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

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: http://www.ft.com/cms/s/0/270e1a6c-9334-11df-96d5-00144feab49a.html?ftcamp=rss
For those interested readers "The Ends of Four Big Inflations" by Thomas Sargent can be found at: http://www.minneapolisfed.org/research/WP/WP158.pdf
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: http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.88.592&rep=rep1&type=pdf, pg. 20
3 Boskin, Michael. (July 21, 2010) "Obama’s Economic Fish Stories" The Wall Street Journal. Retrieved on August 10, 2010 from: http://online.wsj.com/article/SB10001424052748703724104575378751776758256.html
4 Uhlig, Harald (May 15, 2009) "Some Fiscal Calculus" Unpublished. Pg 13. Retrieved on August 10, 2010 from: http://www.princeton.edu/economics/seminar-schedule-by-prog/macro-s09/monetary-fiscal-policy-co/schedule/pdfs/uhlig_FiscalCalculus_v2.pdf
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: http://www.theglobeandmail.com/report-on-business/commentary/neil-reynolds/the-hidden-cost-of-stimulus-programs/article1596810/
7 Cohen, Lauren; Coval, Joshua; Malloy, Christopher. (March 16, 2010) "Do Powerful Politicians Cause Corporate Downsizing?" Unpublished. Retrieved on August 10, 2010 from: http://www.people.hbs.edu/cmalloy/pdffiles/envaloy.pdf
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: http://www.fraserinstitute.org/publicationdisplay.aspx?id=15912&terms=stimulus
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: http://www.businessweek.com/news/2010-06-08/pimco-s-crescenzi-sees-endpoint-in-devaluations-update2-.html
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: http://www.ft.com/cms/s/0/1b3ae97e-95c6-11df-b5ad-00144feab49a.html
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: http://www.gao.gov/new.items/d10468sp.pdf
13 Aldrick, Philip (August 10, 2010) "Bank of England overhauls forecast model after errors" Telegraph. Retrieved on August 11, 2010 from: http://www.telegraph.co.uk/finance/economics/7935732/Bank-of-England-overhauls-forecast-model-after-errors.html

Comments

[delacroix]

drizzle, drazzle, druzzle drone

[SimpleSimon]

Keynesian theory enjoyed a run only because politicians saw it as an easy way to enable them to spend more i.e. empower themselves more. 

[NOTW777]

exactly. it has more to do with politics than economics.

[Temporalist]

Was going to post the exact same idea.

Bailing out one industry snowballs to any industry that thinks it is TBTF.

Giving politicians free money is like giving an arsonist gasoline, explosives and blasting caps.

[MSJChE]

+1 to everyone here.

The question is:  is there any way out?  No country has ever dug themselves out of a debt/entitlement hole.  I can't reasonably argue that the public has the neccessary understanding and fortitude to prevent a cataclysmic end to the Keynesian Era.

[NotApplicable]

Sure there's a way out, repudiation/default.

[cossack55]

Sure, the neocon mantra "Permanant war for permanant peace". Raytheons babys need new shoes.

[suntea12000@yah...]

I guess we will have to grow our way out, with wheat. Oil industry is under attack and coal is absolutely destroying the planet. Think, think, maybe buying PDA's or another TV or car will grow us some GDP.

Nope, employment issue there, hard landing coming.

[robobbob]

1) STOP BORROWING and PRINTING 

2) Pecora commision. people-jail-now

3) ditch all of the progressive BS, NEA, gov unions, EPA, DOI, entitlements. bare essentials only

4) ditch the neocon crap. close the overseas bases, troops home now, only enough bombs to blow up world X1 1/2 times, no more USA world police

5) drill here drill now, mine here, mine now, nuke, nuke, nuke

6) complete revisualization of the US. Nawapa water projects. Turn the western US and northern Mexico into the breadbasket of the world. the future belongs to those with food and water. instead of every bunker for themselves, make it a team effort.

7) massive public transit system high speed rail

8) massive internet connectivity expansion

9) complete scraping of deweys craptastic PU-blic edumacation system.

[ColonelCooper]

At this point I can go for, "robobob 2012". 

[Geoff-UK]

Way out=default via inflation.  Banks will fight it once it appears getting out of hand, but it'll be too late.

[Fred Hayek]

A friend got me onto a list of folks who receive an email newsletter from a guy named Rick Weissman.  The writing is pretty interesting.  His main thesis of late is that the Fed would love, love, love, to duplicate now what the Fed did back in the late 40's which was to buy up massive amounts of treasuries and, somehow, bully everyone into keeping the rates low even as there was pretty strong inflation.  Here's an excerpt from his August 12 newsletter:

. . . For one, let me say that the government has already embarked on an inflationary agenda, by virtue of the QE (money printing) strategy the Fed has embraced. The precedent for these actions is what the Fed has done in the 1940's. This concept is one which no one has managed to understand or consider. Nor is anyone in the popular media talking about this. To repeat what I have said before: the Fed managed to impose an interest rate cap during WW2, with long bonds capped at 2.5%, and the Fed successfully managed to hold the line on this level of interest rates in the late 1940s, and after the war, when we had 25 consecutive CPI readings above 8%, a high monthly reading above 19%, and a 2 year average of 12.5%. How was that possible? The Fed basically bullied market participants to accept the price floor or yield cap on government debt. If you are a bond trader, this is a great situation, since you can go out there and buy bonds anytime it gets near the price floor, knowing that you have the "Fed Put" to bail you out. In fact, knowing that the Fed is there for the markets will encourage investors to buy bonds at yields just below the Fed's cap.

