Eric Sprott: "We Are Now Paying For The Funeral Of Keynesian Theory"

Tyler Durden's picture

Fooled by Stimulus, by Eric Sprott and David Franklin

Despite our firm’s history of investing primarily in equities, we’ve spent much of this past year writing about the government debt market. We’ve chosen to focus on government debt because we fear its impact on the equity markets as a whole. Government debt is an intrinsically important part of the financial landscape. It is the bellwether by which we measure risk, and we believe we have entered a new era where traditional "risk-free" assets are undergoing a tremendous shift in quality.

In studying the government debt market, we have inadvertently been led to question the economic theory that most fervently justified recent government spending programs: that of Keynesian economics. The so called "beautiful theory" of Keynesian economics is arguably the most influential economic theory of the 20th Century, shaping the way Western democracies approached the balance between free market capitalism and government initiatives. Like many beautiful theories, however, Keynesianism has ultimately succumbed to the ugly facts. We firmly believe the Keynesian miracle is dead. The stimulus programs are simply not producing their desired results, and the future debt costs associated with funding these programs may cause far greater strife in the future than the problems the stimulus was originally designed to address.

Keynesian economics was born with the publishing of John Maynard Keynes’ "The General Theory of Employment, Interest and Money" in February 1936. Keynesian theory advocates a mixed economy, predominantly driven by the private sector, but with significant intervention by government and the public sector. Keynes argued that private sector decisions often lead to inefficient macroeconomic outcomes, and advocated active public sector policy responses to stabilize output according to the business cycle. Keynesian economics served as the primary economic model from its birth to 1973. Although it did lose some influence following the stagflation of the 1970s, the advent of the global financial crisis in 2007 ignited a resurgence in Keynesian thought that resulted in the American Recovery and Reinvestment Act, TARP, TALF, Cash for Clunkers, Quantitative Easing, etc., all of which have been proven ineffective, ill-advised and whose benefits were surprisingly short-lived.

The economic historian, Niall Ferguson, recently described a 1981 paper by economist Thomas Sargent as the "epitaph for the Keynesian era".1 It may have been the epitaph in academic circles, but the politicians clearly never read it. Almost thirty years later, we now get to experience the fallout from the latest Keynesian stimulus binge, and the results are looking pretty dismal to say the least.

There are a number of studies we have come across that suggest stimulus is the wrong approach. The first is a 2005 Harvard study by Andrew Mountford and Harald Uhlig that discusses the effects of fiscal policy shocks on the underlying economy. Mountford and Uhlig explain that from the mid-1950’s to year 2000, the maximum economic impact of a two percent increase in government spending was an ensuing GDP growth of approximately three percent. A two percent spending increase inevitably requires an increase in taxes. Due to the nature of interest costs, however, the government would have to raise taxes by MORE than two percent in order to pay back the initial borrowing. According to their data, this increase in taxes would generally lead to a seven percent drop in GDP. As they state in their study: "This shows that when government spending is financed contemporaneously that the contractionary effects of the tax increases outweigh the expansionary effects of the increased expenditure after a very short time."2 Stated simply, ‘borrowing to stimulate’ has never worked as planned because the cost of paying back the borrowed funds surpassed the immediate benefits of the stimulus.

In a follow-on study, Harald Uhlig estimated that an approximate $3.40 of output is lost for every dollar spent on stimulus.3 Another study on the same subject by C’ordoba and Kehoe (2009) went so far as to say that, "massive public interventions in the economy to maintain employment and investment during a financial crisis can, if they distort incentives enough, lead to a great depression."4

If the conclusions of these studies are even close to being correct, we are now in quite a predicament – not just in the US, but across the Western world. Remember that the 2007-08 meltdown was only two years ago, and as we highlighted in April 2009 in "The Elephant in the Room", the US government has spent more on stimulus and bailouts, in percentage of GDP terms, than it did in the Gulf War, Operation Iraqi Freedom, the Vietnam War, the Korean War and World War I combined.5 All that spending was justified by the understanding that it would generate sustainable underlying growth. If it turns out that that assumption was wrong, have the governments made a fatal mistake?

