Rick Kelo doesn't understand economics, and he's not alone. Most of this criticism I'd normally reserve for comments (more), but we've reached the point where denial of Keynesian economics is on the same intellectual level as the birther movement, and reminiscent of the Flat Earth Society and climate science denial. Isolated misunderstandings must be rebutted to prevent them from spreading to the larger public where they can do serious damage when adopted by know-nothing politicians and a simplistic media incapable of understanding these issues any better than Rick does.

A painful misunderstanding of the subject, especially in climate science, is always a common factor in these controversial and always unsupported views:

You may never have heard the name John Maynard Keynes, but he was the architect of Too Big To Fail and all the other government bail outs that have flooded the news for the last 5 years.

The modern idea of too big to fail is that America's largest banks, where wealth has been concentrated at undesirable levels, have become too entwined with risk-heavy investment firms that their failure would cause the entire economy to collapse. That was the actual justification for bailing out Wall Street in 2008, made by Democrats and Republicans like Paul Ryan alike.

Such a thing didn't exist during most of the life of John Keynes, and if he ever held an opinion on the necessity and wisdom of bailing out major financial institutions to protect the economy, he never shared it publicly. His ideas in this area involved the financial regulation of free markets to decrease risk and monetary policy to blunt the negative effects of the business cycle.

Put another way, Keynes advocated regulation of Wall Street so that "too big to fail" would never exist and monetary policy to clean up the mess of excessive risk when it all blows up. Any political response to that in financial recessions like the Lesser Depression of the late 2000s would be dealing with the consequences of not listening to Keynes in the first place.

After the Great Depression, Congress passed laws meant to reduce risk in investment and protect the consumer side of the banking system in case of a large scale investment sector failure. Commercial banks were legally forbidden from also being investment firms and vice versa. A bank could have offer savings and checking accounts, but it couldn't engage in things like credit default swaps (or the 1940s equivalent). Investment firms like Bear Stern and Lehman Brothers could do CDS's, but not savings and loans.

Those laws were weakened or repealed in the 1990s when Citigroup merged with Travelers Group. Rather than obeying the law and divesting itself of insurance and investment related assets, Congress simply repealed the law that Citigroup had just violated.

The 2008 bailout which resulted in more than $1 trillion in on-the-book asset transfers and $16 trillion in secret loans wouldn't have been required, even by the justification of bailout advocates, had Congress not massively deregulated Wall Street during the Clinton administration.

The only part that John Keynes played in all of that is that Congress took his theories to heart after the Great Depression and regulated Wall Street in ways that prevented another Depression for over half a century. The worst recession since then occurred within 10 years of Congress repealing legislation based on Keynes ideas.

The true architect of too big to fail is Wall Street, and the antidote has been Keynesian economics.

One wrong view of another -- you'll find this a substantial trend -- is purposeful or unintentional misunderstandings of what other people actually believe and say:

To tell every politician in the world what they have always wanted to hear regardless of how bad the consequences would be: that ridiculous government spending wasn't harmful, it was helpful.

This misunderstanding has been used to attack stimulus advocates for years, and it's always wrong because it's a view that nobody actually has. A recent example of this strawman attack was MSNBC host and former Republican Representative Joe Scarborough fear mongering about out-of-control deficits and debt by accusing Nobel Prize laureate and economics professor Paul Krugman of wanting big deficit spending basically all of the time. That isn't a view that Krugman actually has. Krugman, like myself and many other economists I'm sure, hold nuanced views about when deficit spending is appropriate and what effects it will have, based strongly on what the specific economic conditions are.

Krugman has written more times than I can count that there's a difference in what will happen in a recession like this one -- lots of private debt, high unemployment, and a lack of demand -- when the government tries to stimulate the economy with deficit spending, and what will happen during other types of recessions and full employment. Some of that is basic macroeconomics and some of that is Keynes. Some of it is based on past experiences during and after the Great Depression and Japan in the 1990s.

It shouldn't be necessary for me to explain what those differences are, and yet I have to precisely because people like Scarborough and Kelo refuse to acknowledge any of this -- they must pretend it doesn't exist, otherwise their own ideas completely fall apart just by looking at economic data from the past 10 years.

