Gary North

Reality Check (March 12, 2010)

On March 11, I spoke at the annual Austrian Scholars Conference, sponsored by the Ludwig von Mises Institute. It was gratifying to see so many attendees that they could not fit into one room.

The Mises Institute is a high-tech outfit. They set up a video camera, and the speech appeared on monitors in other rooms. It will also go on-line within a few days. This will be free. Anyone in the world with Web access can see it from now on. This is a great model for communication and education.

My topic was "Keynes and His Influence." My goal is to recruit half a dozen bright young scholars to begin a joint project in refuting Keynes' "General Theory of Employment, Interest, and Money" (1936) line by line. I have set up a department on my Website to this end.

I tried to make four main points in my speech.

1. Keynes' influence has been indirect (mediated).
2. His legacy will soon be uniquely vulnerable.
3. Only the Austrians called the 2008 recession.
4. It is time for a comprehensive refutation of Keynes

THE MOST INFLUENTIAL MODERN ECONOMIST

There is no question that John Maynard Keynes was the most influential economist in the 20th century. Yet his influence has been different from what economists and the intelligentsia have believed.

In a filmed interview of Keynes' main rival in 1935, but not in 1965, F. A. Hayek, an Austrian School economist, made an important point. Keynes was influential in 1946, the year of his death, but his influence was not yet overwhelming. That came later. Hayek did not say how much later. It came within five years. You can see the video here:

The key to Keynes' influence was the 1948 textbook written by Paul Samuelson, "Economics." It became the most widely assigned college textbook in economics. It had no major competition for at least three decades, and its competitors were also Keynesian in outlook.

Samuelson promoted Keynes' ideas, but he used a very different format. He did not quote Keynes at length. He presented what has since been called the neo-Keynesian synthesis. He applied Keynes' fundamental principle of deficit spending in the Great Depression to apply to the overall economy in a post-depression world. He really did try to make general the "General Theory," which the book had not been.

"The General Theory" was highly specific. It was a program designed to counteract falling spending and a falling money supply in an era in which there was no government insurance for failed banks or their depositors. It was a program to offset widespread hoarding of currency. From the day that the FDIC was created in 1934, American banks stopped failing, and the money supply started to rise. Keynes wrote his book after this transition in the United States. The book was a theoretical defense of policies that had already been adopted in the United States and Western Europe, and which World War II would escalate: deficit spending, mass inflation, and a vast expansion of the government's share of the economy. This is not how the Keynesians have told the story. It is how the story ought to be told. I am trying to recruit economists and historians who will commit several years of research to telling it.

Keynes' "General Theory" has long been an unread book that sits on the shelves of economics graduate students and professors. No one actually has read it except specialists in the history of economic thought. The book is close to unreadable. Compared to his earlier books and essays, it is uniquely unreadable. We do not see its formulas quoted as proof of contemporary policies or recommended policies. The literature cited in economists' footnotes is what we can legitimately call Keynesian, but this literature is an extension of Keynes' work, not Keynes' actual work.

Whether Keynes would approve of what is recommended in his name is moot. Hayek spoke to Keynes a few weeks before he died. According to Hayek, Keynes was not happy with developments being offered in his name.

Keynes had always been an opponent of inflation. His earlier works repeatedly warned against the threat of inflation. Yet, by 1945, inflation was a way of life in the West.

We should compare "The General Theory" to Charles Darwin's "Origin of Species." Darwinists rarely quote Darwin to support their latest papers. They cite him as the originator of the idea of evolution through natural selection. Attacks on Darwin's actual exposition are shrugged off by his followers as irrelevant. We find an entire school of Darwinists who preach an idea that is opposed to what Darwin taught: the "punctuated evolutionism." Darwin believed in tiny changes over long periods of time. They believe in huge changes in brief periods of time. Still, they call themselves Darwinists. Why? Because they believe in his Big Idea: purposeless, random causation prior to man.