Another recently published Harvard study looked at stimulus at a micro-economic level and derived some surprising conclusions. Entitled "Do Powerful Politicians Cause Corporate Downsizing?", the authors compiled 232 occasions over the past 42 years when either a Senator or a Representative was voted into a controlling position over a big-budget congressional committee. Unsurprisingly, the ascendancy of the politicians resulted in extra spending in their respective districts – typically in the form of an extra US$200 million per year in federal funds. The researchers examined the economic effects of this increase in spending and found "strong and widespread evidence of corporate retrenchment in response to government spending shocks." The average firm cut back on capital investment by 15 percent and significantly reduced its R&D spending.

Companies collectively operating in the affected state reduced capital investment by $39 million a year and R&D by $34 million per year. Other consequences included increases in unemployment and declines in sales growth.6,7 Yikes!! That is not the response we’re supposed to get from government spending!

The Canadian government’s experience with Keynesian-style stimulus has been no better. The Fraser Institute reviewed the impact of the Government of Canada’s "Economic Action Plan" and found that "the contributions from government spending and government investment to the improvement in GDP growth are negligible."8 They state that, of the 1.1% increase in economic growth between the second and third quarter of 2009, government consumption and government investment contributed a mere 0.1%. Of the 1% improvement in economic growth between the third and fourth quarter of 2009, government investment and consumption contributed almost nothing. In the end, it was actually net exports that were the largest contributor to Canada’s growth. No Keynesian miracle in this country.

Our own findings compare favourably to the academic studies cited above. We looked at government spending and current dollar GDP increases in our ‘Markets at a Glance’ entitled, "A Busted Formula". Our findings, using decidedly un-econometric techniques, showed similar results, and are presented in Table A below. We looked at current dollar increases in GDP as published by the Bureau of Economic Analysis (BEA) and current dollar expenditures and receipts for the US government taken from the Treasury. One current deficit dollar resulted in an increase in current dollar GDP of a mere 10 cents. Again - no miracle Keynesian multiplier here.

If we use the Fed’s own numbers, the impact of debt on GDP is even more dismal. In Chart B below, we present the marginal impact of debt on marginal GDP since 1966 using data from the Federal Reserve. Deficit spending, which has generated smaller and smaller increases in GDP over time, is now generating a negative impact on GDP due to the costs of servicing the debt. The chart suggests we have already entered what PIMCO refers to as the "Keynesian endpoint", where the government can no longer afford to increase debt levels.10 No debt = no stimulus. No stimulus = ???

A more timely epitaph for our Keynesian funeral comes from a recent op-ed piece by Jean-Claude Trichet, President of the European Central Bank, that was published in the Financial Times and entitled "Stimulate No More". In it Trichet states that, "…the standard economic models used to project the impact of fiscal restraint or fiscal stimuli may no longer be reliable."11 He explains that while debt in the euro zone has increased by more than 20 percent in only four years and by 35 to 40 percent over the same time period in the US and Japan, we have very little, if anything, to show for it. We agree. New housing sales are at all time lows, consumer intentions for auto purchases are at multi year lows, the University of Michigan consumer confidence index has turned negative, new jobless claims have started to increase, and the ECRI - a composite of leading indicators - is now forecasting a recession (see Chart C).

Since Keynesian economics is no longer relevant, some are now arguing that tax cuts will save the day. Two of the academic studies we reviewed suggest that tax relief is a much stronger stimulus to the economy than government spending, and under normal circumstances this is probably true. But we are not in a normal economic environment. Even if the tax cuts implemented by George Bush in 2006 are extended by the next Congress, the US will still face the ‘Keynesian Endpoint’. A Government Accountability Office (GAO) report published in January 2010 states the following: "In our Alternative simulation, which assumes expiring tax provisions are extended through 2020 and revenue is held constant at the 40-year historical average; roughly 93 cents of every dollar of federal revenue will be spent on the major entitlement programs and net interest costs by 2020."12 Extending tax cuts won’t solve anything.