So my question or comment is: how many trillions of dollars of bonds will the Fed need to buy to maintain a rate cap at, say 4% on the long bond, and 3% on the 10 year? With the size of the US publicly held debt at $8 to $9 trillion, and expected to grow by $1.3 to $1.5 trillion a year, it would probably take a few trillion dollars of Fed purchases, or at least the threat of purchases to successfully implement a rate cap. Furthermore, there is about $5 trillion of agency backed MBS and another $1+ trillion of agency debt which might need to be back-stopped as well. So long as there is no inflation, then it is likely that the Fed will print trillions of dollars, first in the name of preventing deflation. If the Fed ever starts targeting interest rates, it is game over for shorting bonds, because they can just print as much currency as possible to soak up the supply of bonds. This would eventually result in inflation, despite the horrific state of the US housing market, and its 40% contribution to CPI. And as our experience in the 1940s showed, it is possible to have double digit inflation with very low interest rates. . .

[aerojet]

It's not so much the fortitude as the mental capacity to even understand what is going on.  Witness the line of black people in Atlanta looking for mortgage workouts.  Those people know nothing about any of this, they just want their handout.  When the handouts end, the chaos begins, then the strong man comes, and we fully realize fascism, with the regular folk cheering all the way because he will restore order.

[RockyRacoon]

That was an amazing scene, and don't think it wasn't broadcast all over the world.  A friend of mine in Nicaragua emailed me and asked what the hell was going on and wondered if I was safe -- 1,200 miles away.  Just like the scenes in Greece, it is only the tip of a larger iceberg.  A  piece of paper seemed to quell the "mob", but soon it will take much more.  I see truckloads of food and water rolling up to calm them very soon in our future.  New Orleans will look like a minor skirmish.

[Jendrzejczyk]

That situation was not for mortgage workouts, it was merely for section 8 voucher application forms----actually, to just get on the waiting list for section 8 vouchers.

Sadly enough, I don't think most of those people knew why they were there.

[FEDbuster]

FREE is a very powerful word.  Chance at free housing attracts 30K in one suburb of Atlanta. 

Number of people on food stamps, 40.8 million. Imagine the "bread lines" on CNN, if the 41 million had to line up every Saturday to get their box of food.

[StychoKiller]

As it's been said before:  You can't fix Stupid!  I too am amazed that this mob scene was just to get on some waiting list -- I was totally gobsmacked!

[mynhair]

They thought it was an Obama Stash distribution point.

[SRV - ES339]

"Witness the line of black people in Atlanta looking for mortgage workouts.  Those people know nothing about any of this, they just want their handout."

 These are poor people (what does black have to do with it?) without jobs, and desperate to refinance their mortgage (not walk away from under water mortgages with millions in the bank, like many of the wealthy are doing)... that's not a handout. But if it makes you feel better to vilify those who have been devastated by the greed of the elite, go for it.

And what if the strong man never comes? Perhaps you may want to temper your contempt for those less fortunate... for your own safety.

[ATTILA THE WIMP]

It's time to cull the herd.

[Caviar Emptor]

+100

Supply siders sold America a swindle that was packaged an economic rescue plan. Following the money trail we find that wealth has been transferred from the middle class to the wealthy who's taxes have been cut. The country is broke, in a depression and with an outsourced productive economy, consuming way more than we produce.

[Ned Zeppelin]

"Keynesian thought . . . 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."

Someone forgot that the intended recipients of all of the forgeoing made out quite well, thank you very much. Ask Jamie or Lloyd how they made out.  Don't forget the footnote to all of this: that Keynesianism was espoused by those types for some very specific benefits that they did receive. They were not thinking about J6P when they asked for all of these programs, just themselves.  We just got the bill.

[trav7777]

Sprott FTW

[Turd Ferguson]

The end of The Great Keynesian Experiment is upon us.

Prepare accordingly.

[ATG]

Bingo

[Mr Lennon Hendrix]

No matter what comes, gold will stay as the best wealth investment; oldest story ever told.  I say the price could drop to $1040 if the Tau gets punished to $8000, but then the seperation would really occur when the dow drops to the low thousands and gold stays in a number that is still "expensive" 9by the standards of "rational consumers" that need new ipoduhs for different outfits.  People look like clowns walking around stuck in the medias cultural trance of mass consumption while the greatest depression continuess on.

[nevadan]

Extending tax cuts won't solve anything, but a few bank failures might be a good start.

[lieutenantjohnchard]

one bone to pick. at the end of the article sprott says that keynsianism fooled us all.

actually, not all of us.

the public (those dumb country folk in flyover country as opposed to the brilliant bright lights on the eastern seaboard) was onto the game from the outset. remember when the house vote on the stimulus bill went down in flames when the public roared no! the market sold off huge, and then the house rammed it through in the next few days to save the asses of the top few percent in the usa. then, the market rallied.

other than that - good piece.

[chunkylover42]

agreed, and one other bone to pick.  Sprott refers to the CBO analyses of budget deficit and GDP projections, particularly when he's discussing the notion of extending the Bush tax cuts.  He fails to mention that those analyses are 'static' in their projections, meaning they don't account for any change in behavior due to a change in tax rates.  Clearly this is dumb, but the CBO does it anyway, which is why every projection they make is off by some factor of 10.

That's not to say that extending the Bush cuts are any panacea, just that the analysis of their impact is incomplete at best.

[lieutenantjohnchard]

just like medicare / medicaid was off by a factor of 10 when passed many years ago. and how obama care (see massachusetts) likely will be off by an equal amount. oh well, the bright side is the taxpayer will never have to pay off these debts. they're too big. no combination of spending cuts, tax increases and growth can win the day. it's inflation or default.

[tony bonn]

speak for yourself sprott - keynesian theory never fooled me and i have lambasted the fool crackpot theory before its first death in the 1980s...when the corpse rolls by me i am going to kick it...but the damned bitch will come back for more - it's a cat and politicans love to ride it since it provides intellectual cover for raping and pillaging....