The short version is that high unemployment creates a gap between what GDP could be at 4% (full) employment, and what it is right now (today 7.x%). That's what the economy would be producing if unemployment were "normal", and what it's actually producing.

During a monetary recession -- one created by the Federal Reserve by increasing interest rates -- demand for goods and services remains the same, but business investment falls because of higher interest rates and some inflation. That's what happened in the early 2000s in what most people call the "dot com bubble". That recession was created intentionally by the federal government to cool off Wall Street before it popped on its own, in effect creating a controlled recession that the Fed could end any time it wanted at a speed that wasn't seriously painful, in lieu of a bubble popping all on its own and causing uncontrolled damage to the economy. The recovery was quick because, again, demand for good and services never changed. Once the Fed lowered interest rates, businesses started investing again immediately because there was sufficient demand for it.

During a financial recession -- one created by Wall Street -- demand drops and businesses start laying off workers due to excess capacity until the two come into balance. Interest rates and inflation fall largely outside of the Fed's control, in some cases nearly to zero for interest rates. Extreme private debt (that's people and businesses) causes people to begin saving and paying off debt which delays recovery.

In non-recession years, unemployment is at 4% and demand is considered to be 100%.

It's critical to understand these details because they tell you what will happen when the government tries to stimulate the economy. The idea that government spending will crowd out private spending during full employment simply doesn't apply in the aftermath of a financial recession. It literally cannot work that way. The reason for high unemployment in the first place is a lack of demand for goods and services. If the government and business sector were in a position to compete with each other in that way, an economy wouldn't have high unemployment in the first place, because businesses would be hiring to keep up with that high level of demand.

That's what I'm talking about when I say that these misconceptions, "ridiculous government spending is always good", rely on getting things wrong. There's a world of difference between "deficit spend all the time" and "deficit spend when it can make a huge different and then stop". The latter is what Professor Krugman has been advocating for half a decade, and it's consistent with the theories of John Keynes.

No you will not believe the story of a man who told Presidents & Prime Ministers they could cure their recessions by hiring people to dig holes & fill them in.

Odd as it may sound, such an activity would stimulate economic growth under the right conditions. A modern era counterpart to that would be replacing old bridges, repaving roads, and demolishing old buildings and replacing them with new ones. It's little different than rebuilding infrastructure after a natural disaster, or building planes and tanks during wartime.

The point isn't to put people on the government payroll as a means to solve an unemployment problem (although arguably that would be the most effective and if done properly would virtually eliminate poverty), the idea is to stimulate job growth.

The government dumps $10 billion into repaving roads, and contractors that do that kind of work will have to hire people to get it done because they've already shed their workforce down to a bare minimum, as all businesses have done. Those people will stop needing unemployment insurance (reducing government spending) and will start spending their salaries on the economy buying food, paying household bills, going out to the theater, maybe getting a new laptop or something along those lines. Increased demand for food, theater tickets, laptops, energy and utilities and such will require businesses in those sectors to hire more people to meet that demand. Now all those people making more laptops and food will have new money to spend on the economy, and the cycle repeats itself until full employment is reached.

That's not a theory of John Keynes, it's economics 101. Where the money comes from and under what circumstances it'll be effective is where Keynes comes in, but what I described above is little more than an artificial acceleration of the business cycle.

The only reason the specific job the government creates would matter is that you want to get the biggest multiplier -- the biggest bang for your buck. Digging a hole and filling it in would only increase demand for shovels, so the multiplier would low. Replacing a bridge or better yet, replacing an old building would have a very high multiplier. Construction materials and new heavy machinery would have to be bought. A new building could easily spur the creation of an entirely new subcontractor that sprang up to meet demand.

Even when the government funding goes away, growth will return to normal instead of being accelerated. It won't stop entirely.

This is all well accepted and understood economics. People who mock it, as with all things in life, just don't understand it. Or they don't want to. It's not secret that Republicans and small government activists oppose "big government" programs not because they won't work, but actually because they will work, and they don't want people coming to like the idea that government can work when it's run by the right people.

