Keynesian economics is a fraud. It has neither theoretical coherence nor empirical support. It was adopted out of desperation in the 1930s.
Many contemporary economists of the time protested that the fundamentals of the theory were incorrect. Economists had rejected some of its premises more than a century before John Maynard Keynes was born. For a sampling of some of the reactions see The Critics of Keynesian Economics.
This article will explore the following topics:
- How Keynesianism Was Accepted
- The Case Against Keynesianism
- How Politics Complicates Economics
- Why There Will Be No Political Solution
Why Did Keynesian Economics Dominate?
Keynesian economics represented a major shift in economic thinking. To understand how it dominated, some commentary on paradigm shifts is useful.
Thomas Kuhn described how knowledge advances in the physical sciences. His work popularized the term “paradigm shift.” He asserted that more than just a crisis and “proof” was needed for a new paradigm to be accepted:
… crisis alone is not enough. There must also be a basis, though it need be neither rational nor ultimately correct, for faith in the particular candidate chosen. Something must make at least a few scientists feel that the new proposal is on the right track, and sometimes it is only personal and inarticulate aesthetic considerations that can do that….
Kuhn’s understanding of progress did not claim monotonically increasing knowledge. According to the Stanford Encyclopedia of Philosophy, Kuhn anticipated occasional loss with the adoption of a new paradigm:
… a later period of science may find itself without an explanation for a phenomenon that in an earlier period was held to be successfully explained. This feature of scientific revolutions has become known as ‘Kuhn-loss’ (1962/1970a, 99-100).
The social sciences are more complex, but presumably paradigms shift in a similar fashion. The degree of uncertainty regarding the interpretation of data in the social sciences complicates the problem. Some epistemologists argue that behavioral data cannot prove or disprove anything. Friedrich Hayek’s “scientism” was coined to describe the misuse of physical science methodologies to behavioral fields.
More variables, sometimes exceeding thousands, are related to an outcome. Most of these variables are not knowable or measurable. Many exist only in the mind of the actor(s)). Controlled replication of experiments is virtually impossible.
“Proof” is a difficult hurdle. It is in this context that the paradigm shift to Keynesian economics should be viewed. Politicians wanting to expand the role of government delighted in the new theory. This attractiveness, plus the desperation associated with The Great Depression, enabled hundreds of years of prior economic knowledge to be discarded literally without normal due diligence.
Economists were also beneficiaries. Economists gained higher income and prestige as well as more power. Government funded research ensured the continued academic support for economic activism.
President Eisenhower warned about the corrupting influence of such funding in his farewell address:
The prospect of domination of the nation’s scholars by Federal employment, project allocations, and the power of money is ever present – and is gravely to be regarded.
Economists who acted on principle did so at their own personal expense. Few opposed the switch to activist economics and government, especially when better incomes were made available. Big government won and historians fell right in line and created the myth that government spending got us out of the Great Depression. The truth is that the economy did not recover until the government cut spending dramatically at the end of WWII, precisely the opposite of what Keynesians would predict.
The Case Against Keynesian Economics
Keynesian economics lost much of its luster during the 1970s when the economy was burdened by both slow growth and high inflation. Slowly, however, it climbed back to its position of prominence as a result of its usefulness to a government committed to expansion.
The current economic crisis is more severe than any since the Great Depression causing the Keynesian paradigm to again be questioned.
Kevin Hassett claims that the net effect of Keynesian stimulus must be negative:
Every stimulus effort has not two but three stages. When the stimulus is imposed, there is some positive short-run increase in GDP. When the stimulus is removed, there is an approximately equal and opposite reduction in GDP. But after that, the stimulus must be paid for with higher taxes or ongoing borrowing—causing a further reduction in GDP. Thus the total impact of the Keynesian policy is negative over its life. This fact is visible even in the fine print of Congressional Budget Office analyses so often cited by stimulus apologists, such as its 2009 finding that the Obama stimulus would reduce output in the long run.
In a sense, Mr. Hassett cedes the value of stimulus to Keynesians and still shows it is not net beneficial. Some Keynesians now question the value of stimulus itself – an unpardonable sin in the eyes of big government economists.
According to the Austrian School of Economics governmental intervention (government spending/credit creation) disrupts market prices, necessarily creating distortions in relative prices. These “incorrect” prices serve as false signals to economic actors, resulting in decisions which may be both unwise and unsustainable. An imbalance between consumption and investment is one result, as are distortions within these categories.
Imbalances are not immediately apparent but they do lower the efficiency of what an unhampered economy would produce. Additional stimulus, generally in increased dosages, is necessary lest the distortions surface. These additional stimuli further distort until a point is reached where additional stimulus is insufficient to cover up the problems.
