Where Keynes Went Wrong: And Why World Governments Keep Creating Inflation, Bubbles, and Busts
by Hunter Lewis (Axios Press, 2010); 384 pages.
In the wake of the bursting of the housing bubble and the resulting financial collapse, many politicians and high-profile economists (such as Nobel winner and New York Times columnist Paul Krugman) have missed no opportunity to push the idea that the economic tonic Americans need to get over their troubles is “stimulus.” What that means is increased spending by the federal government, thereby pumping up demand for goods and services and in turn putting people back to work. Of course, there is considerable disagreement over that notion, but its popularity is widespread, especially among intellectuals. Intellectuals are prone to distrust the supposed “messiness” and even “chaos” of freedom and easily fall for theories that extol socio-economic planning by experts such as themselves.
That haughty disdain for individualism perfectly mirrors the economic philosophy of the man most closely associated with the theory that an advanced economy needs constant government intervention — John Maynard Keynes.
Keynes, who lived from 1883 to 1946, was the progenitor of the economic theories that have mostly ruled the roost since the 1930s. Starting with Franklin D. Roosevelt, most American presidents have been under the sway of advisors who were trained in the Keynesian approach. The Obama administration is full of them, and its efforts at reviving the economy through massive deficit spending are right out of the Keynesian playbook. In recent years, there has been a surge of articles and books hewing to the line that we need to pay attention to Keynes if we are to escape from recession and enjoy a stable, growing economy. Typical of that genre is Robert Skidelsky’s Keynes: The Return of the Master. But should we look to Keynes for economic wisdom as we might, for example, look to Mozart for musical wisdom or Albert Einstein for scientific wisdom? Author Hunter Lewis maintains that we should not.
In his latest book, Where Keynes Went Wrong: And Why World Governments Keep Creating Inflation, Bubbles, and Busts, Lewis utterly deflates Keynes’s reputation. Not only was Keynes not a brilliant, original, far-seeing economist, Lewis shows, but his system of thought was nothing more than a hodgepodge of false ideas. In fact, he was merely recycling the notions of economic dabblers and cranks whom serious thinkers had long before refuted.
Instead of being laughed at and ignored, Keynes became a giant, however. That seeming oddity is explained by the fact that his ideas were enormously appealing to statist politicians and academics. They gave intellectual respectability to a vast increase in government power. Ordinary people are harmed by that because expanding government inevitably means decreasing freedom and decreasing economic efficiency, but scarcely any of them understands how they are hurt by Keynesian voodoo. After reading Lewis, it’s impossible to disagree with Murray Rothbard’s judgment that Keynes was “a charming but power-driven statist Machiavelli, who embodied some of the most malevolent trends of the 20th century.”
Keynes’s reputation rests largely on one book, The General Theory of Employment, Interest, and Money, published in 1936. At that time, he was already a rather well-known public intellectual (more so in Europe than in the United States), but the General Theory got people talking about him everywhere. He was hailed as a deep, iconoclastic thinker who had discerned a new path for economic policy. By 1971, Richard Nixon would declare, “We are all Keynesians now.”
Just what did he say in that book, though? Was it truly penetrating and innovative, as so many have heard? Lewis essays an examination of the major themes of the book and concludes that the adulation for Keynes is an instance of much ado about nothing. Far from advancing human understanding, The General Theory is a confusing, poorly written jumble of antiquated ideas. It was as if someone wrote a book on medicine saying, in obscure and intellectually intimidating language, that we should forget about bacteria and once again think about how diseases are caused by an imbalance of bodily humors.
Lewis readily admits that he is not the first writer to undertake a demolition job on Keynes. He praises Henry Hazlitt’s magisterial 1959 book, The Failure of the “New Economics,” for having accomplished the Herculean feat of a line-by-line debunking of The General Theory. Instead of reprising Hazlitt’s work, Lewis gives us an easily read book that concentrates its fire on Keynes’s major ideas.
Under that fire, the Temple of Keynes is reduced to less than rubble.
Not an economist
At the outset, Lewis observes that Keynes wasn’t really an economist at all, but was “the first of a breed that we have come to know well: the government policy entrepreneur. He lived and breathed policy, loved being consulted, pursued and even lionized by the political and business elite.” The policy that Keynes pushed was the antithesis of laissez faire. Rather than leaving the economy to the “invisible hand” — which is to say, to millions of individual decisions and transactions — Keynes wanted experts such as himself to control “the commanding heights” and make the choices that would shape the general contours of the economy. In the typical fashion of an upper-class British elitist (and Keynes was emphatically that), he scorned ordinary people, even those who had accumulated wealth, made business investments, and were profitably producing goods and services. It seems not to have occurred to him that when people deal with their own money, they have very strong incentives to plan and choose carefully.
