Posts Tagged ‘Keynesianism’
The Keynesian model is a Cargo Cult, mired in a distant, romanticized past where Central Planning, intervention and manipulation were solutions rather than the root of the economy’s fatal disease.
If we want to trace today’s policy failures back to the source, we find ourselves at Richard Nixon’s famous statement that “We are all Keynesians now.” The fundamental Keynesian project is that the Central State and Central Bank should manage market forces whenever the market turns down.
In other words, the market only “works” when everything is expanding: credit, profits, GDP and employment. Once any of those turn down, the State and Central Bank “should” intervene to force the market back into “growth.”
The Keynesian has two basic tools: the State can borrow and spend money (fiscal stimulus) and the Central Bank can create money and “inject” it into the economy (monetary stimulus): quantitative easing, lowering interest rates, extending unlimited credit to broker/dealer investment banks and financial institutions, etc.
The sharper the downturn, the greater the State/Central Bank intervention. This accounts for the martial analogies of State/CB responses: “bazookas,” “nuclear option,” etc., as the market is overwhelmed with ever greater fiscal/monetary firepower.
After basically voiding the market’s ability to price risk and assets, the Keynesians believe the market will naturally resume pricing risk and assets at “acceptable to Central Planning” levels once fiscal and monetary stimulus is dialed back.
The entire Keynesian Project has numerous blindspots. When reality inconveniently fails to meet Keynesian expectations, reality is ignored or massaged to suit the Keynesian Cargo Cult’s belief system.
For example, the Grand Poo-Bah of the Keynesian Cargo Cult, Paul Krugman, loves to repeat that massive fiscal-stimulus deficits haven’t raised interest rates, confounding doomsdayers, but he never mentions the Federal Reserve’s role in this magic: what would interest rates be if the Fed wasn’t buying hundreds of billions of dollars of Treasury bonds every year?
The honest position would for Keynesians to state that the Central Bank’s role is to print money to enable unlimited, fiscally reckless spending by the Central State. But dishonesty is a modest Keynesian fault compared to the blindspots in their core policies.
Here is a partial list of Keynesian blindspots:
1. The Keynesian Model no longer works; it is counter-productive and destructive.
2. Markets that have been managed by the Central State/Central Banks are broken and no longer function in pricing risk and assets.
3. Keynesians are incapable of recognizing opportunity cost: the money they borrow and squander on sinkholes is no longer available for productive uses.
4. Keynesians are blind to the difference between an investment that yields a positive return and a sinkhole that sucks scarce capital away from productive uses.
5. Keynesians are incapable of recognizing institutionalized moral hazard is the inevitable consequence of flooding the financial sector with cheap, easy money.
6. Keynesians are blind to the fact that cheap, easy money at near-zero rates destroys the premium on real capital (saved cash), fatally distorting the economy and finance.
7. The Keynesians are blind to the eventual consequences of higher interest rates on rapidly rising sovereign debt. What’s left of the private market for bonds eventually recognizes that Central Planning has pushed the risk of default or currency depreciation much higher. That will push interest rates higher, unless the central Bank buys essentially all newly issued Treasury debt.
Regardless of who buys the debt, increasing sums of national income are diverted to pay interest on debt taken on to fund marginal-return Bridges to Nowhere, starving the State and economy of income and investment capital. Default is the only possible endgame when debt rises faster than income and productivity.
8. Keynesians are blind to diminishing returns: ever-higher debt produces ever-smaller returns.
I have often identified Keynesian economists and the Federal Reserve as cargo cults. After the U.S. won World War II in the Pacific Theater, its forces left huge stockpiles of goods behind on remote South Pacific islands because it wasn’t worth taking it all back to America. After the Americans left, some islanders, nostalgic for the seemingly endless fleet of ships loaded with technological goodies, started Cargo Cults that believed magical rituals and incantations would bring the ships of “free” wealth back. Some mimicked technology by painting radio dials on rocks and using the phantom radio to “call back” the free-prosperity ships.
The Keynesians are like deluded members of a farcical Cargo Cult. They ignore the reality of debt, rising interest payments and the resulting debt-serfdom in their belief that money spent indiscriminately on friction, fraud, speculation and malinvestment will magically call back the fleet of rapid growth.
To the Keynesian, a Bridge to Nowhere is equally worthy of borrowed money as a high-tech factory. They are unable to distinguish between sterile sand and fertilizer, and unable to grasp that ever-rising debt leaves America a nation of wealthy banks and increasingly impoverished debt-serfs.