The same is true of Keynes' "General Theory." It was Keynes' primary idea that dominates the thinking of economists: government budget deficits as the means of overcoming economic slumps. As to simple formulas and concepts in the book, modern economists rarely cite them in professional journals. If one or more specifics of the book are refuted, his supporters shrug it off. Keynes' influence relates to the one big idea, just as Darwin's influence does.

The specifics in the book are forgotten today, such as his statement that the government could plant bottles full of money, bury them, and let workers dig them up for a living. He also said that building the equivalent of Egypt's pyramids would help restore prosperity. He really believed this. His disciples do not refer to these passages. When pressured by critics, they dismiss them as merely rhetorical. They were rhetorical, but not merely rhetorical.

A VULNERABLE LEGACY

Today, Keynesians insist that their man was right. They take credit for the recovery since late 2009, such as it is. This assertion is widely accepted. It is so widely accepted that Wikipedia has an article on it: "Keynesian Resurgence."

Yet the reality is far different from the perception. Keynes' solution in 1936 was a program of fiscal deficits, coupled with mild monetary expansion in a time of monetary contraction. These government deficits were supposed to stimulate consumer spending.

Yet the heart of the U.S. government's program in 2008 was not the $787 billion spending program. Rather, it was the prior doubling of the Federal Reserve's monetary base, the FED's face-value swaps of its marketable Treasury debt for unmarketable toxic assets owned by the biggest banks, the AIG bailout, and the subsequent $1.25 trillion pumped into Fannie Mae and Freddie Mac, after their nationalization by Henry Paulson in September 2008. None of this was Keynesian. All of it was ad hoc monetary inflation and central bank subsidies to large banks.

Keynes recommended government spending and employment by government. He did not recommend central bank bailouts of large banks. He focused on fiscal policy, not monetary policy.

The biggest banks were saved by these interventions. Small banks continue to go under, Friday afternoon after Friday afternoon. The banking industry as a whole has contracted its loans to commercial and industrial firms. Banks have added over $1 trillion to their excess reserves at the FED, thereby sterilizing money. This is anti-Keynesian: a restriction of spending, meaning a reduction in aggregate demand compared to what would otherwise have been the case.

Keynesianism as an idea has received a shot in the arm -- mainly with fiat money, not Federal deficits. Yes, the deficits have been enormous, just not by comparison to central banks' money creation. The deficits are unprecedented, all over the world. Yet the economic recovery is universally criticized as weak.

If enormous deficits are not serving as stimuli for widespread recovery, then what credit should Keynes get? Keynesians are saying that government policies kept the world economy from collapse. But this is not the same as saying that the policies have restored prosperity. They haven't.

There have been some protests by economists. Several hundred academic economists, mostly in obscure universities, publicly protested the stimulus package.

But no group of economists, other than the Austrians, said in 2008 that the FED should do nothing, that Fannie and Freddie should be allowed to go under, and that the stimulus bill should be voted down. With only this exception, the entire academic community of economists became cheerleaders for the FED's bailouts of 2008. They sold their non-Keynesian birthrights for a mess of Federal Reserve pottage.

The silence of the profession in 2008 and after has boxed them in. They are defenders of moral hazard, despite their timid warnings to the contrary.

If one person has summarized the alternative economic scenarios facing us, it is Merle Hazard. Merle is not his real name. He is a financial planner in Nashville. He began performing on YouTube in 2009. He and his partner, Bretton Wood, sang the question: "Will it be Zimbabwe or Japan?" So far, it's Japan.

The governments of the West have made one thing inescapably clear. They do not intend to enforce high bank capital ratios established by the Bank for International Settlements. The European Union and the European Central Bank have also made it clear that they will not enforce EU rules on the deficit-to-GDP ratio. There is only one rule today: "Tax and tax, spend and spend, inflate and inflate."

The looming bankruptcies of Western governments and Japan are now becoming clearer to the literate public. Observers are becoming more Austrian in their perception. Investors do not accept this scenario emotionally, but the numbers are clear. There will have to be a cutting back of Medicare, Social Security, and unemployment benefits, either sooner or later.