Ludwig von Mises
The current housing crisis is an example of a major distortion that can no longer be hidden. It was created by a credit-induced misallocation of resources. Housing prices are now painfully correcting. Governmental interventions to prevent these adjustments have failed.
The continued unresponsiveness of employment and economic growth at this stage of the so-called recovery indicates serious underlying structural problems. Additional stimulus is unlikely to prevent the inevitable, as described by Ludwig von Mises:
There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.
An interesting discussion of Austrian economist reactions to the stimulus program(s) is available in The Austrians Were Right, Yet Again.
Politics and Economics
The relationship between economics and politics is tenuous. Politicians are notoriously short-term focused while economics is properly long-term focused. Mr. Keynes was an influential politician sans office. His economics reflected this. He famously defended his economic policy against criticism by retorting “in the long-run we are all dead.”
Mr. Keynes died within his “short-run,” but the rest of us are left to deal with the “long-run” distortions of continuous short-run economic fixes. To be fair to Keynes, it is not clear he would have approved what his epigones have done in his name.
Mr. Hassett described the relationship between politics and intervention economics as a “Keynesian death spiral:”
… aggressive stimulus sets off a kind of Keynesian death spiral in which nervous politicians adopt repeated stimulus packages in order to avert near-term distress, the cumulative effect of which can be ruinous.
The economy is now well into this death spiral. The continuing shadow of Keynes on current policy and our feckless and cowardly political class was demonstrated in the debt-ceiling charade. This deal was pure snake-oil. It accomplished nothing regarding spending or deficit reduction.
It provided politicians with a new credit card which they promptly used by increasing debt $239 billion on Thursday of last week. To put this in perspective, prior to Obama, the largest annual deficit in history was $455 billion.
Government debt is clearly unsustainable. Adding more is akin to pouring gasoline on a raging fire. That Washington pretends otherwise is disgraceful. Either politicians are the most ignorant fools in the world, or they believe their constituents are. Neither hypothesis is flattering; either suggests that these clowns should be removed from office at the earliest opportunity.
Political irresponsibility is so blatant that S&P has downgraded the US government’s debt rating, now rating our debt less safe than France’s.
Mr. Hassett concludes the case against Keynesian economics is so definitive that other motives might be suspected:
The arguments against recent stimulus actions are so strong that one wonders whether big government ideology is the true source of the Democrats’ Keynesian enthusiasm. President Obama’s plan all along may have been to expand government spending massively in the name of temporary stimulus, and then fight to never let it decline.
The political motives that drive Keynesian enthusiasm today are the same ones that powered it past the objections of sound economists in the 1930s. Keynesianism is the vehicle for the expansion of government. Many naïve politicians believe government should continue to expand.
Hassett ends his piece with the rather forlorn hope that a lesson may finally have been learned:
Perhaps now that the Keynesian approach has so visibly failed, policy makers can finally see clearly enough to do the right thing.
That is unlikely to be the case for reasons discussed below.
The Myth of Government
Aided by Keynesian economics, the political class cultivated and promoted the myth that government was responsible for economic success, especially the notion that more government means more success.
Government is like the rooster who believed his crowing caused the sun to rise. More accurately, the propaganda-conditioned voters see government as this rooster.
Government cannot cause the economic sun to rise. It can, however, prevent it from rising. That is the point this country has reached. Government has crippled the economy with an unbearable burden of poor policies, unnecessary regulations and overspending.
Now the rooster crows but the sun does not rise. The economic crisis persists and worsens, despite unprecedented government crowing (spending).
The economic solution is simple: pare back government and its burden on the economy. Get government out of the way and the economy will recover. The economic sun then will again rise.
The political solution is not simple. Government is bound by its own Gordian Knot. It has convinced voters that more crowing is always better. Less crowing would be political suicide for whoever proposed it. The carefully-crafted and false myth of government is a barrier to any political solution. To admit the myth was a lie requires an admission that government has been a fraud for the last seventy-five years.
That is why no political solution to the economic problem will be forthcoming. The rooster will crow until markets behead it. Spending and deficits will not decrease until the economic system collapses and we rebuild from the ashes that remain. Ludwig von Mises described both Keynesian economics and our current situation:
Keynes did not teach us how to perform the miracle . . . of turning a stone into bread, but the not at all miraculous procedure of eating the seed corn.
Make sure you preserve your seed corn. Hard times are ahead!
This post originally appeared on American Thinker on this same date.
RChavez: 
HappyinHowell: 
Mr Misno: 
Marsha: 
Brian Wilson: 
Steve: 
Larry Crouse: 
Brian Wilson: 
Monty Pelerin: 
Bob Snyder: 
Thank you for writing this article. Keynesianism needs to be exposed for the fraud it is.