The Cargo Cult faithful do not understand diminishing returns: at some point, the interest on skyrocketing debt drains income and capital from potentially productive investments to pay for previous unproductive spending on fraud, friction and malinvestments, starving the economy of productive investment.
“Free money” creates moral hazard, which means that those who can borrow money for almost nothing and never have to pay it back act entirely differently from those paying market rates for money and backing their loan with real collateral that is at risk.
The Keynesian definition of Heaven is World War II, because that war “proved” that digging a gigantic hole (global war) and filling it with trillions of dollars of borrowed money is the perfect (and perhaps only) way to create enough “aggregate demand” to lift an economy out of depression.
What clueless Keynesians cannot see is that World War II was a one-off and cannot be duplicated. The Global War “solution” had a key characteristic that is almost universally ignored.
Depression-era calls to bulldoze homes to be rebuilt and destroy grain so it could be regrown were rightly dismissed as malinvestment on a vast scale. But war is more or less an equivalent malinvestment on a grand scale. Hundreds of ships were built and then sunk, thousands of aircraft were built and then shot down or lost, and monumental mountains of provisions and supplies were manufactured and then either consumed or lost to enemy submarines, bad weather, rot and a host of other causes.
At the end of the war, most of the leftover goods manufactured–ships, tanks, aircraft, munitions, etc.–were mothballed or scrapped.
Despite this staggering waste, the war spending launched a long boom. How did it work this magic? One, it constructed new plant; unlike the Keynesian calls to bulldoze houses so they could be rebuilt, the war investment created factories that could then be converted to produce goods.
More importantly, the war spending created a vast pool of private capital–what we call savings. As resources were diverted to the war effort, rationing limited both the manufacture and availability of consumer goods. Meanwhile, tens of millions of people were put to work, either in the Armed Forces or in the war manufacturing sector, and most had few opportunities to spend money. Industrialists also piled up war profits.
Though the 1930s Central Planning extend-and-pretend policies did not write off the overhang of debt that had depressed the economy and destroyed the market’s ability to properly price risk and assets, this gargantuan pool of private capital simply overwhelmed the remaining debt overhang.
Third, trust in the system was restored: the Federal government had effectively “won the war” by printing money and drawing upon the nation’s vast surplus of energy and labor, and the manufacturing and financial sectors had been brought to heel by the extraordinary demands of the war and by legislation that had responded to financial fraud and over-reach of the late 1920s.
Keynesians are blind to the fact that the root of “capitalism” is capital.Capitalism requires two fundamentals–capital to invest and open markets for goods and services that transparently price risk, assets, hedges and goods.
Note that debt, and fiscal and monetary intervention are not essential to capitalism. Indeed, if we explore the roots of modern capitalism in the 14th and 15th centuries, we find that commercial credit and hedges were the key ingredients of success, not debt. Lacking sufficient coinage to handle the rising volume of trade, merchants settled accounts at the great trading fairs in Europe.
Long, risky trade voyages were hedged with the equivalent of options and limited stock companies that distributed risk for a price. Leverage was limited by the transparency and appetite for risk.
Compare that with Bernanke’s Keynesian policies, all of which severely punish savers (i.e. the accumulation of capital) and reward leverage and debt. By lowering interest rates to zero, Bernanke has imposed the opposite of the World War II experience of forced savings–he has made cash into trash and pushed everyone into risk assets.
By making credit dirt-cheap and backstopping financial-sector losses (i.e. institutionalizing moral hazard), Bernanke has destroyed the market’s ability to discipline malinvestment and openly price risk and assets.
World War II launched a boom precisely because private capital accumulation/savings were enforced; when the war ended, there was a vast pool of capital available for investment and consumption.
Keynesian policy is to punish capital accumulation and reward leveraged debt expansion. Rather than enforce the market’s discipline and transparent pricing of risk, debt and assets, Keynesians have explicitly set out to re-inflate destructive, massively unproductive credit bubbles.
This is why the Central Planning Keynesian policies has failed so completely, and why they will continue to fail. The Keynesians are not engaged in capitalism, they are engaged in the destruction of capital, productive investment and the open pricing of risk, debt and assets. The markets are not allowed to price risk, capital and assets, so the economy is crippled. The Keynesian model is a Cargo Cult, mired in a distant, romanticized past where Central Planning, intervention and manipulation were solutions rather than the root of the economy’s fatal disease.
Charles Hugh Smith – Of Two Minds
Goldman's Blood-Sucking Leeches Model, Money Multipliers, Macroeconomic Dark Ages, the Taylor Rule, and Nonsense from Trichet
Caroline Baum has an excellent column on Bloomberg today regarding money multipliers and a Goldman Sachs projection of what Republican budget cuts may do to the economy.
