effective demand” would apply during times of underemployed labor and resources, which, under Keynesianism, could exist indefinitely. Under such circumstances, Keynes offered the following principles:

1.An increase in savings can contract income and reduce economic growth. Consumption is more important than production in encouraging investment, thus reversing Say’s law: “Demand creates its own supply” (1973a [1936], 18–21, 111).

2.The federal government’s budget should be kept deliberately in a state of imbalance during a recession. Fiscal and monetary policy should be highly expansionary until prosperity is restored, and interest rates should be kept permanently low (128–31, 322).

3.Government should abandon its laissez-faire policy and intervene in the marketplace whenever necessary. According to Keynes, in desperate times it may be necessary to return to mercantilist policies, including protectionist measures (333–71).

4.The gold standard is defective because its inelasticity renders it incapable of responding to the expanding needs of business. A managed fiat money is preferable (235–56; 1971, 140). Keynes held a deep-seated disdain for the gold standard and was largely successful in dethroning gold as a worldwide monetary numeraire.

What Did Keynes Really Mean by “In the Long Run We Are All Dead”?

Keynes’s cavalier statement, “In the long run we are all dead,” is in many ways a symbol of his turning his back on classical economics.

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Many economists consider his remark an affront to Frédéric Bastiat’s classical view (“What Is Seen andWhat Is Not Seen”) that economists must take into account the long-run and not just the short-run effects of government policies. For example, deficit spending may stimulate certain sectors of the economy in the short run, but what will be the impact in the long run? Tariffs may save some manufacturing jobs, but what impact will this have on consumers? As Henry Hazlitt declares, “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequencesofthatpolicynotmerelyforonegroupbutforallgroups” (1979 [1946], 17). And Ludwig von Mises, another critic of Keynes, concludes, “we have outlived the short-run and are suffering from the long-run consequences of [Keynesian] policies” (1980 [1952], 7). Keynesmayhaveindeedusedhisdictumtosupportshort-termpolicies like deficit spending, but he also used it in other contexts.

Keynes Attacks Monetarism

The first time Keynes made the famous remark quoted above, he used it to deride Irving Fisher’s extreme monetarism, which claimed that monetary inflation has no ill effects in the long run but only raises prices (see chapter 4). Keynes retorted, “Now ‘in the long run’ this is probably true . . . 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 long past the ocean is flat again” (1971, 65). No doubt Hazlitt and Mises would find much to agree with in this statement.

Britain First!

Keynes also used his famous phrase in the context of British foreign policy in wartime. In 1937, when Churchill advocated rearmament and warned against appeasing Hitler, Keynes seemed to support short-term peace initiatives: “It is our duty to prolong peace, hour by hour, day by day, for as long as we can. . . . I have said in another context that it is a disadvantage of ‘the long run’ that in the long run we are all dead. But I could have said equally well that it is a

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great advantage of ‘the short run’ that in the short run we are still alive. Life and history are made up of short runs. If we are at peace in the short run, that is something. The best we can do is put off disaster” (Moggridge 1992, 611). Was Keynes advocating peace at any price?

After Pearl Harbor was attacked in December 1941, Keynes reacted with dismay to the British Foreign Office argument that free trade with America would be beneficial to Britain “in the long run.” Keynes blustered, “The theory that ‘to get our way in the long run’we must always yield in the short reminds me of the bombshell I threw into economic theory by the reminder that ‘in the long run we are all dead.’ If there was no one left to appease, the F.O. [Foreign Office] would feel out of a job altogether” (Moggridge 1992, 666). This was Keynes the mercantilist.

Keynes’s Long Term

Keynes was truly a social millennialist who ultimately envisioned a world evolving to the point of infinite accumulation of capital. His utopian vision is best expressed in his essay, “Economic Possibilities for Our Grandchildren” (1951 [1931], 358–73). Keynes believed that by progressively expanding credit to promote full employment, the universal economic problem of scarcity would finally be overcome. Interest rates would fall to zero and mankind would reenter the Garden of Eden. In Keynes’s mind, the gold standard severely limited credit expansion and preserved the status quo of scarcity. Thus, gold’s inelasticity—which the classical economists considered its primary virtue—stood in the way of Keynes’s paradise and needed to be abandoned in favor of fiat-money inflation (1951 [1931], 360–73). The Bretton Woods agreement was the first step toward removing gold from the world’s monetary system. Keynes would undoubtedly be pleased to see gold playing such a moribund role in international monetary affairs in the twenty-first century.

