I know that probably the first thing you are asking yourself is why some nut would actually set out to read this early twentieth century tome explaining how to fix the Great Depression economy. Keynes provided the answer himself, in Chapter 24, Book 6, page 383 (of the First Harvest/Harcourt paperback edition of 1964):
The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.
Keynes is the defunct economist to whom practical men are now enslaved. Being a more or less practical man, I felt it incumbent that I take steps to understand to whom I was enslaved.
The book comprised one-third of a summer classics reading project I undertook to while away the long, hot miserable days of a subtropical Southern summer, which this year was unusually wrought with anticipation for the fall. For me, the summer marked a time of passage. It was the last when my parenting/nursing services would be much needed. My daughter will get her license to drive sometime this week (her sixteenth birthday was September 16) if the weather cooperates (the DMV won’t give the road test in the rain). My son is away at college, and no longer requires my services as his bone marrow transplant nurse. At the start of summer, I had to repress a feeling of giddiness at the freedom its end might bring. To keep my mind occupied during the interminable wait (the prospect of freedom is always a titillating wench), I decided to read some classics on subjects that interested me.
I read an abridged version of Edward Gibbon’s The History of the Decline and Fall of the Roman Empire. It was awful. I’m about halfway through with St. Augustine’s City of God. It is a marvelous work. The Penguin Classics’ Henry Bettenson translation I have been reading captures well the lyrical qualities of Augustine’s prose, perhaps almost as well as the original Latin (but I have no Latin, so have no basis for comparison). Gibbon wrote in 18th century English, which is to say, in the common language separating the US and Britain, but it was not translated or updated in the version I read, which probably explains why he seemed so often to be utterly indecipherable. Keynes is somewhere in the middle, writing in twentieth century British prose, which means his prose is mostly intelligible but not often lyrical, and is a bit pompous and arrogant, just as one might expect from an upper crust intellectual luminary of an empire upon whom the sun was rapidly and permanently setting.
The General Theory would be hard to understand without some foundation in economics. I have an undergraduate economics degree (which I was able to attain without ever having read Keynes—my crappy alma mater—Alabama–is quite remarkable when it comes to producing championship football teams, but is rather less so when it comes to producing educated graduates), and so I had no trouble with the jargon and the basic principles to which Keynes alluded. I doubt the book would hold much meaning for the average person not trained in economics. If you are interested in reading Keynes as part of a self-education program, but have no training in economics, I would suggest you at least read and internalize an introductory macroeconomics textbook before tackling The General Theory. Or, just settle in and read this review. It is my intent that once you are finished here, you will understand how you too are enslaved to the defunct economist who wrote this book. It’s not nearly as complicated as Keynes and his progeny, which includes virtually every professional economist employed today, make it out to seem.
Ideas can only be understood in context. We need to first place the book and its author in its proper historical context. (Warning: the portion of the following historical analysis pertaining to the Great Depression will necessarily contain causative analysis that is highly disputed. My analysis closely follows that of what has come be known as the monetarist view, but there are others, and ultimately, all of them, mine included, contain so much conjecture as to reside more comfortably in the realm of opinion and theory, rather than fact.) The General Theory was written during the depths of the Great Depression, an economic calamity during the 1930’s that more severely affected the US than Keynes’ Great Britain (in the US, unemployment jumped 607%; in Great Britain, it increased by only 129%). At the onset of the Great Depression, and in the economic times leading up to it, the reigning theory of how to manage economic systems for the best possible outcome was the classicists’ laissez faire approach, which advocated letting markets alone to work out supply and demand fluctuations through the price mechanism.
As Milton Friedman pointed out in his monetarist magnum opus, The Monetary History of the United States, this laissez faire approach is all well and good so long as the money used to price things does not itself get queered up by forces outside of ordinary supply and demand metrics. Friedman pinned the severity of the initial collapse which started the Depression upon mismanagement of the money supply by the US Federal Reserve. He believed the Fed’s tight money policies of the time exacerbated what would otherwise have been a very severe, but not inordinately so, contraction, causing a full-on economic collapse. Given that the US at the time was on the gold standard, and gold began flowing out of the Treasury once the collapse got underway, he’s probably correct that money became, instead of an aid to commerce, an impediment to it. The less gold in the Treasury, the lower the prices went (this is a result of simple math—if in an economic system pinned to the gold standard there is a hundred bushels of corn and fifty of beans, and each bushel of corn costs an ounce of gold, while each bushel of beans costs half an ounce, the economic system needs to have 125 ounces of gold to maintain stable prices. If the amount of gold declines to say, 100 ounces, the price for corn and beans will commensurately decline, to about 4/5th an ounce for corn and about 2/5th an ounce for beans.) And the lower the prices went, the more demand cratered and the more employment and the economy contracted (somewhat paradoxically, as low prices generally would seem to support expanding demand, but the prices were crashing because demand had been vastly oversupplied through efficiencies of industrial production coming to full fruition by the age, and due to previously increasing prices because monetary expansion, particularly through the private banking system, had created a temporary illusion of expanding demand). The remedy for this foolishness was to abandon the gold standard, which was one of Franklin D Roosevelt’s first acts upon his inauguration. As the money supply stabilized with gold’s abandonment, prices were able to find a bottom, and the economy expanded again, until a follow-on crash, not nearly as severe as the first, occurred in 1937.