Some history from Kotlarz:
“The founding of the Bank of England in 1694 represented, effectively, the formal institutionalization of usury. It was chartered as a private corporation authorized to purchase bonds from the monarchy during William III’s desperate reign, in exchange for written-out-of-thin-air currency issued to the Crown. The bonds were then resold to private investors (precisely as in the Federal Reserve’s so-called “Open Market”). In the prospectus for this private company, William Patterson wrote, “The Bank hath benefit of interest on money which it hath created out of nothing.” Nathan Mayer Rothschild (1777 to 1836), who gained control of the Bank of England, boasted famously:
“I care not what puppet is placed upon the throne of England . . . The man that controls Britain’s money supply controls the British Empire, and I control the British money supply.”
The dynamic by which central banks extended their control is summed up by British economist Richard Douthwaite:
“Currencies produced by one group for use by another have been instruments of exploitation and control. For example, whenever Britain, France, or one of the other colonial powers took over a territory during the “scramble for Africa” towards the end of the (eighteenth) century, one of the first actions was to introduce a tax on every household that had to be paid in a currency that the conquerors had developed for the purpose. The only way Africans could get the money to pay the tax was to work for their new rulers or supply them with crops. In other words, the tax destroyed local self-reliance, exactly as it was supposed to do . . . Very little has changed. Over 95 percent of the money supply in an industrial country is created by banks lending it into existence. These banks are usually owned outside of our areas, with the result that we have to supply goods and services to outsiders even to earn the account entries we need to trade among ourselves. Our district’s self-reliance has been destroyed just as effectively as it was in Africa, and whatever local economy we’ve been able to keep going is always at the mercy of events elsewhere, as the current world economic crisis is making too clear.”
The colonists reasoned early-on that they could not prosper if they remained dependent on borrowing money from the Bank of England to carry out their commerce. They responded by creating their own money. Some was minted, but most were printed “Bills of Credit.” In fact the paper money issued by these colonies has the distinction of being the first government-authorized paper currency in the Western world, with Massachusetts starting it off in 1690. America was to become the test case for paper-money economics, and was closely watched by the rest of the world. It was an experimental effort, and had its mishaps, but the Colonies gradually became skilled in the use of paper currency. When asked about how he could explain the prosperous condition of the Colonies, Ben Franklin replied:
“That is simple. It is only because in the Colonies we issue our own money. It is called colonial scrip, and we issue it in proper proportion to the demand of trade and industry.”
The Crown set itself in continuous opposition to these unapproved issues and Parliament passed laws in an attempt to curb them. The Currency Act of 1764 banned the extension of legal tender status beyond certain dates, and England assumed the authority to approve or disapprove any laws the Colonies might pass related to new issues. Its foot dragging on such measures effectively deprived the Colonies of their money, and led to the first two now-uncomprehended justifications for breaking with England as set forth in the Declaration of Independence, specifically:
(1) – He has refused his Assent to Laws, the most wholesome and necessary for the public good.
(2) – He has forbidden his Governors to pass laws of immediate and pressing importance unless suspended in their Operation till his assent should be obtained; and when so suspended he has utterly neglected to attend them.
It is interesting to note that the issue of money creation was not mentioned by name in these two items. With respect to the audiences for whom it was intended, both the royal regime in opposition and the body patriotic to be roused, evidently no such explicitness was deemed necessary. The issue of money was already a firmly rooted fixture of the popular political consciousness as the matter about which all else turned. This is telling witness to how far this nation has strayed from its original inspiration, all the sophomoric patriotism of the current political ballyhoo notwithstanding.
We have been subjected to much myth making with regards to the American Revolution. Selected parts have been endlessly quoted and manipulated to promote jingoistic notions, to buttress disingenuous agendas, and ultimately to co-opt our economic and political heritage. Without sufficient historical understanding, even phrases such as “taxation without representation” and the “Boston Tea Party” have come to have a distorted meaning. Closer to the truth was Franklin when he said:
“The Colonies would gladly have borne the little tax on tea and other matters had it not been that England took away from the Colonies (the right to issue) their money, which created unemployment and dissatisfaction.”
Senator Robert Owen, prominent banker and the first chairman of the Senate Committee on Banking and Currency, explained that when the Rothschild-controlled Bank of England heard of the situation in the Colonies:
“They saw that here was a nation that was ready to be exploited; here was a nation that had been setting up an example that they could issue their own money in place of the money coming through the banks. So the Rothschild Bank caused a bill to be introduced in the English Parliament which provided that no colony of England could issue their own money. They had to use English money. Consequently the Colonies were compelled to discard their script and mortgage themselves to the Bank of England in order to get money. For the first time in the history of the United States our money began to be based on debt.”