In short, Keynes’s goal was not to saveAdam Smith’s house, as his adherents contended, but to build another house entirely—the house that Keynes built. It was his belief that economists would live and work most of the time in Keynes’s house, while using Smith’s house occasionally, perhaps as a vacation home.

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Is Capitalism Inherently Unstable?

Keynes rejected the classical notion that the capitalist system is self-adjusting over the long run. The General Theory was written specifically to create a model based on the view that the market system is inherently and inescapably flawed. According to Keynes, capitalism was unstable and therefore could become stuck indefinitely at varying degrees of “unemployed equilibrium,” depending on the level of uncertainty in a fragile financial system. Keynes wanted to show that the economy could remain “in a chronic condition of sub-normal activity for a considerable period without any marked tendency either toward recovery or toward complete collapse” (1973a [1936], 249, 30). Paul Samuelson correctly understood the meaning of Keynes: “With respect to the level of total purchasing power and employment, Keynes denies that there is an invisible hand channeling the self-centered action of each individual to the social optimum” (Samuelson 1947, 151).

Keynes explained what he meant by “unemployment equilibrium,” but used no diagram to illustrate it. In a masterful article, “Mr. Keynes and the Classics,” British economist John Hicks developed a graphic framework (known as the IS-LM diagram) to demonstrate Keynes’s version of full-employment equilibrium (the special classical theory) versus unemployment equilibrium (the general theory) (Hicks 1937). Today’stextbooksuseasimilardiagramtodemonstrateaggregatesupply (AS) and aggregate demand (AD).

In Figure 5.1 we see how the economy is depressed at less than full employment. According to Keynes’s model, the classical model only applies when the economy reaches full employment (Qf), while the Keynesian general theory applies at any point along the AS curve where it intersects with the AD curve.

Who’s to Blame? Irrational Investors!

Keynes blamed the instability of capitalism on the bad behavior of investors. The General Theory creates a macroeconomic model based essentially on a financial instability hypothesis. As Keynesian economist Hyman P. Minsky declares, “The essential aspect of Keynes’s General Theory is a deep analysis of how financial

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concentrate resources upon the holding of ‘liquid’securities” (1973a [1936], 155). According to Keynes, the stock market is not simply an efficient way to raise capital and advance living standards, but can be likened to a casino or a game of chance. “For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs—a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbor before the game is over, who secures a chair for himself when the music stops” (1973a [1936], 155–56).

Keynes was speaking from experience. He reasoned that the 1929–33 crisis destroyed his portfolio without any rational economic cause—the panic was due toWall Street’s irrational demand for cash, what he termed “liquidity preference” and a “fetish of liquidity” (1973a [1936], 155).

The Culprit: Uninvested Savings

If Keynes were Sherlock Homes, the economist-investigator would point an accusing finger at Miss Thrifty in his murder mystery, “The Case of the Missing Savings.” In Keynes’s model, the key factor causing an indefinite slump is the de-linking of savings and investment. If savings failed to be invested, total spending in the economy would fall to a point below full employment. If savings were hoarded or left in excessive reserves in the banks, as was the case in the 1930s, the fetish for liquidity would make national investment and output fall. Thus, thrift no longer served as a dependable social function.

In The General Theory, Keynes argued that as income and wealth accumulate under capitalism, the threat grows that savings will not be invested. He introduced a “psychological law” that the “marginal propensity to save” increases with income (1973a [1936], 31, 97). That is, as individuals earn more income and become wealthier, they tend to save a greater percentage of their income. Thus, there is a strong tendency for savings to rise disproportionately as national income increases. But wouldn’t a growing capitalist economy always be under pressure to invest those increased savings? Keynes responded, “Maybe, maybe not.” If savings are not invested, the boom will turn into a bust.