[lieutenantjohnchard]

exactly. and yet in b school we students had lecture after lecture in economics over the fool theory. sure, i sold out and regurgitated the crap on tests. but now i feel like one of those soviet era commisars whose education was based on a discredited theory.

[akak]

Regarding Keynesian "theory":

... politicans love to ride it since it provides intellectual cover for raping and pillaging....

That is really all that needs to be said, and the ONLY reason that Keynesian economic thought (sic) dominated in the academic and political realms for the last 80 years.  Even thieves and murderers like to have some high-sounding theory to justify their rape and slaughter.

[Rainman]

" Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency ".

                                               J.M. Keynes

                                               The Economic Consequences of the Peace

[FEDbuster]

Just in case anyone missed this one:

http://www.youtube.com/watch?v=d0nERTFo-Sk

[Cognitive Dissonance]

Rick Santelli just had a quiet toe to toe with Ron Insana around 3:05 PM EDT. As is typical with Insana, when he's challenged, his back goes up and his sensibilities are outraged that anyone would question the insufferable prick.

"What's that got to do with my point Rick" and "Yes, I would like to get back to the point of the discussion" and so on. And don't forget the eye rolling and the "Lord save me from these insufferable fools" look on his face. Someone needs to stick a point in his annulus.

I'm not going to try and recite what was said but it's clear Insana is a believer in all things Fed and has little problem pushing the propaganda. In fact, I believe he's the most dangerous type of propagandist out there. He might actually believe what he's saying is true.

[Dadburnitpa]

Thank you CD.  Well put.

[NotApplicable]

Is there anything Ron Insane-a can't fail at?

Other than being the CNBS junk-yard dog, that is. I guess after this morning's rant, they had to bring him out to put Rick "back in his place" in the eyes of their comforted herd.

[watchingdogma]

I saw Rick so I turned up the volume - it looked to me like Ron genuinely was stumped - like he didn't understand why Rick was worried about money that came out of nowhere - like he understood how to breath, but all of this talk about oxygen was completely over his head.  "Stop talking about oxygen Frank (er - I mean Rick!) - let me get back to my discussion on the need for air when breathing!"

[RockyRacoon]

Ron is rabidly, insanely afraid of gold.  I saw him a couple of weeks ago get really apoplectic and get spittle all over his $200 tie.  Gold is the final bogeyman that will give ole Ron a fatal heart attack.

[akak]

I still have daydreams of cramming a 400 oz. gold bar down the throat of Erin "What good is gold, you can't eat it?" Burnett, and crowing "See, you can eat it, BITCH!"

[Pamela Anderson]

+100

[Oswald Spengler]

Keynesianism has given intellectual cover to the socialists who come ever closer to enslaving us.

[MSJChE]

Key point...and nice a$$

[TBT or not TBT]

I never thought it would come to this, but apparently America is into bondage.

[centerline]

Got to give credit for Chart B to Nathan Martin over Economic Edge.

[Jake Green]

+1 for Nate

[gaugamela]

This bit gave me a good laugh. Complete rubbish. Quote: "A two percent spending increase inevitably requires an increase in taxes." Really? Inevitable? Reads like an undergrad term paper.

[Astute Investor]

It's confirmed - you really are an ignoramus.

[Segestan]

You assume... usury is not the second oldest profession.

[shargash]

Not all deficit spending is Keynesianism. Since the failure of Keynesianism in the 1970s, you haven't been able to find a Keynesian in any position of power pretty much anywhere. The Chicago school of monetarists dominated economics until they blew up the world in 2008.

Keynes never said you should run permanent structural deficits. Keynes never counted bailing out failed banks as stimulus. What's been going on in the past 40 years resembles Keynesianism about as much as the current US economy resembles capitalism.

Now look, I don't like Keynesianism either. But language matters. All this recent bashing of Keynes is just to set us up for austerity -- i.e. now that they took our shit, we're supposed to suffer quietly.

But the fact is that neither austerity nor stimulus is going to do jack, until the economy is reformed, the banks are reined in, and the bezzle is removed from the system.

[gaugamela]

"But the fact is that neither austerity nor stimulus is going to do jack, until the economy is reformed, the banks are reined in, and the bezzle is removed from the system."

This is the problem with the debate: there is no way to test both methods. Keynesiast say that w/o stimulus the slowdown would be worse and that the modest growth we've experienced is b/c the stimulus was not large enough. I tend to side w/ this argument. Nobody else but the Fed would have bought MBS securities in early 2009.

However, you can't argue that austerity would work better b/c you can't run two scenarios in a live economy and see how people's expectations play out.

[VWbug]

it's a moot point, as it is simply immoral to take money forcefully from some and give it to others.

It's doubly immoral to take it from the poorest and give to the richest,  or from the most competent to the least.

[gaugamela]

Yes, indeed, both "austerity vs stimulous" and "kenysianism vs. monetarists" debates are moot. It's also a good that you are not the arbiter of what is moral.

[Geoff-UK]

Are you really claiming that VWBUG's statement above is arguable?!  That it was, in fact, moral to take $ from the middle class to bail out AIG/GS/et al?

[knukles]

Here, here. 

Used to be Right vs. Wrong,
Then degenerated to Legal vs. Illegal,
Now resting upon "What can I get away with without being caught."

Historically, societal justification of the latter condition has pre-staged revolutions.

[faustian bargain]

We're each the arbiters of what is moral.

What we aren't, are the arbiters of what is legal.

[Caviar Emptor]

The "Monetarists" were more Keynesian than Keynes. Many believe that pure monetarism ended in 1981. Deficit spending and supporting the trade deficit then became the major source of economic stimulus. 

[perchprism]

 Nobody else but the Fed would have bought MBS securities in early 2009.

At par.

At the actual market value, if one had been allowed to be established, there'd have been plenty of buyers.  That's how it's supposed to work.