In the end, Keynesian stimulus ultimately fooled us all. It roped in the politicians of the richest countries and set them on an unsustainable course of debt issuance. Recent Keynesian stimulus has even managed to fool the sophisticated economic models designed by central banks. The process of accounting for massive government spending ‘confuses’ the models into calculating a recovery trajectory when it doesn’t exist. The Bank of England confirmed this with its announced £3.5 million overhaul of its current model due to its inability to generate accurate inflation and recession forecasts.13

Keynesian stimulus can’t be blamed for all our problems, but it would have been nice if our politicians hadn’t relied on it so blindly. Debt is debt is debt, after all. It doesn’t matter if it’s owed by governments or individuals. It weighs on the institutions that issue too much of it, and the ensuing consequences of paying off the interest costs severely hinders governments’ ability to function properly. It suffices to say that we need a new economic plan – a plan that doesn’t invite governments to print their way out of economic turmoil. Keynesian theory enjoyed a tremendous run, but is now for all intents and purposes dead… and now it’s time to pay for it. Literally.


1 Ferguson, Niall (July 19th, 2010) "Today’s Keynesians have learnt nothing". Financial Times. Retrieved on August 10, 2010 from:
For those interested readers "The Ends of Four Big Inflations" by Thomas Sargent can be found at:
2 Mountford, Andrew and Uhlig, Harald (July 2005) "What are the Effects of Fiscal Policy Shocks" SFB 649 Discussion Paper Humboldt-Universität zu Berlin. Retrieved on August 10, 2010 from:, pg. 20
3 Boskin, Michael. (July 21, 2010) "Obama’s Economic Fish Stories" The Wall Street Journal. Retrieved on August 10, 2010 from:
4 Uhlig, Harald (May 15, 2009) "Some Fiscal Calculus" Unpublished. Pg 13. Retrieved on August 10, 2010 from:
5 Sprott Asset Management, Markets at a Glance April 2009. The Elephant in the Room.
6 Reynolds, Neil. (June 9, 2010) "The Hidden cost of Stimulus programs" The Globe and Mail. Retrieved on August 10, 2010 from:
7 Cohen, Lauren; Coval, Joshua; Malloy, Christopher. (March 16, 2010) "Do Powerful Politicians Cause Corporate Downsizing?" Unpublished. Retrieved on August 10, 2010 from:
8 Amela Karabegovic, Charles Lammam, Niels Veldhuis (March 23, 2010) "Did Government Stimulus Fuel Economic Growth in Canada? An analysis of Statistics Canada Data" Fraser Institute. Retrieved on August 10, 2010 from:
9 We used current-dollar GDP numbers provided by the BEA to determine the marginal impact of deficit spending on GDP. There is no separate data set generated by the BEA, however the number is published in their news releases. It is also worth noting the divergence between reported numbers from the BEA. While the current dollar measurement of GDP decreased by $185.1 billion or 1.3% on 2009, real GDP was widely reported as increasing by 0.1%. This divergence is due to seasonality adjustments in real GDP and the percentage change reported is a blended increase over the 4 quarters in 2009.
10 Goodman, Wes and Reynolds, Garfield (June 8, 2010) "Pimco’s Crescenzi Sees ‘Endpoint’ in Devaluations (Update2)" Bloomberg. Retrieved on August 10, 2010 from:
11 Trichet, Jean-Claude. (July 22, 2010) "Stimulate no more – it is now time for all to tighten" Financial Times. Retrieved on August 10, 2010 from:
12 United States Government Accountability Office. The Federal Government’s Long-Term Fiscal Outlook January 2010 Update (GAO-10-468SP). Retrieved on August 10, 2010 from:
13 Aldrick, Philip (August 10, 2010) "Bank of England overhauls forecast model after errors" Telegraph. Retrieved on August 11, 2010 from:


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ATG's picture

Four horsemen of the economic apocalypse:

1) Fractional reserve banking

2) Monetarism

3) NeoCons

4) NeoKeynesianism



cossack55's picture

Shame you can't fit mercantilism in there somewhere.

tip e. canoe's picture

Great Britain





Strongbad's picture

Haha good list.  I'd maybe throw Athens or Byzantium in there.

scratch_and_sniff's picture

Think your missing a trick there my olde chum.

