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: 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

 

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Shameful's picture

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's picture

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

www.youtube.com/watch?v=C_ImqMyQXYU     

 

Joe Davola's picture

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's picture

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's picture

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

Attitude_Check's picture

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!

Pope Clement's picture

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's picture

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

firstdivision's picture

PPT keeps kicking into high gear everytime the SPX breaks 1080.00

centerline's picture

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

eatthebanksters's picture

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's picture

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's picture

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

akak's picture

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

Shameful's picture

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's picture

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's picture

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's picture

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's picture

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's picture

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

Fred Hayek's picture

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

CrockettAlmanac.com's picture

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's picture

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's picture

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's picture

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

StychoKiller's picture

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's picture

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's picture

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's picture

  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's picture

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

tom's picture

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's picture

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's picture

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's picture

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's picture

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's picture

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's picture

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's picture

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's picture

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's picture

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.

cxl9's picture

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's picture

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.

RobD's picture

Bust I believe but where would the boom come from?

bugs_'s picture

"diminishing marginal productivity of debt"

i'm getting wood.