[lieutenantjohnchard]

excellent thoughts. but how does the bottom 90% of law abiding, peaceful citizens remove the bezzle from the system captured by a corrupt 10% oligarchy with the force of law and arms behind it?

maybe november is a start. or a crash.

[Walt Whitman]

I wish the oligarchy was 10%; if it was, there might be some trickle down. As it exists, the oligarchy is around .0001%. At that percentage, it's royalty, not oligarchy. Just ask them, they'll tell you. They just employ a rather large buffer between them and the law abiding, peaceful citizens.

[lieutenantjohnchard]

you're closer to being right than me. i use the 90/10 only inasmuch as it represents stock ownership across the usa.

[Geoff-UK]

I don't think November is going to fix it.

In fact, I wouldn't be surprised if there's nothing we could to do fix it, short of guillotines.

Ruling class is getting theirs, and they have enough financial power at this point to buy as many politicians as they need to maintain their funding stream (i.e. "us in the middle class").

As John Derbyshire says, We Are Doomed.

[Mark Noonan]

I'm sorry, but that is a bit like saying that Marx never envisioned Stalin - but the fact remains that Stalin was implicit in Marxist theory from the start, just as Pelosi's $36 billion payoff to the government unions was implicit in Keynesian economics from the start.

Things are never half true or half false - they are true or false.  It was always false to say that government could provide a net gain to economic activity.  The simple fact that government has no money is stark, inescapable and is entirely missed by Keynes.  Government only has what is can extract from the people - it can only move resources around (invariably wtih a bit of carrying charges) so that even if there is a "gain" by government action, it comes at the expense of some other activity now unfunded because government took the money. 

Keynes theory is this beautiful calculation which, unfortunately, starts off with 1+1=3.  It doesn't matter what else is said beyond that first error, it will all be wrong.  It will all be false.  That grafting politicians and businessmen would latch on to it and add even more nonsense doesn't excuse Keynes from his first, incredibly stupid error.

[VWbug]

exactly. wish i could say it that well

[akak]

Excellent points, and well said!

[mark mchugh]

Nice.

[CrockettAlmanac.com]

You said it.

[uraniuman]

Very well reasoned, and astute - thanks

[Temporalist]

+1 +1 = +3

[George Costanza]

Keynse empowered politicians.  It gave them a  theory (excuse) to increase their power and influence.    It will be difficult for them to adopt another theory, which would require them to reduce their own influence and power.

That may require a true Depression.

[michael.suede]

Not one mention of the Austrian School.

This is an outrage.

[ATG]

Austrian proponent of free markets for creative destruction...

http://en.wikipedia.org/wiki/Joseph_Schumpeter

[eddybaby]

What we have here is a failure of elected officials to show the courage to make real tough choices, because their own personal career success of failure does not depend on an assessment of long term performance, but on short term popularity.

This collective self interest and moral cowardice has led us to into a very dangerous world, and yet, still its politics as usual.

If you stand back far enough you see one of histories great tragedies playing out in front of you.

[LeBalance]

the politicians do not and have never been working for you.

they do not make choices that you understand because they do not work for an agenda that you are aware of.

they understand a larger portion of the matrix that we live in.

[traderjoe]

They do not understand a larger portion of the matrix. I agree with your first two points. They merely use the system to their own benefit and the voters favor short-term gain over long-term sustainability. 

[tip e. canoe]

"they understand a larger portion of the matrix that we live in."

that's what they like to think.  then again, kings used to think of themselves as one step closer to God.   the question is:  are they?  do they?  and if so, why do they?  couldn't be all that secret information they've been hiding from the plebes for thousands of years could it?

[Dr. Sandi]

This is too true.

Unfortunately, none of has to stand back too far to enjoy this tragedy. Coming soon to a household near you.

[Geoff-UK]

Elected officials DID make a courageous choice--that Joe Sixpack would not notice the elected official got campaign donations and free golf trips from AIG/GS/BoA/et al.

Middle class doesn't have the cash to compete=we're screwed.  Feudalism's back.

[centerline]

Keynesian stimulus fooled no one over here.  Need to revise the "all"  statement at the end.  Debt-backed money was doomed to fail from the moment it was conceived (1913 for the USD).  The game is much, much older than the USD though.  That is really the sad part.

[Tao Jonesing]

What dominates the cliff-diving in Chart B is not Keynesian economics but the monetarism of Milton Friedman as managed by his devotee, Helicopter Ben.

The overwhelming majority of new debt incurred by the U.S. government was not used for Keynesian stimulus but to prop up the TBTF banks as reserves on their balance sheets (and it continues to stay there).  Keynes did not believe that propping up the supply side of money would do all that much, that a proper stimulus required giving money directly to the demand side, who would spend it instead of hoard it.

So, what Sprott is really eulogizing is the death of the Chicago School of economics, or Ponzinomics, as I like to call it. 

[centerline]

Nicely put.  There have been several other debates over this illustrating that even Keynes would be pissed off at what is going on.  This is way beyond Keynesian economics.

[Caviar Emptor]

Exactly.

[Fred Hayek]

Are you suggesting that Milton Friedman would have advocated propping up the TBTF banks?

[Council of Econ...]

One name to save us Friedrich Hayek, a rational economic thinker opposite keynes and against  reagan tax cutting + deficit spending. 

[LeBalance]

that is certainly one, but there are hosts of others, Mises, Rothbard, de Soto, Baum, every Sci-fi writer writing incisive pieces under cover: Orwell for instance, Brunner, Malzberg, many others.  The list is very long, but they are out there.

[CrockettAlmanac.com]

every Sci-fi writer writing incisive pieces under cover:

Vonnegut's Harrison Bergeron is too good to miss.

[Ripped Chunk]

Viking funeral appropriate here. 

[LeBalance]

I think the USSA is going to do the "rockets red glare" and thermobaric and air-fuel mixture "bombs bursting in air" deal, with a healthy dose of DU for long term killing power.