It is also clear that unemployment will not be significantly reduced by the present recovery. The Keynesian tools are not working. They have not worked in Europe for a generation, where life on the dole is permanent for 10% of the work force.

When the bust comes, the Keynesians will take the blame. They have demanded credit for the recovery, and they have received it. They are consuming public favor today. They will pay for it later.

"WE TOLD THEM SO!"

The Austrian School's representatives predicted the recession. The defining moment was Peter Schiff's debate with Art Laffer in 2006. Schiff said a crash was coming. Laffer ridiculed him. Because of YouTube, this story will not go away.

The Austrian theory of the business cycle was the tool that enabled Schiff and others, such as me, to predict in 2006 that a recession would hit in 2007. It did -- in December 2007. We told them so. This establishes our credentials, but more to the point, it establishes Ludwig von Mises' credentials. He thought that economic logic alone was necessary to defend a position. But in political debate, having the numbers demonstrate that you were right is also necessary.

When the USSR went bust economically in 1988, then lost the Afghan war in 1989, and finally committed suicide in 1991, Marxism died. All the footnotes in the Marxist books no longer mattered in academia. All the post-1991 wailing by Marxists that the Soviet Union really had never been truly Marxist has been ignored. Why? Because the Marxists took credit for the USSR for 74 years. They praised the Soviet Union's central planning. So, in 1991, they could not get off the sinking Soviet ship in time to justify the Marxist system.

By 1991, China's economy was booming because of Deng's abandonment of Marxist economics in 1978. That left only Albania, Cuba, and North Korea. The Marxists had nowhere to turn to that offered evidence of economic success. Overnight, they became a laughing stock on campus.

This will be the fate of Keynesians when the governments of the West finally go bust or else abandon the deficits and the fiat money.

Who will still be standing to pick up the intellectual pieces? The Chicago School economists did not predict 2008. They did not defiantly protest the FED's bailouts of September and October. Neither did public choice economists, rational expectations economists, or behavioral economists. They all climbed aboard the Good Ship Keynes, which was in fact the Good Ship Bernanke. The Austrians did not.

The Austrians, few in number, are the last men standing to challenge the Keynesians. This is their great opportunity. They have waited a long time.

GOING ON THE OFFENSIVE OFFENSIVELY

As W. C. Fields said so long ago, "Never give a sucker an even break." This also applies to bloodsuckers. The Keynesians are apologists for the bloodsucking class: tax collectors, deficit-expanders, and boondogglers of all shapes and sizes.

I have set up www.KeynesProject.com to help mobilize the guerrilla troops in a comprehensive assault Fort Keynes. This is a supplement to the vast collection of free books and materials found on www.Mises.org, especially the books in the Literature section of the home page.

There has to be a full-scale assault on the "General Theory" that shows how it is illogical, line by line. This has been done sporadically in the past, but not systematically. To oppose Keynes' overall system was to commit academic suicide.

When the decks are cleared, then there must be a systematic critique of the post-Keynes literature. But this is too large a job for a handful of scholars. It will take at least a decade to produce the basic critique of Keynes. My hope is that this project will be complete in time for the crisis produced by today's policies.

To persuade the next generation of economists and talking heads that Keynes was wrong, and therefore his apologists are wrong and have been wrong, we need two things: (1) a body of material in all the media that shows that "The General Theory" was a con job from day one; (2) an economy universally suffering from the effects of the policies that have been justified in the name of Keynes. Since we are going to get the second, why not work on the first?

CONCLUSION

We have lived in the shadow of Keynes since 1936. That shadow has darkened academia for over 70 years. Keynes justified what politicians and salaried academic bureaucrats always wanted: more power for politicians and tenured bureaucrats.

Keynes justified this system of parasitic bloodsucking. The bills are now coming due. The voters are going to join a tax revolt against these bills. They will seek justification. Austrian School economics is best positioned today to offer that justification. To become even better positioned, a younger generation of Austrian School economists must publicly gut "The General Theory."