B9K9's picture
  1. Demographic change - Uneducated, unskilled resource consumers being substituted for high value-added, taxpaying workforce.
  2. (Domestic) resource depletion - USA imports 2/3 of its daily oil consumption, with 1/2 of those imports coming from exchange with hostile countries. (Please note subtlety of last word - which countries are 'hostile' is not specified.)
  3. Off-shoring - Concomitant with demographic change, international conglomerates, which may or may not be domiciled in the US, play out global wage arbitrage while seeking lowest cost providers.
  4. Financial suicide - 65 years in the making (since the end of WWII), compounding principle+interest has caused incremental debt to drop below the magic 1:1 ROI on GDP as diminishing marginal utility has eroded future investment incentives to negative returns.

I know this keeps getting repeated, but we're screwed, blued & tattooed. Not sure why people feel compelled to continue producing these apparently sincere analyses of the failings of certain economic policy decisions. I mean, talk about falling for the diversion; yes, Keynesian theory is simply a cover story.

To paraphrase Voltaire, if Keynes did not exist, it would have been necessary for the power-elite to invent him. The real game has always had one goal - whatever tools, techniques, and tricks periodically became available were simply co-opted & employed to
further their agenda.

I mean, look at that list above - anybody who was even half-awake could tell the roulette wheel was broken. Predicting these outcomes is child's play to anyone paying attention. We were set up to be taken down by making damn sure those who never pay attention had full voting franchise.

I find these reports intensely boring. Talk about barn doors & horses after the fact. My primary focus is to figure out a way to make sure these guys don't get away with their crimes. Hopefully, sufficiently increased public awareness may potentially cut-off their various avenues of escape when the SHTF.

Geoff-UK's picture

Exactly--Austrian policy was right, no elected officials give a shit, only questions are:

1.  If I leave the U.S., where the hell do i go that isn't going to be just as shitty once WW4 starts?

2.  How long do you roast a squirrel before it's edible?

centerline's picture

+1.  The really scary thing here is that I have actually pondered the same questions before.  LOL.

RobD's picture

Can't answer number one but squirrel is best cooked slow with lots of fluids like in a crock pot or a stew. Squirrel is also good in a pot pie.

Perseus son of Zeus's picture

Laugh now you squirrely mother f*er. But before long the penultimate Cognitive Enhancement will alter your cynicism.

The soft kill system. You servile android.

grunion's picture

Use a pressure cooker, drives out the wild and very tender.

TBT or not TBT's picture

Deep fried in oil.   Use the same instructions as for a turkey, down to the minutes per pound of turkey.    Come to think of it, maybe we ought to go head to head with Tyson with a squirrel business, and spin offs like the obvious ducksquirrelen market.

Strongbad's picture

We make squirrel jerkey in W.Va., Kentucky, etc.  Same as making deer jerkey or anything else.  Also it is greasy so it makes decent gravy. ;) 

I take it you don't do a lot of squirrel hunting in the UK these days, lol.  Maybe soon though!

Bendromeda Strain's picture

Good stuff, Rusty. That backyard aquaponics is genius.

Rusty Shorts's picture

 - hey, thanks Strain, ,, check this guy, here's an distilling example...

FEDbuster's picture

We have lots of quail and rabbits around my place.  Both can be taken with a pellet gun or wrist rocket.  Should help us get through year 1 P.C. (post collapse)

Red Neck Repugnicant's picture

All this talk about digging a hole in your backyard, stocking it full of guns, gold, water and dead squirrels... WTF?

You guys are nothing but a bunch of G.I. Joe wantabes.   

Wake up and be a respectable member of society, rather than living in a dirt bunker with the worms and dead squirrels waiting for urban warfare.   

For the love of GOD, get a fucking grip!

Rusty Shorts's picture

 - yeah, well, i was a g.i. joe grasshopper, back in the day.


trust me, I got a fucking grip.

Rusty Shorts's picture

2nd Marine Div, MP Detachment

New_Meat's picture

I was classmate with CO Weapons Co, taught with the doggie WO running the counter mortar radar, worked with the Recon CO and the MAU SgtMaj.  All gone.


- Ned

Rusty Shorts's picture

Those were dark days indeed. I really didn't know anyone from 1/8, the few acquaintances that I did make were all killed.

As fate would have it, half of our MP detachment (including me) received orders to join the 22nd MAU in that other success story, the Grenada invasion.