[Shameful]

Glad to know I'm not the only one waiting for Hillary to play the Nuclear Blackmail card.

[Ripped Chunk]

Well she did have the wedding 2 weeks ago. Now she will get back to the bidding of the dark overlords.

[TBT or not TBT]

If our state dept isn't playing the nuclear blackmail card, it no longer represents the american people.   Nukes are very cheap as big sticks go.  Been working their magic for 65 years.

[Temporalist]

Yea but now too many players have the same toys so everyone gets to blackmail...look at North Korea, Pakistan, Isreal, India, China...

[TBT or not TBT]

U-238 and jacketed lead bullets have scarcely different radioactivity levels, for practical purposes of health effects on humans.   For what it is worth, I'm for both, each in its role.

[flacon]

Why Governements try to control prices, by Keynes

"A sentiment of trust in the legal money of the State is so deeply implanted in the citizens of all countries that they cannot but believe that some day this money must recover a part at least of its former value. To their minds it appears that value is inherent in money as such, and they do not apprehend that the real wealth, which this money might have stood for, has been dissipated once and for all.

This sentiment is supported by the various legal regulations with which the Governments endeavor to control internal prices, and so to preserve some purchasing power for their legal tender. Thus the force of law preserves a measure of immediate purchasing power over some commodities and the force of sentiment and custom maintains, especially amongst peasants, a willingness to hoard paper which is really worthless...

If, however, a government refrains from regulations and allows matters to take their course, essential commodities soon attain a level of price out of the reach of all but the rich, the worthlessness of the money becomes apparent, and the fraud upon the public can be concealed no longer."

~John Maynard Keynes, Economic Consequences of the Peace, NY, 1920, p. 239-40

[ATG]

Or Gold and Economic Freedom by Alan Greenspan in Ayn Rand's 1966 Capitalism, the Unknown Ideal...

http://www.lewrockwell.com/north/north204.html

[Temporalist]

Right so those that defend Keynes also are advocating his condoning a lie upon all people.

[THE DORK OF CORK]

I think we can all be good Austrians on the Internet and feel a warm glow inside but speaking from a country that took a 16% drop in GDP and more importantly a 25% drop in GNP, its hard.

Also the safety valve of young people leaving our shores and exports to more stimulated economies has protected us from a full scale implosion.

But this is not a solution to the world economy - listening to Santeli on the other thread he is dead right about the stupidity of dead money going into dead housing to keep the money supply going.

What is missing from Anglo economies for some time as been large scale core applied science endeavours - we have tinkered with i pads and technologies that give marginal efficiencies with existing technology for too long now.

If we are prepared to spend trillions to pour into black holes which by definition is inflationary as the money printed does not add any value why can we not have one shot at reaching for the stars, splitting the atom and other such noble endeavors.

The spirit of adventure and maybe conquest is what has defined the wests culture and identity for so long now we cannot turn our backs on it in this moment of crisis - it is our final chance is it not.

If we are to fall down lets not collapse making houses in some zoo city or hudde around some Austrian cavefire.

Lets light this fucking candle.

[Shameful]

At least you guys took the hit even if your political class is also in bed with the banks.  We here in the states are trying to push off the day of reckoning.  So when that day comes it will wash over us and leave nothing intact after it's passing.

[THE DORK OF CORK]

@Shameful

Its over in Ireland - we have been a tax haven for American corporations and a monetary  sink for corrupt banks for decades although in the last 10 years this has gone exponential.

Our monetary external debts are over 10 times our fiscal debt which was at zero before the crisis when you count our pension surplus which was thrown on the banking fire.

We are therefore not a good example as our level of globalisation or more accurately control by our banking masters is extreme.

[Shameful]

I'm not trying to paint it as good over there, I know it's not.  And I must confess to not watching you guys closely, but it looked to me like the banks were in charge.  My only point was at least you guys took a decent part of the hit up front.  While in the States we have decided to ponzi till there is nothing left.  I like many would have rather taken the hit, preferably after the Dot.Com bubble but we are well past the point of no return over here.

I'm looking for a country that the banking oligarchs don't run, or are not pillaging.  The globe does seem like a small place...

[THE DORK OF CORK]

  Laputa maybe - but they are not very bright up there.

www.youtube.com/watch?v=C_ImqMyQXYU     

[Rusty Shorts]

Mosquito Coast

"Good bye America, and have a nice day."

http://www.youtube.com/watch?v=hLgmUnKrPNs&feature=related

[DaveyJones]

very well put, and sad

[Joe Davola]

Wait a minute, are you trying to say that a $500 device that allows you to update your social network 24/7 isn't an essential technology?  I'm Jobs-smacked!!!

Even though it is a living, I sometimes think we'd have been better off if Maxwell hadn't recognized the displacement current contribution to electromagnetic fields.  Don't even get me started on Heaviside...

[tip e. canoe]

actually Joe, i think you should start on Heaviside.  his perversion of Maxwell's original equations is a brilliant metaphor for much of what is happening.

[Attitude_Check]

Don't forget Tesla and AC generation, transformers and efficient power distribution from centralized plants

[Attitude_Check]

Oh and the displacement current is a mathmatic artifact and NOT physical.  The source term is time changing electric charge - period!  Maxwell's equations are really non-linear, and when we linearize them to "make the math easy" we end up with goofy results!

Sorry a bit off topic, but you wouldn't believe the nonsense I have to deal with by folks blineded by this fact.  I just have to keep proving them wrong I guess!

[duncecap rack]

Great post.

[Pope Clement]

Corkman, you and Murphy/Midas rock - I wouldn't want to be in bankster shoes when you all get your oirish up at the Risen of the Moon...

[THE DORK OF CORK]

Thank you your Eminence but Murphy is a true long time activist - I however am just a slightly pissed off observer.