There were so many things in her post I wanted to reference that I asked Caroline if I could use her entire post. She graciously replied “Let ‘er rip”.
Macroeconomics really is stuck in the Dark Ages.
Take “fiscal stimulus,” for example, the idea that the government can step in to fill the void when the private sector isn’t spending and boost economic growth in the process.
Economists have been debating the pros and cons of fiscal stimulus since the 1930s, when John Maynard Keynes diagnosed the problem as one of inadequate private investment and prescribed public spending, financed by borrowing, as the cure.
The discussion hasn’t advanced very much in eight decades. Sure, economists have devised elegant mathematical models that purport to show that $1 of government purchases translates into — take your pick — no increase in gross domestic product (the multiplier is zero, according to Harvard’s Robert Barro) or $1.50 of GDP (a multiplier of 1.5, according to Berkeley’s Christina Romer, who was chairman of President Obama’s Council of Economic Advisers when the $814 billion stimulus was crafted in 2009). They haven’t really proven anything.
Keynesian economics went into hibernation in the latter part of the 20th century following an array of stimulus failures on the part of both Democratic and Republican administrations in the 1970s. The only thing the spending stimulated was stagflation.
In the 1980s, inflation came down, the Berlin Wall came down, economists thought the volatility of the business cycle had come down, and the notion of government as the solution went out of vogue.
All it took was a good financial crisis for the Keynesians to come out of the woodwork.
The debate over fiscal stimulus went viral last week (at least in the geek world) with an economic forecast from Goldman Sachs Group Inc. (GS), a counter from Stanford University economist John Taylor (he of the Taylor rule), and an addenda from Goldman yesterday.
The Goldman gang projected an economic drag (that would be the opposite of stimulus) on GDP growth of 1.5 to 2 percentage points in the second and third quarters if House-passed budget cuts of $61 billion for the remainder of fiscal 2011 become the law of the land.
Asked about the Goldman forecast Tuesday following testimony to the Senate Banking Committee, Federal Reserve Chairman Ben Bernanke demurred.
“Our analysis doesn’t get a number quite like that,” he said. “Two percent is an enormous effect.”
He could have added: “especially when the rest of government is growing.”
Wrong on Everything
“Total government spending is up 6.7 percent in 2011 from 2010,” Taylor told me in a telephone interview.
Defense spending is rising, as are non-discretionary outlays for programs such as Medicare and Social Security that are on automatic pilot.
The proposed cuts would reduce non-defense non-security discretionary spending, a teensy share of the federal budget, back to 2008 levels.
In a Feb. 28 blog post, Taylor said Goldman’s analysis was “wrong.” He criticized it for failing to consider the beneficial effects that expectations of lower future deficits and smaller tax increases would have on the economy. He criticized the methodology for relying on the same “large multiplier theory” used to justify the 2009 stimulus. And he criticized the assumption that proposed spending equates with actual spending, which trickles out over time.
Aside from that, Mrs. Lincoln, the Goldman analysis was spot on.
‘Alchemists and Quacks’
This fundamental disagreement among professional economists about whether government spending helps or hurts represents the state of the art, or science, today. In what other science do practitioners design a treatment plan based on inconclusive proof that the medicine does any good?
There are no control studies in economics, no way to hold everything else constant to determine the impact of one variable, no way to falsify conclusions that models spit out. Financial Times columnist John Kay, writing yesterday about risk modelers, referred to them as “alchemists and quacks.”
A bit harsh, perhaps, but he’d probably hold macroeconomic models in the same high regard.
Whenever oil prices spike, modelers instantly project how much the increase will subtract from GDP growth. No mention of why prices are rising. Is it the result of a supply shock, which results in higher prices and reduced quantity demanded, or an outward shift in the demand curve, which equates with higher price and quantity demanded? There is a difference.
In microeconomics, which is the study of how individuals and firms interact in specific markets, certain truths are self-evident. Which doesn’t mean economic planners can see them. Governments across Asia right now are using subsidies and price controls to ease the pain of higher oil and food prices even though their actions will exacerbate the crisis.
Goldman countered Taylor’s critique with a clarification. The projected 1.5 to 2 percentage point hit to GDP was to the quarterly annualized growth rate, not to the level. Thanks for that.
As I said before, we entered the 21st century with macroeconomics still looking for an Age of Enlightenment.
Five thousand years ago in ancient Egypt, medics used leeches to suck the blood of ill patients, believing the practice could cure everything from fevers to food poisoning.
Today’s physicians have largely forsaken bloodsuckers for modern medicine. It’s about time macroeconomics emerged from the Dark Ages as well.
Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own.)
Dark Ages Indeed
I am wondering “How many times does an economic model have to be discredited before it is discarded?”
This idea that government spending can stimulate the economy is total nonsense. If it worked, we would see something more than 2.8% economic growth for a deficit of $1.4 trillion dollars.
The Fed purchasing Trillions of Fannie Mae and Freddie Mac bonds did nothing for housing, nor did several rounds of housing tax credits.
Government spending accounts for an ever-increasing share of GDP. Moreover, the only reason GDP is up at all is that by definition, government spending adds to GDP. The multiplier is actually negative. It takes an increasing amount of “stimulus” spending just to say in the same spot.
Taylor Model Nonsense
Taylor criticizes the Goldman multiplier model and rightfully so.
However, his own economic model is fatally flawed. He believes all the Fed needs to do is go on autopilot, hiking or lowering interest rates in accordance with the Taylor Rule.
In economics, a Taylor rule is a monetary-policy rule that stipulates how much the central bank would or should change the nominal interest rate in response to divergences of actual inflation rates from target inflation rates and of actual Gross Domestic Product (GDP) from potential GDP. It was first proposed by the U.S. economist John B. Taylor in 1993. The rule can be written as follows:
In this equation, is the target short-term nominal interest rate (e.g. the federal funds rate in the US), is the rate of inflation as measured by the GDP deflator, is the desired rate of inflation, is the assumed equilibrium real interest rate, is the logarithm of real GDP, and is the logarithm of potential output, as determined by a linear trend.
Unmeasurable Economic Gibberish
The idea that interest rates can be set by mathematical modeling when the variables themselves are subject to debate as to how to measure them is preposterous.
Take the CPI for example. I believe home prices should be in the CPI. They used to be.
Somewhere along the line some theorist decided “owners’ equivalent rent” (OER) was a more valid concept. What is OER? It is the amount one would pay himself if renting a house from himself. It is the single largest component of the CPI. The measure of inflation from 2002 to now would be wildly different if one used actual home prices instead of OER.
Which model is more accurate? Look at the Fed’s chasing-its-tail actions hiking in baby steps on the way up, then lowering interest rates to zero when the economy collapsed.
ECB President Jean-Claude Trichet, a Keynesian Clown Too
Just today, Jean-Claude Trichet is talking about hiking rates in Europe.
His concern is pass-through inflation as noted in the Bloomberg article Trichet Says ECB May Raise Rates, Show `Strong Vigilance’
“There is a strong need to avoid second-round effects,” Trichet said, calling for moderation from wage and price setters. The ECB is “prepared to act in a firm and timely manner.”
This whole idea of pass-through inflation and second-round effects is yet more Keynesian claptrap. If someone pays more for gasoline, they have less to spend on clothes. It is as simple as that, but not to those purposely hiding behind economic models and their multiplier effects.
Alchemists and Quacks Galore
Making decisions on flawed models is bad enough in closed economic society.
Errors in every model are exacerbated by the fact we have a global economy subject to economic pressures of all kinds from countless places.
Financial Times columnist John Kay, writing yesterday about risk modelers, referred to them as “alchemists and quacks.” There are no control studies in economics, no way to hold everything else constant to determine the impact of one variable, no way to falsify conclusions that models spit out.
On that basis, the analyst from Goldman Sachs, Taylor, Bernanke, Krugman, Greenspan (and countless others) are all quacks.
Why Model at All?
There are no control studies because it is impossible to do them.
The real world is constantly changing, while mathematical models, Goldman’s and Taylor’s alike sit there as unmeasurable economic gibberish, when every component is subject to measurement errors and debate about what needs to be measured in the first place.
End the Fed
The free market could not possibly have done a worse job in setting interest rates than the perpetual chasing-their-own-tail central bank tactics that continually create boom-bust bubbles of ever-increasing amplitude in both directions.
If central bankers knew where interest rates should be we would not be in this mess, or at least the mess would be smaller. For further discussion about what the Fed does and does not know, I strongly encourage you to read the Fed Uncertainty Principle.
Ironically, the one thing the Fed never mentions and the ECB seldom mentions is money supply.
Here’s the deal: Inflation is a direct result of the cheapening of money. Strike that, inflation IS the cheapening of money and central bank policy in conjunction with fractional reserve lending is the cause.
Central bankers do not talk about such things because they are at the root of the problem.
The solution of course is to not only get rid of the Taylor rule, but to get rid of the Fed, the ECB, and central bankers around the globe.
Mike “Mish” Shedlock
Global Economic Analysis