Actually, this criticism of uninvested saving is an old saw with

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Keynes. He acknowledged the necessity of thrift and self-denial during the nineteenth century in a delightful passage of The Economic Consequences of the Peace (1920, 18–22), stating that thrift “made possible those vast accumulations of fixed wealth and of capital improvement which distinguished that age from all others” (19). But in A Treatise on Money (1930), the Cambridge economist raised the likelypossibilitythatsavingandinvestmentcouldgrowapart,creating a business cycle. In a modern society, saving and investing are done by two separate groups. Saving is a “negative act of refraining from spending,” while investment is a “positive act of starting or maintaining some process of production” (1930, 155). The interest rate is not an “automatic mechanism” that brings the two together—they can “get out of gear” (1951 [1931], 393) and savings can be “abortive.” If investment exceeds savings, a boom occurs; if savings exceeds investment, a slump happens.9

During the depression of the 1930s, Keynes lashed out at frugal savers and hoarders who kept down “effective demand.” The conventional wisdom in bad times has always been to cut costs, get out of debt, build a strong cash position, and wait for a recovery. Keynes was opposed to this “old-fashioned” approach, and he was joined by other economists, including British Treasury official Ralph Hawtrey and Harvard’s FrankTaussig, in encouraging consumers to spend. In a radiobroadcastinJanuary1931,Keynesassertedthatthriftinesscould cause a “vicious circle” of poverty, that if “you save five shillings, you

9. Historians Elizabeth and Harry Johnson even went so far as to suggest that Keynes’s negative attitude toward saving was related to his misogynistic tendencies. The Johnsons noted that Keynes and his followers often referred to savings as female and investment as male. Female saving was usually seen in a negative light and male investment in a positive way. “The maleness of investment is attested to by among other things the frequent references by Joan Robinson and other Cambridge writers to ‘the animal spirits’of entrepreneurs; the femaleness of savings is evident in the passive role assigned to savings in the analysis of the determination of employment equilibrium” (Johnson 1978:121). Keynes himself wrote in his Treatise on Money, “Thus, thrift may be the handmaid and nurse of enterprise. But equally she may not” (1930, 2:132). However, Keynes was sometimes ambiguous about the sexual identity of saving. In the same Treatise, Keynes commented on the lack of economic progress in Europe in the 1920s. “Ten years have elapsed since the end of the war. Savings have been on an unexampled scale. But a proportion of them has been wasted, spilt on the ground” (1930, 2:185). This is an allusion to the biblical story of Onan, who spilled his seed on the ground (Genesis 38: 8–9).

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put a man out of work for a day.” He encouraged British housewives to go on a buying spree and government to go on a building binge. He urged, “Why not pull down the whole of South London from Westminster to Greenwich, and make a good job of it. . . . Would that employ men? Why, of course it would!” (1951 [1931], 151–54).

Keynes’sbiasagainstthriftreacheditszenithinTheGeneralTheory, wherehereferredtotraditionalviewsonsavingsas“absurd.”Heboldly wrote, “The more virtuous we are, the more determined by thrift, the more obstinately orthodox in our national and personal finance, the more our incomes will fall” (1973a [1936], 111, 211). Keynes praised theheterodoxnotionsofunderworldfiguresandmonetarycranks,such as Bernard de Mandeville, J.A. Hobson, and Silvio Gessell, who held underconsumptionist views (333–71). He was undoubtedly influenced by the popularity of Major Douglas of the social credit movement and underconsumptionists Foster and Catchings during the 1920s.

An Antisaving Tradition

Keynes was not the first to question the virtue of thrift. Over the years, a small group of radical thinkers, known generally as underconsumptionists, have dissented from the traditional endorsement of thrift. They include Simonde de Sismondi, Karl Rodbertus, J.A. Hobson, and Karl Marx. Keynes expressed sympathy toward the “heretical” views of Major C.H. Douglas, an engineer who began the social credit movement in Canada in the 1920s and wrote several books championing “economic democracy” (1973a [1936], 370–71). Believing that saving created a permanent deficiency in a nation’s purchasing power, Major Douglas advocated strict below-market price controls so that consumers could afford to buy the products they produced.

William T. Foster, past president of Reed College, and Waddill Catchings, an iron manufacturer and partner in the investment firm of Goldman Sachs, proposed a different scheme. Foster and Catchings wrote a series of books on a similar antisaving theme. “[E]very dollar which is saved and invested, instead of spent, causes one dollar of deficiency in consumer buying unless that deficiency is made up in some way” (Foster and Catchings 1927, 48). What way? Foster and Catchings advocated that the government issue new money credits to consumers to make up for consumer buying deficiency.