[firstdivision]

PPT keeps kicking into high gear everytime the SPX breaks 1080.00

[centerline]

lots of open air below.  epic battle here at 1080.

[eatthebanksters]

One of life's certainties is that people will believe what they want to believe even if it means denying the truth...The only thing that's worse than denial is manipulation and our government does that with a smile every day. As long as it serves someones purpose, Keyensian economics will never die.

[LeBalance]

one of life's little riddles is understanding that everyone is a beautiful being and is living their truth.  It is a diverse experience tapestry that allows each and every one to form and hold that distinctness within them.  Without that diversity you can not be who you are.  They serve themselves and you by being themselves, just as you do for them.  We are a community of individuals enabled by our polar differences.

Maybe.

[Attitude_Check]

So what kind of "beauty" do you make of child molesters and FED officials?

[akak]

At least child molesters only molest one relatively small subset of society.

[strannick]

AK's back!

[Shameful]

I think he is calling the death a little early. Look at Washington are they going to stop any time soon? They will only stop when they are forced to stop. And about the only way that will happen is a currency crisis.

Just because a theory is wrong doesn't mean it won't be used.  Politicians love an econoic theory that they can hold up to justify their theft and spending.

[centerline]

More appropriate term is probably "undead."  Zombified.  We are the walking dead.  Just doesn't get "real" until a major body part falls off.

[tecno242]

tax cuts will not make enough impact and compound the deficit problem.

you need to just debase the currency and give away a crap ton of money to every family in America.  Like 30K per family.

with a stipulation that it must be used to pay down debt.

then have a full out attack on streamlining government spending.

which neither of those things will ever happen.. so it's bound to fall apart.

[drwells]

Don't worry, it goes back a lot farther than 1936 and it'll keep getting up again and again, with a resilience the Terminator could only dream of.

[Zina]

Keynesian stimulus can’t be blamed for all our problems

Since Keynesianism only became "mainstream" in the last days of the Bush administration, after Lehman Brothers gone bankrupt, materialized on the TARP bailout, then Keynesian stimulus REALLY can’t be blamed for all our problems.

The problems didn't started in the last days of the Bush administration. The problems didn't started in the beginning of 2009, one or two weeks before the launching of zerohedge.blogspot.com. No. The problems started a long time ago. The housing bubble started a long time ago. The credit crunch of 2007 was a lot of time before Keynesianism became mainstream, materialized in the TARP bailout.

You really can't blame Keynesianism for having started all this mess. Deregulation started all this mess.

Footnote: I am not Keynesian. I don't believe Deficit Spending is a solution for anything. But I'm not inclined to expose now here the bases of Zinaism, the economic theory I'm quietly developing in the last few months...

[faustian bargain]

If you're going to blame it on 'deregulation', at least qualify it as 'selective deregulation'.

[Fred Hayek]

Amen.  Or perhaps simply not enforcing the existing regulations.  Fraud is fraud.  It's illegal in any form of commerce. 

[CrockettAlmanac.com]

Nixon said "We're all Keynesians now." Predates Bush by decades.

Deregulation is never a problem. Deregulation allows each and every individual the freedom to make his own choices about his own life. The term deregulation has been used by those who seek looser rules for themselves but not for others but that can not properly be called deregulation.

Did Bush's bullshit claim that he bombed Iraq for what he called "freedom" mean that real freedom is a bad thing? Same goes for deregulation.

[Zina]

Believing in "efficient markets", with no government regulation, is the same thing of believing that a bunch of 7-year-old children can safely play without any adult supervision.

[Lexington Duffet]

Keynes advocated general guidelines for the banks and solutions specific to the fact patterns which existed at the time.  It is unfair to Keynes and to his theory to believe that all the deficit spending around the world should be laid on his name or at the doorstep of his works.    As Zero Hedge previously noted, Keynes even wrote FDR to complain about people using his name and works to justify policies Keynes himself had nothing to do with.   In the seminal work, A Tract on Monetary Reform, for example, Keynes argued deflation was a problem, but inflation was the worst problem a monetary system can face. 

IMO, Keynes was the greatest economic mind of his generation and the misuse of his name and ideas is not good for anyone.  To use the term "Keynsian" as a curseword is to attack applied math and common sense.  Maybe a better word can be found to attack current policies.  And for those who revile Keynes:  Read his works, understand them, then write a book or article pointing out the flaws in his math:  You will win yourself a nobel prize.

Not, please understand, that I endorse all the monetary policies or spending policies going on.  IMO, the US needs to ending the 2 recent wars, bring home those troops and troops from other places around the world, and take steps to reduce the US oil consumption to lower the trade deficit. 

A good read is Lords of Finance by Liauqat Ahamed, about the financial affairs from 1910 or so through the great depression.

To evaluate the 2009 stimulus package, I'd suggest a) comparing the trillion dollar stimulus package to the US balance of trade deficit (2/3 of that going to foreign oil interests not that certain people seem to care about reducing the US use of oil); and b) someone figuring out how many jobs were created by the tax cuts in the latest Stimulus package (bet the figure is close to zero, just like the effect of cutting say Anthony Mozillo's taxes with the "temporary" Bush tax cuts).

Since the oil import/ US overspending problems remain unaddressed, it  seems to me the US basically ended up taking a trillion dollars of borrowed money (less the useless tax cuts which I bet added close to zero jobs) and because the trade deficit runs so high, sending that money overseas.

[Fred Hayek]

Thank you for the book recommendation.  Just bought a used copy through Amazone.

[StychoKiller]

Ya don't want a big chunk of trained killers added to the unemployment line, so troops will stay where they are -- until the implosion, that is.

[AnAnonymous]

Keynes advocated general guidelines for the banks and solutions specific to the fact patterns which existed at the time.  It is unfair to Keynes and to his theory to believe that all the deficit spending around the world should be laid on his name or at the doorstep of his works.  

