– July 15, 2014

America’s monetary and fiscal policies rest upon the ideas of some of the most prolific economists since the turn of the 20thcentury. Ironically, these economists put their theories to test in making bold predictions, only to be proven dead wrong.

#4 Paul Samuelson, 1943 Forecast: Post WWII Great Depression

Thanks to Samuelson’s #1 selling economic textbook, Economics, the teachings of Lord John Maynard Keynes became so embedded in economic policies that President Nixon announced to the world, “We are all Keynesians now.” During WWII, Samuelson urged the government to continue wartime production and deficit spending even after the war ends. Samuelson believed that the higher level of government spending during the war ended the Great Depression. So he was convinced that even if the government returned to the relatively lower level of deficit spending of the 1930s, “…there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced.” When WWII ended, President Truman ignored Samuelson’s advice and ended wartime production, cut government spending by 61%, constructed no domestic large scale public works program, and aside from the GI bill (in which only 5% of returning soldiers used) provided little relief to dismissed soldiers. But in 1945, the economy only underwent an 8 month recession in which unemployment rose to just 5.2%. By 1947, the economic prosperity that hadn’t been seen in almost 2 decades finally returned.

#3 Ben Bernanke, 2005 Forecast: Housing Prices Will Not Fall, No Recession

The man who is considered today’s foremost expert on monetary economics and the cause of the Great Depression not only did not see the housing collapse and the ensuing recession coming, but refuted the possibility. At the heights of the housing bubble in July 2005, Bernanke, then chairman of President Bush’s Council of Economic Advisers, went on national television and rejected the “crazy talk” that the housing boom was really a bubble waiting to pop. In response to this argument, Bernanke stated, “I guess I don’t buy your premise, it’s pretty unlikely possibility, we’ve never had a decline in house prices on a nationwide basis. So what I think is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit, I don’t think it’s going to drive the economy too far from its full employment path though.” A year later, housing prices hit their peak and the rest (as you know) was catastrophic history. Somehow, the man who was completely blindsided by the worst recession since the Great Depression was able to get reelected to the chair of the Federal Reserve by President Obama, and was voted Time Magazine’s Person of the Year in 2009.

#2 John Maynard Keynes, 1927 Forecast: There Will Be No Financial Collapse

As alluded to earlier, Lord Keynes is the most notable economist of the 20thcentury. In his world renowned book, The General Theory (published in 1936), he theorized that the solution to recessions is for the government to increase consumer demand via deficit spending financed by inflating the money supply. If this sounds familiar, it should. Both President Bush and his successor, President Obama, have fully adopted the Keynesian playbook. Though Keynes was claimed to have found the solution to recessions, he publicly stated 2 years before the start of the Great Depression that, “We will not have any more crashes in our time.”

#1 Irving Fisher, 1929 Forecast: Stocks Will Not Fall

Ben Bernanke proudly proclaims that he became an expert of the Great Depression by learning straight from the founder of monetary economics, Milton Friedman. And Milton Friedman was a student of the godfather of monetary economics, Irving Fisher. Fisher theorized that central banks should supply enough money to meet demand, which would keep consumer prices relatively stable. So Fisher was delighted that the Federal Reserve Bank of New York informally adopted his approach from 1922-1928. Unfortunately, Fisher’s premise, in which America’s entire monetary policy is now built upon, led to the demise of his investment firm, his personal wealth, and his reputation. On October 17, 1929, just days before the stock market crash, Fisher infamously predicted that, “Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as (bears) have predicted. I expect to see the stock market a good deal higher within a few months.” On October 28th (Black Monday) the Dow Jones dropped 38 points (13%) and on the next day (Black Tuesday) fell 31 points (12%). During the stock market crash, Fisher tried to convince Wall Street that a recovery was just around the corner. But, it would take 26 years before the Dow Jones recaptured its 1929 peak.

It is not by accident that all of these economists made horrific forecasts with regards to money and banking. While Keynesians and Monetarists are two different schools of thought, they are both clueless when it comes to money. Both groups believe in the fallacy of all fallacies that the supply of money must increase in order for an economy to grow. However once the free market establishes a form of money, as in the case of gold, the supply does not have to increase for the economy to grow. Money (historically) is simply a commodity that serves as a medium of exchange, not the end to an exchange. If the demand for money rises as production rises, than the price of money will rise just like any other commodity. Or in other words, prices will fall. Yet falling prices should not be regarded as the boogeyman, but the blessing of production. Every price is a cost to someone, and an economy grows because entrepreneurs, in search of profits, find new ways to reduce the cost of producing goods and lower prices to increase market share and profits. Admittedly, it is possible that production can expand to the point where the commodity money becomes too scarce to transact with, e.g., a gallon of milk currently costs .003 of an ounce of gold. But such a problem can only be fixed by the free market by discovering what alternative or additional money would be best. This is why people used silver along with gold for ages.

It is only when banks, usually at the direction of a central bank, inflate the money supply do you get inflationary booms followed by deflationary busts. Because Austrian economists such as Ludwig von Mises and Peter Schiff understood that inflated credit ultimately results in economic chaos, they were able to easily predict the Great Depression and the Housing Collapse respectively.

Despite being proven incompetent, economists, journalists, and politicians continue to follow in the footsteps of Keynes and Fisher. But why that is, is a topic for a different blog.

Devin Roundtree received his M.A. in economics from the University of Detroit Mercy.

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