The General Assumptions of Policy, Regulation, and Intervention
An open letter to a Washington Post columnist.
Dear Mr. Klein,
Regarding your article in the Washington Post today, “The dangers of misinterpreting Keynes,” I feel it is important to clear up some misunderstandings that have done great damage to the world economy, and especially here in the U.S.
It is difficult to refute modern “Keynesianisms” because those who came after Keynes, and consider themselves disciples of his, have altered or discarded so many of his “theories” that they might not even be called Keynesians had they not so named themselves. I will, however, point out that Keynes did not even have a theory; he had a set of assumptions that led by construction to his preconceived conclusions. Keynes did not prove “market failure,” instead –like A.C. Pigou – he assumed it and then concluded that government intervention was the cure. The government policies at the root of these so-called “market failures” is a subject for a much longer letter.
What role has the government to play besides that of an institution through which a society provides for its own security and rule of law? Keynesians believe that it is also there to steer the economy (in the direction determined by those with their hands on the reins). Free market economists, and people working in (what remains of) the voluntary sector of the economy, beg to differ.
You state that “Keynes… taught us that although markets are usually self-correcting, they occasionally enter destructive feedback loops in which a shock to, say, the financial system scares business and consumers so badly that they hoard money, which worsens the damage to the system, which further persuades other economic players to hoard, and so on and so forth.” Leaving aside the fact that it is government policy, regulation, and monetary manipulation that encourages and allows these imbalances to persist, in spite of the self-correcting mechanisms of a free market under the rule of law, you miss a fundamental point about money and prices when you assume that the government must step in to save us from “hoarders.”
First of all, “hoarded” money goes into the banking system where those who would make investments or purchases can then borrow it; the more that is “hoarded,” the lower the interest rate at which it will be loaned. Those who desire safety earn interest, and those who wish to spend have access; the economy marches on. In the worst-case scenario (for Keynes), money is “hoarded” under mattresses. But even in this case hoarding by some in the economy raises the purchasing power of the dollars left in circulation. This encourages spending by those still willing, and raises the cost of hoarding to the timid. In laymen’s terms, less spending means inventory left on shelves inducing retailers to lower prices; lower prices attract customers and bring mason jars stuffed with cash out of the rose garden. There is no need for the “government to break the cycle,” because growling bellies and “low, low prices!” will do the trick far better. There will never be a time when spending stops, not on this side of the Garden of Eden, anyway.
The implication, then, is that “the government spends better than individuals,” or the bureaucrats, politicians, and their house economists would not presume to take the money and spend it themselves. If “aggregate spending” dips then this is just an indication that people in general have decided to cut back; if a specific industry (e.g. housing, specialty ice cream shops, etc.) is hurt, this is just an indication that consumers no longer desire those products with the same intensity as before. There is no crime here, and to try to save these industries (and those who made bad investments in them) is to punish everyone else in the economy for having different tastes and preferences than the politicians.
Besides, these sharp drops in spending are the result of a fiat currency gone wild. The government’s inflation of the money supply is what makes these general boom/bust cycles possible. After crippling or destroying the self-correction mechanisms in a free market with misguided (or criminal) policies, government economists step in to cure the economy with more policies more severe and damaging. As F.A. Hayek showed us, government intervention begets further intervention. And as a young Alan Greenspan pointed out, the process of the cure is mistaken for the disease.
As for your second problem, the “practical” one, here is I believe where the fatal conceit is revealed. I cannot put it any better than Lawrence Summers in your article: “Anybody who is honest and knowledgeable will say it is harder to move money quickly and well in reality than it is in the textbook model.” To get an understanding of what he is actually talking about I would introduce you to a branch of Economic science called Public Choice. The name is a bit misleading because what it really examines is private choice in the public sphere. What it is is the acknowledgement that people retain their self-interest (and greed!) even when their hands touch the sanctified levers of government. A contractor remains human in a world of scarcity even when his contract is with the government, a bureaucrat remains human in a world of limited information even when he clocks into his bureau, and a politician remains a politician – ‘nuff said.
The world doesn’t work like Summers’ models because it isn’t filled with discrete variables running around, easily manipulated and acting in completely predictable ways. People are dynamic variables, they adjust to changing conditions; they have self-interest that supersedes the needs of an economist’s curves. That reality does not act as the models demand is not an indictment on reality. As easy to control as the world would be if people could be ordered around like automatons, or at least like children, it would also cease to be a place you or I would like to live in. It certainly is not the world we do live in.
I hope you recognize how ridiculous it sounds to advocate keeping projects in “’shovel-ready’ condition when times are good.” Should we put off projects that are worthwhile so that they will be around for a crisis? If something is worthwhile we should do it now! Or do you mean that we should have in mind projects that are un-profitable (read: wealth destroying) so that they can be begun as soon as the economy tanks?
Your point is well taken that if we “are going to spend during downturns, [we] have to save during expansions.” But leaving aside that our government has been out of debt for one year of its entire existence, your preferred policies destroy that very incentive. Constant money-pumping has kept interest rates so low that saving money is a fool’s game; government policy punishes saving. If they could, they would outlaw it. And the government’s solution to some citizens’ disinclination to save for their own retirements? Social Security has a “lock box” full of IOU’s. I think it best if we do not rest our faith in the prudence of politicians with no stake in the economy past their terms.
Keynesianism is not Economics, it is Policy. Monetary policy works in direct proportion to its deceptiveness; if people know what is happening they adjust and the policy doesn’t work. Fiscal policy works in direct proportion to its forcefulness; if people can resist being coerced into action, the policy doesn’t work. The cure for the bad policies, monetary and fiscal, of the past is, unfortunately, painful. The answer is to let people make their own choices, and live with them, in the future. Freedom and the rule of law will lead to a recovering economy. More policy will only make it worse.
Very Sincerely,
Ted Phalan