Why not? It is not like governments went bankrupt before Keynes' ideas. They started all. Governmental debt was unknown before him and certainly not by governments involved in expansion.

[Lexington Duffet]

Keynes advocated general guidelines for the banks and solutions specific to the fact patterns which existed at the time.  It is unfair to Keynes and to his theory to believe that all the deficit spending around the world should be laid on his name or at the doorstep of his works.    As Zero Hedge previously noted, Keynes even wrote FDR to complain about people using his name and works to justify policies Keynes himself had nothing to do with.   In the seminal work, A Tract on Monetary Reform, for example, Keynes argued deflation was a problem, but inflation was the worst problem a monetary system can face. 

IMO, Keynes was the greatest economic mind of his generation and the misuse of his name and ideas is not good for anyone.  To use the term "Keynsian" as a curseword is to attack applied math and common sense.  Maybe a better word can be found to attack current policies.  And for those who revile Keynes:  Read his works, understand them, then write a book or article pointing out the flaws in his math:  You will win yourself a nobel prize.

A good read is Lords of Finance by Liauqat Ahamed, about the financial affairs from 1910 or so through the great depression.

Not, please understand, that I endorse all the monetary policies or spending policies going on.  IMO, the US needs to end the 2 recent wars; bring home those troops and troops from other places around the world; and take steps to reduce the US oil consumption to lower the trade deficit. 

To evaluate the 2009 stimulus package, I'd suggest a) comparing the trillion dollar stimulus package to the US balance of trade deficit (2/3 of that going to foreign oil interests not that certain people seem to care about reducing the US use of oil); and b) someone figuring out how many jobs were created by the tax cuts in the latest Stimulus package (bet the figure is close to zero, just like the effect of cutting say Anthony Mozillo's taxes with the "temporary" Bush tax cuts).

Since the oil import/ US overspending problems remain unaddressed, it  seems to me the US basically ended up taking a trillion dollars of borrowed money (less the useless tax cuts which I bet added close to zero jobs) and because the trade deficit runs so high, sending that money overseas.

[John McCloy]

  I want everyone to be aware of what I just witnessed on the Dylan Ratigan show a moment ago. They had a Professor Shiller on from Yale who looked completely dumbfounded and was advocating some "New Deal" reboot Pres. Obama style and his first grand plan to create jobs was to hire teachers aides for all teachers simply to employ people. If anyone TIVO's that show please take a ganders.

 I have never seen someone with such supposed credentials look like such a verbally bumbling fool. These are our great minds? I must remember that he does possess a PHD in Keynesian Houdini Economics and him and his decoder ring are more than qualified unlike us morts to discuss solutions for the modern day depression.

[faustian bargain]

Damn I wish I could get paid as much as a Yale professor just for being stupid.

[tom]

I obviously am going to agree with just about everything in this article, especially the sentiment. But unfortunately it doesn't get any happier after the funeral. We're running over 10% of GDP of deficit spending, debt-to-GDP's hitting 100% soon, the only way to escape default and collapse is austerity now. But austerity hurts, and I don't see Americans lining up to vote for pain.

Keynesian theory actually started its comeback in the early 90s, with the Republican New Keynesians Gregory Mankiw and John Taylor. Bernanke is more New Keynesian than monetarist, although there's not any clear dividing line between those schools.

I have some sympathy for Keynes and Roosevelt. It was different times. You've got to have sympathy for Oregon's Timberline lodge, at least. But Keynes' "beautiful" theory was actually abandoned already in the 50s, except in Samuelson's textbooks, but nobody really took it seriously. It takes no account of the foreign sector. It describes an equilibrium in which one of the factors is a flow affected by the equilibrium level, and thus logically can never be in equilibrium. Even the fanatic Keynes disciple Hansen admitted it doesn't add up. The only thing of Keynes' that survives in modern Keynesian theory is his belief that demand always leads (not original), his belief that government should borrow to fund stimulus during recessions (not original either), and his name.

But some of his witty quotes will outlast Keynesian theory and us all.

http://keynesianfailure.wordpress.com/2010/08/05/dont-always-blame-keynes/

[AchtungAffen]

Everybody is quick to draw their guns and shoot at Keynes. But the bullet rarely if ever hits probably the biggest culprit of them all: MILTON FRIEDMAN. It wasn't Keynesianism who defeated regulation on banks, such as Glass Steagall. It wasn't Keynesian thought who believed you shouldn't regulate derivatives because that would hamper "financial innovation". But once we all see some quasi Keynesian moves by the "gubermint", we all forget about Milton's Paradise Lost and start buying into Keynes as the Devil in Red.

And what I conclude from such an attitude is that in their frustration from a laissez faire economy gone berserk, everyody needs to vent on someone which doesn't discredit what we all love so much: our own greed. So there goes Keynes down the hell hole of history, while we enshrine Milton as the unspeakable god of our times.

[Shameful]

Sigh, regulation is not the problem.  The problem is the banks operate on their face criinally.  Can I engage in fractional reserve manufacturing?  They can in effect commit fraud by lending more then they have and then check kiting.  Adding to this crime is a Central Bank there to bail them out should their check kiting scheme fail.

The problem is not regulation, but that modern fractional reserve, or fictional reserve banking with a central bank.  If we had a 100% reserve system and no central bank  can assure you this ponzi debt scheme would have never made it this far.  What good are regulators?  The SEC was watching tranny porn as the system, crashed.  The only thing they might be good at is regulating the quality of tranny porn!

I don't want criminality to be allowed and then trust a government bureaucrat to regulate them.  I want no more criminality!

[AchtungAffen]

While you can always argue about the structural problems from the current system, you could also check certain values which precipitated the mess in which the world is in. While I know not much about the Fed (as it is, it seems, different from most central banks), one could always argue that removing the central bank could easily turn monetary policy to the executive branch: I'm not sure anybody would want that.