ColonelCooper's picture

FWIW Gentlemen, given the opportunity I would gladly choke the everloving fuck out of whoever junked your little conversation.


merehuman's picture

Caused memories of Ft Meade Md. I was in a MP unit during 68/69'. Always on alert due to vietnam protesting and civil rights. So us soldiers being on alert constantly, many of us went AWOL in order to see our girlfriends, family or just to get out. Being on alert meant being stuck on base over the weekend so we had a high awol rate.

akak's picture

Well, I haven't shot and eaten any squirrels (lately), but I have been gathering and eating wild mushrooms (not the hallucinogenic variety, either) --- does that make me respectable or unrespectable in your eyes?

And when I go out picking wild blueberries with friends, are we thereby being rednecky and unrespectable too? 

How about fishing: respectable, or no?  Or does it depend on the species of fish being sought (trout: respectable, bass: unrespectable)?  Does using a motorized boat while fishing damn one as unrespectable perhaps, but leave fly-fishing as respectable?

Is all hunting unrespectable, or just the hunting of wild arboreal rodents?

Is hunting perhaps respectable with a bow, even if it may not be with a rifle?  Does using a hunting dog make wildfowl hunting more or less respectable?

Please give me the guidelines on respectability if you would --- I can be SO clueless in such matters! 

akak's picture

Unfortunately, the only psychodelic mushrooms that grow in my region (such as Amanita muscaria) are only sporadically and mildly psychodelic, and their ingestion is invariably accompanied by various severely unpleasant gastrointestinal effects which I am not willing to suffer.

ColonelCooper's picture

Please add whether or not gardening, canning, pickling, freezing etc.. are the activities of a madman also.

Raising your own animals, butchering, sausage making, smoking.... Are they cruel redneck endeavors?

I always thought these things were just what country people did.

***Hey Akak, you have UNfuckingBELIEVABLE wild blueberry crop this year where you live?

akak's picture

CC, I haven't gone up into the mountains yet to check, but I am guessing that we don't ---- most of the other wild berries have done miserably in this perpetually cloudy, gloomy, wet so-called "summer" that we've been having.

grunion's picture

Yup...And when you show up at my bunker all gaunt with ribs sticking out and hollow eyed, if you don't get shot, I might just feed you. You see, I have a big heart...

grunion's picture

I pray sir that is not your contingency plan!

New_Meat's picture


keep away from pork.

eat more squirrel ;-)

- Ned

Rusty Shorts's picture

I have a special place reserved for you, in my smokehouse.

lilimarlene1's picture

Ugh. Sounds like groundhog stew with dumplings!


Interesting sighting today. I live near a huge mall not far from New York, Woodbury Commons. It was absolutely packed, busiest I have seen it in three years. Lots of foreigners as well. Just an observation. 

Dantzler's picture

Recommend you parboil it first and stay clear of the central nervous system--squirrels can have a prion-based disease similar to mad cow or Creutzfeldt–Jakob.



Ricky Bobby's picture

As to squiral my great uncle used to refer to them as limb kittens, cuase he ate plenty of them. Not for sport but for real live we gotta eat. One shell, one shot and you better hit the target because those shell cost.

Dantzler's picture

Same goes for my Dad in rural SC in the 50's.


Back then he could bring his Savage over/under .22/.410 to school, leave it in the coat closet, and hunt as he walked home.'s picture

Americans were once free. Who would believe it today?

ColonelCooper's picture

I graduated from high school in the mid eighties.  Even then we were allowed to keep guns in our cars.  I always had either a shotgun or rifle with me from mid-September to Mid-November.

Funny how when we used to let kids have exposure and experience with guns there weren't any school shootings.  Now that they're taboo and mysterious, kids are blowing each other away left and right; urban and rural.

Rusty Shorts's picture

 - it's amazing really, what has happened to our country. When I was in school, '70s - early '80s, every swinging dick had a gun rack in his truck, hell, I kept a couple more (guns) behind the seat.

grunion's picture

In the .22 mag/.410 configuration, that is a wonderful survival tool. I carried one for 2 years in central America as my food getter. Never went hungry!!!

Red Neck Repugnicant's picture

Personally, I prefer a shopping cart at Albertsons. Sometimes, on Tuesdays, they offer double coupons.  Why eat a dead squirrel, when you can get a 1 pound box of Twizzlers for 99 cents?

I always find what I need, and they've got good prices.  

I never go hungry, either.  Yippee!