“Benjamin Franklin stated that in 1 year from that date the streets of the Colonies were filled with unemployed.”
The Crown’s stonewalling of the colonist’s monetary needs also caused an open and widespread violation of the law, even by merchants and statesmen. This resulted in an effective training ground for resisting subjugation, which eventually found expression in Revolution. According to monetary historian Steve Zarlenga, “The skirmishes at Lexington and Concord are considered the start of the Revolt, but the point of no return was probably May 10, 1775 when the Continental Congress assumed the power of sovereignty by issuing its own money.”
Alexander del Mar stated the matter with great force:
“Lexington and Concord were trivial acts of resistance which chiefly concerned those who took part in them and which might have been forgiven; but the creation and circulation of bills of credit by revolutionary assemblies in Massachusetts and Philadelphia, were the acts of a whole people and coming as they did upon the heels of the strenuous efforts made by the Crown to suppress paper money in America, they constituted acts of defiance so contemptuous and insulting to the Crown that forgiveness was thereafter impossible. After these acts there was but one course for the Crown to pursue and that was, if possible, to suppress and punish these acts of rebellion. There was but one course for the Colonies; to stand by their monetary system. Thus the bills of credit of this era, which ignorance and prejudice have attempted to belittle into the mere instruments of a reckless financial policy, were really the standards of the revolution. They were more than this: they were the Revolution itself.” “ check out this monetary history and please pass it on – economictree.org/Iraq_Am_Revolution2.html
Recent events in Iceland should tell you that they are not running to gold but simply telling the bankers to buzz off. Then they went back to doing real stuff and trading their real goods with their own currency. Gold will not bring a country Sovereignty.
What is it with the mathematical illiteracy of people not getting it that when a people use debt for money they can only get more debt and that over time the exponential debt burden will overcome the entire productive capacity of the people? It is precisely this reason why Debt Based Fiat currencies have failed and why Ron Paul predicts that this one will fail too, though sometimes even he does not call out the fact that it is the Debt Basis that is driving the printing of more currency, since the system started short (issue only principle but ask for principle + interest back) and is exponentially getting more short every day (Fractional Reserve Banking issuing only principle but every issue is owed back plus interest…so where does the interest come from? More Debt! And then the eventual Quantitative Easing As the Central Bank tries to give a fancy name to just printing to cover the shortage that the System Itself Created!). Using Debt As Money will always and only grow the debt, no matter the level of spending, if any of the debt based currency is left in circulation, which it needs to do if it is going to serve the utilitarian purpose of a money system to facilitate trade. It should be obvious that needing to remove money from circulation to avoid debt accumulation is at odds with the very purpose of money that needs to be in circulation as the tool for exchange. So it makes little sense to use Debt As Money.
It is the unrealistic expectation that a certain currency should have a rate of return all by itself which takes away the very utilitarian purpose for that money itself that is at the heart of this problem. It is like investors have no ability to know what real business to invest in and resort to just investing in money itself. However, the volume of money must be adjusted by the real business and economic activity within a people’s economy (True Free Enterprise), and attempting to do so by setting an interest rate on the very tool itself can only have the effect that less of the tool will be available, and the entire economy will suffer. Compound this problem by issuing currency through fractional reserve banking and the entire population is feeling the ever present and ever growing shortage as the issue is only principle but what is owed is principle + interest. This is your source of inflation as the shortage is addressed by issuing More Debt.
Attempting to compare relative “value” of one tool to another is asinine if the attempts at such actually remove the tool’s ability to serve the purpose for which it came into existence. If you think there can be no such problem with gold or silver just wait. And just who do you think is in control of the supply of these?
The American Revolution was to get free from the problem of the Colonists themselves not being in control of their own money supply. The money system imposed on them was oppressive and actually would not could not serve the Free Enterprise they were engaged in. When they found that the country had large silver deposits and started using silver as money the Rothschild Bankers sent their envoy to intercede: “I went to America in the winter of 1872-73, authorized to secure, if I could, the passage of a bill demonetizing silver. It was in the interest of those I represented – the governors of the Bank of England – to have it done. By 1873, gold coins were the only form of coin money.” – Ernest Seyd (Representative of International Bankers)
Yet we are in the same situation today, and some are advocating using gold as money? Either they are a fools or mathematically illiterate or know nothing about real sovereignty and the utilitarian nature of the tool called money as it relates to True Free Enterprise, or they are the modern day Ernest Seyd.