There is no economic argument that the government hiring people to dig holes and then fill them in wouldn't stimulate the economy. It's diversionary because it seems silly, but it's fundamentally sound.

Then you may decide for yourself if you want to live in a Keynesian world forced to ride a roller coaster from one economic bubble to the next...

The truly sad thing about economic ignorance in America is seeing claims like that. Keynesian economics respects the free market but is fundamentally an interventionist approach to stabilization. Opposing the theories of Keynes is to embrace a "roller coast from one economic bubble to the next" because there's nothing there to stop it. Keynes' insights involved, as I wrote above, smoothing out the business cycle so that it's not a roller coaster. To say otherwise is to reveal a fundamental ignorance of what the man believed.

There are people who understand Keynesian economics but don't agree with it, and I'm sure they have legitimate criticisms. Part of being an intellectually honest person is accepting that there are few absolutes and that you should always be open to new data and new ideas and willing to accept being wrong, and adjusting your views accordingly.

My beef isn't with those people, it's with those who literally don't know what they're talking about and end up unintentionally polluting the conversation with falsehoods and errors like the one I quoted above.

Keynes wanted to control & direct all investment

That statement borders on libel and is laughable. John Keynes was generally a free market advocate and was himself a prolific private investor. Keynes passed away having amassed a fortune on Wall Street that'd be worth $348 million today.

Keynes book, The General Theory of Employment, Interest and Money, argued that free market capitalism was a net asset to society but inherently unstable, and that conventional monetary wisdom didn't apply without full employment. That insight is why he's famous. It's why his theories have perfectly predicted everything that's happened since 2008.

Direct government control of all investment is actually what Keynes sought to avoid:

As a man of the centre described as undoubtedly having the greatest impact of any 20th-century economist, Keynes attracted considerable criticism from both sides of the political spectrum. In the 1920s, Keynes was seen as anti-establishment and was mainly attacked from the right. In the "red 1930s", many young economists favoured Marxist views, even in Cambridge, and while Keynes was engaging principally with the right to try to persuade them of the merits of more progressive policy, the most vociferous criticism against him came from the left, who saw him as a supporter of capitalism.

Moreover, the quote that is supposed to support the false claim that John Keynes "wanted to control and direct all investment" is taken out of context by Rick Kelo. Here is what Rick quoted to support his bizarre claim:

The theory of aggregated production... can be much easier adapted to the conditions of a totalitarian state [eines totalen Staates] than the theory of production and distribution... put forth under conditions of free competition and a large degree of laissez-faire.

And here is what he left out, which changes the passage substantially:

This is one of the reasons that justifies the fact that I call my theory a general theory. Since it is based on fewer hypotheses than the orthodox theory, it can accommodate itself all the easier to a wider field of varying conditions. Although I have, after all, worked it out with a view to the conditions prevailing in the Anglo-Saxon countries where a large degree of laissez-faire still prevails, nevertheless it remains applicable to situations in which state management is more pronounced. For the theory of psychological laws which bring consumption and saving into relationship with each other, the influence of loan expenditures on prices, and real wages, the role played by the rate of interest-all these basic ideas also remain under such conditions necessary parts of our plan of thought."

Keynes said the exact opposite of what Kelo claimed. He did not support totalitarian government control of private investment, instead his book and theories applied "to a wider field of varying [government and economic] conditions" including "Anglo-Saxon countries where a large degree of laissez-faire still prevails".

Here is Harold L. Wattel writing about that passage:

In this statement Keynes does not say that his theory is more applicable to a totalitarian state than to a democratic state. What Keynes says is that his macroeconomic theory of output as a whole is more easily adapted to a totalitarian state than is classical microeconomic theory of the production and distribution of a given output produced under conditions of free competition and a large measure of laissez-faire. The distinction is an important one. Keynes is comparing the usefulness of micro and macro theory in a totalitarian state. He is not comparing the usefulness of his macro theory in a totalitarian state with its usefulness in a democratic state.