Rather than leaving something as crucial as investment to the whims of ordinary people, Keynes thought that nations should rely on cool, unemotional experts. Doing so would eliminate one of the chief causes of the boom and bust cycle, namely the tendency for ordinary people to get carried away by their “animal spirits.” That is how Keynes explained the Great Depression of the 1930s — investors had gone wild, but after the bubble burst they had gone into a terrible funk. Getting the economy moving again would call for government to step in and “prime the pump.” It needed to “invest” money in projects chosen by government planners.
It is important to note that Keynes was not a totalitarian. Unlike many other British intellectuals at the time, he wasn’t enamored of Stalin’s regime. He wanted to preserve a fairly large measure of personal liberty alongside his politicization of investment. What he could not or would not see was that when the state controls “the commanding heights,” the details of the landscape below will be increasingly subject to political control as interest groups find that they can manipulate the government to suit their own ends.
Lewis points out that at the time Keynes was penning his ideas that “animal spirits” drive the economy dizzy and that government action was necessary to stabilize it, the Austrian theory of the business cycle was known in London. F.A. Hayek was teaching there and the two had exchanged letters in newspapers. (Lewis doesn’t mention this revealing tidbit, but back in 1914, Keynes had reviewed Ludwig von Mises’s pathbreaking book The Theory of Money and Credit and panned it as offering nothing original. Years later Keynes admitted that his comprehension of German was too spotty for him to understand such an insightful book.) The Austrians had explained that the business cycle was a result of previous government interventions, mainly efforts at “stimulating” the economy with artificially low interest rates.
The Austrian theory stood in direct opposition to his own explanation, but Keynes never engaged it. As Lewis shows, Keynes was good at using satire and misrepresentation to make himself seem far smarter than “old fashioned” economists, but he never bothered trying to refute the Mises/Hayek explanation for the business cycle. Perhaps he understood that if he so much as talked about the Austrians, people might start to ask uncomfortable questions about his pet theories.
Perhaps the most astounding feature of Keynes’s economic beliefs was that capital was not really scarce. All government needed to do was to create so much money that interest rates would be driven down to almost zero and goods would become abundant for all. He maintained that greedy capitalists kept the price of money artificially high for their own gain, thus limiting investment that would greatly expand the nation’s production. He proposed high taxes on the wealthy, whose funds would no longer be needed for investment once the state stepped in to provide capital. If you believed Keynes, the government could easily bring about a society that was simultaneously more prosperous and more equal.
That belief is on a par with thinking that through politics we can turn stones into bread, but during the desperate times of the Depression, people were eager for any quick fix. Keynes’s message was just what most wanted to hear — especially politicians.
But wouldn’t the policy of printing money to keep interest rates near or at zero lead to unsustainable booms and “bubbles”? Keynes had a breezy answer for those who raised that objection: the government must never let such bubbles burst! Apparently it never dawned on him that attempting to shore up bad investments (like the overgrown American housing industry circa 2007) must mean accelerating inflation and wasting resources. As Lewis repeatedly shows, Keynes rarely thought through the long-run implications of his ideas.
Equally irresponsible was Keynes’s opposition to hard money. He called gold a “barbarous relic” and favored adoption of “a more scientific exchange standard.” What he meant was a fiat-money regime under the control of experts (naturally) in a central bank such as the Bank of England or the U.S. Federal Reserve. If government kept the “barbarous relic” in use, how could it do its job of driving interest rates to zero and “stimulating” the economy whenever aggregate demand was insufficient? A modern economy needs a “flexible” monetary system, doesn’t it?
Lewis counters that the scarcity of gold is exactly what makes it good as money. Unlike paper money, politicians can’t shower the nation in gold; if they want to spend it, they have to tax it away from people, who directly and immediately see the effects of increased government spending. To those who worry that under gold there might be deflation, Lewis points out that slowly falling prices would spread the benefits of increasing productivity throughout the economy, as consumers’ incomes would buy more.
That last point indicates another virtue of the book. Not only are readers disabused of Keynes’s faulty economic ideas, but they learn a good many true ones.
If we want to boil down a short answer to the question “Where did Keynes go wrong?” the answer would be that he popularized the habit of thinking about the economy as if it were a machine. People are always talking about the government’s needing to “fix” the economy, to keep it from “overheating,” or to “rev it up.” That’s how Keynes looked at it: the economy was a simple, poorly built machine that needed constant government attention. The economy, however, is nothing like a machine and government attention (spending, borrowing, mandating, prohibiting, inflating) only interferes with the network of human relationships — the spontaneous order — that we call “the economy.”
Keynes was no “master” economist. He was a pseudo-intellectual showman whose addled notions gave (and still give) advocates of the megastate cover for their assaults on liberty and property. Bravo to Hunter Lewis for making the case against him so effectively.
This article originally appeared in the October 2010 edition of Freedom Daily. Subscribe to the print or email version of Freedom Daily.