There were certain regulation issues which made, what one could argue were structural problems, into a full blown crisis. Glass Steall and the derivatives frenzy are just a part. Crazy leverage levels left open for the companies to decide is another. Because there's been fractional reserve banking for a long time now, but it wasn't always that the levels of fictions now reached where attained.

I'm not an expert, but I could argue that fractional reserve works up to the point where it becomes too much of a fiction (like contemporary leverage levels show). If not, well, there's always Islamic banking where no interests may be charged. That's another option, although I really doubt most people here would really want that.

[Apostate]

There's a real grain of truth to blaming Milton Friedman.

To a large extent, we're living within the contradictions in Friedman's ideology.

Rothbard punctured him decades ago, but almost no one listened. If you go to college today, you will hear liberals and conservatives alike using Friedman's arguments for fractional reserve banking, public property, and the role of the state.

The irony is that the most prominent advocate of the "free market" in the 20th century ensured that said market would be destroyed by upholding such fundamental errors. 

[Caviar Emptor]

Friedman's monetarism was much more a political agenda with a patina of economic theory. Friedman's theories came into vogue during the high water mark of international communism in the 1970s. He was a proponent of the overthrow of Salvador Allende by the CIA in Chile (paid for in part by bribes from ITT corporation to save seized assets). He was the chief architect of Chile's capitalist economy. It was this success that made him popular among conservative GOP leaders such as Jack Kemp, the father of "Supply-Side". 

[Shameful]

Fractional reserves work as long as there is NEVER a crisis of confidence which would upset the con game.  There are banking alternatives such as the 100% reserve banking.  You would not accept a scheme where a realtor sold rental houses under the assumption that only 1 in 10 would look at the property are you?

And I'm against any central monetary regime, what's wrong with the people picking what they want to use as money?

[AchtungAffen]

What if then private banks want to start minting cash? At some point, before the advent of central banking, each bank printer its own notes.

[Apostate]

I'm a free banking advocate.

No, there's nothing wrong with people choosing what they want to use.

So I should have said "no Fed" or whatever. Fractional reserve would be ACTUALLY fractional reserve without the Fed, instead of infinite reserve (for all intents and purposes) as we have now. 

[centerline]

The real problem in the debt-backed money scheme is that it is simply flawed from the get-go.  It creates a compounding curve that requires not-linear, but non-linear growth.  Only the time lag of debt creation to debt destruction keeps the machine alive.  Just not sustainable.  It appears to work well for awhile - while one is low on the curve.  Of course, we are on the parabolic side now... not such a fun ride.  Of course, this actually would have all ended some time ago.  It was via deregulation and creating ponzi schemes that leverage was amped up to current unmeasureable levels.  This is what kept the monster alive and is fueling ever larger boom-bust cycles.  Massive structural instabilities that will eventually pull the system apart.  Usury is the key issue underneath IMO.  No easy answers there.  But at least we have shown the full-tilt usury is a mistake.  Oops.

[DaveyJones]

rhymes with

[cxl9]

Can I engage in fractional reserve manufacturing?

Sure you can. The airlines routinely sell more seats for a flight than they are able to deliver, betting that not all passengers will show up. And look at how great that industry is doing.

[tom]

Well, since my article I'm pointing to is titled "Don't always blame Keynes", I agree some with you as well.

But my point in not blaming Keynes is that what we call "Keynesian" today is not Keynes. Self-described Keynesians have gone down various directions and are all over the political map. Taylor is one of Bernanke's harshest critics. They're both Keynesians.

One of the most common misconceptions about Keynes is that he was a theory-first academic. Not at all. He was a politically activist academic who sought all his career to come up with theories that would support his agenda. He started supporting public works in the 20s, and co-wrote the Liberal party platform built around public works in 1929. His theoretical stuff from the time eg the Treatise on Money he later disavowed and today nobody reads. The General Theory didn't come out till 1936. The theory itself is internally illogical. Even Keynesians admit that. Check it out if you don't believe me.

Keynes believed that as society became more affluent it would employ a lesser proportion of people, and hence government should fill the gap by running public works at all times, not just during recessions. That proposal fell out of favor even among self-described Keynesians by the 1950s. It pretty obviously would have led to stagnation.

If there's any aspect of Keynes that was really revolutionary and lasting, it was his focus on demand as the driver of supply. Classical theory focused on supply as the driver of demand, which makes sense when you're analyzing technological advancement, but not when you're analyzing recession.

Modern Keynesians propose a combination of fiscal and monetary stimulus but only during recession, and not necessarily through public works. Their theoretical justifications are built around sticky prices, not on Keynes' General Theory.

Keynesian theory is not dying because academics are discovering faults in the theories. It's dying because it's wreaking economic havoc in practice. Sustained deficit spending of more than 10% of GDP is clearly driving the US full-speed towards economic collapse, and hence a global collapse. It's still theoretically possible to avoid that by taking the austerity route immediately, but with the mainstream US political debate coming down to "less taxes!" vs "more spending!", I just don't see that happening.

As for Friedman, yeah, he was wrong too, and Greenspan's softening of the reserve requirements and generally lax stand on regulation surely helped cause the pattern of bubbles and meltdowns. A bit about that here: http://keynesianfailure.wordpress.com/2010/08/13/qe2-the-overblown-herohorror-stories-and-the-mediocre-reality/ 

Perhaps you could say it was the combination of Friedmanist and Keynesian ideas that proved to be such a devastating cocktail for the US in the past decade. That doesn't mean Keynesian ideas aren't wrong.

[johnmilan]

Fed Official Warns of Starting a Cycle of Boom and Bust

http://www.nytimes.com/2010/08/14/business/economy/14fed.html?_r=1

[RobD]

Bust I believe but where would the boom come from?

[bugs_]

"diminishing marginal productivity of debt"

i'm getting wood.