In other words, Keynes is explaining that his theory applies equally well to a totalitarian state and economy because his theory applies to all types of economies and states whereas macro theory at that time applied best only to one type of economy and not all of them, which on its face would make any theory a shitty theory.

The search for a grand unified theory in physics which incorporates classical physics and quantum theory would be akin to what Keyes was trying to accomplish.

That Rick didn't understand that isn't surprising, this is not Sunday afternoon economics. He's writing about things that are well beyond his understanding and making serious and unconscionable errors because of it:

Enter the problem: Deficit spending & easy money cause recessions, but to Keynes they were the cure as well.

That weird claim contradicts about a hundred years of economic history in the United States and it doesn't represent the views of even most opponents of Keynesian economics. First and foremost, the United States experienced recessions before the existence of the Federal Reserve which definitively precludes "easy money" as a single cause of economic downturns.

Second, deficits are complex because they can be driven by recessions and also by political policy. Deficits today are largely being driven by the Lesser Depression where some spending increased on things like unemployment insurance and a massive drop in tax revenue due to high unemployment, and deficits were in fact dropping in the run-up to the recession.

The 2004 deficit was $412 billion, followed by drops to $318 billion in 2005, $248 billion in 2006, and $160 billion in 2007. The recession began in 2007, and the deficit ballooned to $458 billion in 2008 and $1.4 trillion in 2009.

Deficits follow recessions because of increased spending in unemployment insurance and food stamps and tax revenue plummets as businesses lay off workers.

Regardless of whether or not Keynes was right that deficit spending in recessions can boost the economy, it's way out on the fringe to claim that deficits cause recessions. That's nonsense that basically nobody believes.

Recessions cause deficits and that's a fact.

They [deficits] certainly caused the "Great Recession".

Again, that's just the opposite of reality. It's fiction, and poor fiction at that. As the graph shows that I just linked, the last two recessions were proceeded by decreasing deficits which after the recession went on to increase significantly.

The real big kick in the knee here is that the first recession on that graph was intentionally caused by the Federal Reserve tightening money policy to cool off the stock market. It was tight money, not lose money that caused that recession, and it was a recession proceeded by shrinking deficits (surpluses, even).

Everything Rick thinks he knows here is wrong.

The cause of recessions is the necessary cleansing of malinvestments that were created by the preceding boom period. But instead stimulus acts like an anchor around the economy's neck and prevents it from naturally adjusting the damaged industries (like auto manufacturing) downward to levels that are sustainable.

The auto industry as a whole wasn't having any problems in the United States, it was only General Motors. Toyota was doing fine and neither it nor Ford took any federal funds. GM's problem was decades of mismanagement that was exasperated by the recession sending auto sales off a cliff.

It's false to say that the auto industry was damaged at all -- it was not. That's simply not true. There wasn't any adjustment needed outside of GM needing new management.

They adjusted into sustainable long-term industries. What would they be doing instead if we'd bailed out the mortgage industry and artificially created conditions so they kept writing mortgages?

Rick doesn't seem to understand that what he just described is exactly what the federal government did when it bailed out Wall Street and what it's been doing for four years with quantitative easing. It's why the government bought AIG, why it rescued the Fannie and Freddie, why it loaned trillions to Bank of America et al., and that's to a large degree what it's spending money on for QE3.

The biggest problem that people like Rick Kelo have is that they just don't understand any of this. Rick demonstrated that he doesn't know what the Wall Street bailout did, didn't know that deficits had dropped before each of the last two recessions, didn't understand what Keynes was saying in the book he quoted from, and doesn't understand the nuanced views of the people he disagrees with.

He's not alone. These are the problems that plague Congress as well. It's why Congress didn't vote 100-0 for the Recovery Act when it should have, why it hasn't done anything to stimulate the economy since 2009, and why we're all stuck with a Japan-style lost decade (even as Japan rapidly embraces expansionary policy right now).

The theories of John Keynes have held up perfectly in the last five years, the only problem is that too many people don't have a meaningful understanding of economics and nobody is out there helping them understand it.

Recent Entries