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The Keynes Disaster


The government and the private sector should start spending more to turn the economy around. That’s what a former Obama administration official, speaking to a recent UBS adviser conference, said in making no apologies for the administration’s poor performance since 2009. Indeed, he said that Barack Obama had “saved” the country from a depression in 2009. He also called for advisers to cast aside their beliefs in the efficacy of saving.

Lawrence Summers, who served as director of the White House National Economic Council and was almost chairman of the Federal Reserve, said it is the public-spending ideas of the economist John Maynard Keynes that would bring prosperity and not the “old fashioned” ideas about saving and balanced budgets.

“This is no time for austerity,” said Summers, who was the featured speaker on Thursday at the UBS Global Forum. The weak economy, whose growth rates have disappointed over the last four and half years, has “a shortage of demand instead of an excess of supply.”

The essential problem of the economy, he insisted in an address that often referenced Keynes, is that “we live in a demand-constrained economy — it is being constrained by demand, rather than limited by supply.”

“Consumption — to state the obvious — is the sole object of all economic activity,” Keynes famously wrote. Summers added that too little consumption has led us into Keynes’s “liquidity trap.” That means that many people’s holding high cash balances and not buying leads to an underperforming economy, according to Keynes.

“And it means that many of the principles we have traditionally had in economics — the virtue of savings and balanced budgets and the like — have to be re-thought for the era we live in,” according to Summers.

He also emphasized the importance of the government’s finding a way to raise stagnant wage rates. That will encourage millions of young people, who have quit looking for jobs, to come back into the work force, he said. Summers complained that the United States is in the grip of “a deficit hysteria,” even though the debt-to-GDP ratio is projected to decline over the next decade.

But some advisers in the audience didn’t agree.

“Even if you are correct that the debt-to-GDP ratio may decline in the next five years, it still remains fairly high by historical standards,” warned Jorge O. Mariscal, CIO, Emerging Markets, UBS Wealth Management. He also cautioned that, even though there is little apparent inflation now, many people are holding on to cash out of a fear that “at some point they’re going to be taxed” and that inflation later on will “confiscate” their wealth.

Another audience member was similarly unimpressed by Summers’s Keynesian message.

“Much of what you said made sense,” one adviser said. “But when you got to the issue of austerity, that blew my mind and almost your credibility. How can you say that austerity should not be exercised? It sounds like the government — spending, spending, spending.”

Summers laughed him off the question and comment. He continued with his argument, using Keynes’s paradox of thrift as an example of why the economy is not briskly expanding in the fourth year of a recovery.

“I think the essential points that I would emphasize are that there is a very big difference between an economy and a household. With the Summers household it is certainly true that, if we spend less, we will save more. And that means we will increase our wealth and decrease our debt. And that is all there is to it. But the thing about an economy, though, is that my spending equals your income. And so when I spend less, you have less income. And that also affects how much you can save. And that affects your situation,” Summers said.

But the former presidential adviser ignores several factors: American saving rates have been declining for generations as Americans, consciously or unconsciously, have embraced Keynesian ideas about the so-called dangers of thrift. And Keynesian policies haven’t worked; otherwise Summers wouldn’t have been pleading with financial professionals to jettison their ideas about saving.

Even a report to Obama, The Budget Message of the President 2013, concedes that the recovery that began some four years ago has been tepid. The recovery, according to The Budget Message, has been weaker than previous ones.

“From 1960 to 2007, the U.S. economy had seven recessions, and the annual rate of growth of real GDP during the 12 quarters following these recessions was 4.2 percent,” the presidential report said. “In contrast, during the 12 quarters following the trough in the second quarter of 2009, the average annual rate of growth of real GDP was 2.2 percent. After three years of recovery, the cumulative growth of real GDP was 6.3 percentage points lower than the average value for the earlier post–1960 recessions.” Also of interest, the report noted that Americans savings rates have been declining for many years.

Yet Summers’s critique of traditional thrift and his call for more public and private spending — the essence of the theories of Keynes, who has dominated much economic thinking for generations — raised several questions that were never asked, since Summers didn’t allow any questions from the press:

• Why is the country in such a weak recovery, with unemployment still high and GDP projected to be only about 2 percent this year, despite the application of Keynesian remedies by the Obama administration, which has frequently praised Keynes?

• How much longer can the United States continue to spend at dangerous levels that threaten to bankrupt the country some day?

• Isn’t there a danger in telling Americans — many of whom have little in savings and investments, potentially facing a retirement with a declining standard of living — that saving is bad, when that is precisely what many of them need to do at a much greater rate?

• Why did the Obama administration’s $1 trillion stimulus not jump-start the economy?

• And aren’t there any dangers, in telling governments to go on a spending binge, that they will get carried away?

(That was famously discussed by a Dutch post–World War II prime minister who founded the Netherlands’ Social Security system. “I have always pleaded that people should be careful when overseeing the government’s finances,” said the socialist prime minister Willem Drees in a warning never heard in places such as Greece and Spain. “There are many who are too easily inclined to act as though they are inexhaustible.”)

So why are the policies that Summers endorsed in the first years of the Obama administration now conceded as not working?

And, given that the George W. Bush also tried a small stimulus, how many more stimuli will be needed to get the economy going?

Indeed, it is not as though Keynes and his countercyclical, run-deficits ideas haven’t had friends and influence in administrations from Franklin Roosevelt to Obama. For example, Republican president Richard Nixon, in disastrously committing the country to wage and price controls and breaking America’s last link to gold, famously said, “Now I am a Keynesian in economics.”

Ronald Reagan didn’t proclaim himself a Keynesian. But his policies of high deficits, fueled in part by huge military budgets, were certainly Keynesian. Summers’s much-admired Obama became the first president to run four consecutive trillion-dollar deficits.

George W. Bush, in his book Decision Points, shows the influence of Keynes, even if he had never read him. Speaking about the outset of the market meltdown of 2008, he writes, “If we were really looking at another Great Depression, you can be sure I’m going to be Roosevelt, not Hoover.”

Unfortunately, Bush and many other American presidents seem to think that Roosevelt’s countercyclical/Keynesian policies stopped the Depression and restored prosperity. That, of course, is an economic myth that Larry Summers is propounding.

All those Keynesian presidents, who may or may not have seemed initially successfully, left the nation with looming economic problems. The New Deal never produced prosperity. Nixon gave Americans a Potemkin Village economy. It looked great for a couple of years — then stagflation struck.

Reagan gave Americans “Morning in America” — then the crash of 1987 and huge deficits ensued. Both Bushes left the nation with economic woes. And Obama, with 2008 promises of a booming economy by 2012 and a deficit cut in half, has also failed.

This sorry record of spend, tax, and spend some more has not given our nation anything resembling a strong recovery. It has led to a familiar pattern of boom and bust, as predicted by the Austrian School, whose economists have no influence on the Obama administration.

Maybe it is time to revisit the Keynes/Summers record and try something totally different. Maybe it is time to revisit the formula that helped the United States recover from the depression of 1920–1921: a balanced budget, much less government spending, big tax cuts, and let each American have more choice about what is best for him to spend or save. Better yet, how about restoring the system of economic liberty on which America was founded: no income tax, no welfare state, no warfare state, no central bank, and no fiat money — the system that produced the greatest and most sustained outburst of economic prosperity and voluntary charity the world has ever seen?

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  • This post was written by:

    Gregory Bresiger, an independent business journalist who works for the Sunday New York Post business section and Financial Advisor Magazine, is the author of the book Personal Finance for People Who Hate Personal Finance.