Yet the Federal Reserve was quite hawkish in its monetary stance throughout the Depression, so even when the obstacle of the gold standard was overcome, there was still the obstacle of the Fed doing all it could (if perhaps unintentionally) to otherwise decrease the money supply. The Fed’s laissez faire stance on bank failures contributed to the problem, as every time a bank failed, millions of dollars simply vanished from the economic system, and literally thousands of banks failed in the years from 1929 to 1939.
Both Keynes and Friedman understood that money, intended as a medium facilitating trade in goods and services, could by turns, become an impediment instead if its supply relative to the goods and services it purported to represent was improperly managed, particularly in the manner with which it declined during economic contractions. Since gold has a more or less fixed supply worldwide, growing very slowly, if at all, it could not be used to properly account for the vast increases in output the new efficiencies of industrialization allowed without forcing price reductions in excess of those already implied from lowered costs due to greater efficiency. Keynes was right in his assertion (not in The General Theory) that the gold standard was a barbarous relic.
Having sketched the historical context in which Keynes wrote The General Theory, it would also help to explore the impetus behind the book. In short, Keynes wanted to once and for all dispel laissez faire notions that economic systems would naturally reach a state where, like Pangloss tried to convince of his young protégé Candide, “all is for the best in the best of all possible worlds”. Keynes did not believe economic systems would naturally achieve the best of all possible outcomes. He believed investment could be so impaired by the dampening of animal spirits accompanying economic contraction that the economic system could reach a state of equilibrium where vast economic resources, particularly labor, were left idle. Keynes believed that, without government intervention, supply and demand could settle into stasis at relatively high levels of unemployment. It was his argument against the laissez faire idea that such a thing was not possible that formed the thematic foundation of The General Theory.
Keynes therefore stands for the idea, widely accepted today, that economic systems can and must be actively managed if they are to achieve the best of all possible outcomes. Keynes, however, was not, as he is often misunderstood, advocating socialism, i.e., government ownership and control of the capital and investment necessary to achieve favorable economic outcomes. Keynes sought to work within the context of private property ownership exemplified in capitalist economic systems, leveraging government power only so far as was necessary to properly incentivize the capitalist/laborer relationship to achieve his economic holy grail of full employment. For Keynes, the purpose of actively managing the economic system is to achieve full employment, of ensuring that everyone who wants a job has one, and proposes solutions that, though preserving the free markets for labor and capital, he hoped would lead the twin horses to water in a state thirsty enough to ensure that they drank.
Keynes in fact abhorred the idea of true socialism, as represented by the growing Communist movement of the time, stating as much in A Short History of Russia (1925):
How can I adopt a creed which, preferring the mud to the fish, exalts the boorish proletariat above the bourgeois and the intelligentsia who, with whatever faults, are the quality in life and surely carry the seeds of all human advancement?
He perhaps ignored that no matter which economic system one choses, there would always be a hierarchy of ability and drive to curdle a limited group of plutocrats, bourgeois and intelligentsia, to the top, and that the Communists were substantially similar to Fascists, and even to the capitalists, in practice, if not in the myths they claimed to believe. Keynes’ outlook was decidedly that of a British imperialist, one who felt confident that if the proper balance between civilization and barbarity could be struck, and then deftly controlled and appropriately channeled through the vessel of the state, such as Britain attempted throughout her far-flung reign of colonization; that if a system could be devised that profited from an only moderately quelled avariciousness, all could thereby profit and gain. Keynes had no mind to destroy capitalism, but wished to see it didn’t destroy itself through the natural tendency for barbarity and inequity to overtake its soul. Were Keynes alive today, he would likely feel quite at home in either of the mainstream American political parties, but my guess, because his basic program was to defend capitalism by socialist tweaks around the edges, is that he would be a centrist Republican.
Now that we know a little about the man who enslaves us, and have given historical context to his ideas, it is time at last to turn to the program he laid out in The General Theory for how to actively manage an economic system to full employment. It may come as something of a surprise, but in The General Theory, Keynes basically provided the justification for today’s central banker operations the world over. Indeed, both Alan Greenspan and Ben Bernanke are Keynesian; Paul Volcker less so. The ECB is Keynesian. So too is the Bank of Japan. Keynes connected the dots between employment and interest rates. He is more famous for advocating government deficit spending in the face of economic contractions, but the primary mechanism he proposed for dragging an economic system out of the doldrums of contraction was interest rate, i.e., money supply, manipulations. ZIRP and QE’s I, II and III? All Keynesian. (The roughly $5.2 trillion in deficit spending the US has engaged in since 2008 is also Keynesian, but wasn’t the primary program he advocated in The General Theory).
Here’s Keynes’ outline of his program, from Chapter 3, Book 1, page 27:
The outline of our theory can be expressed as follows. When employment increases, aggregate real income is increased. The psychology of the community is such that when aggregate real income is increased aggregate consumption is increased, but not by so much as income. Hence employers would make a loss if the whole of the increased employment were to be devoted to satisfying the increased demand for immediate consumption. Thus to justify any given amount of employment there must be an amount of current investment sufficient to absorb the excess of total output over what the community chooses to consume when employment is at the given level. For, unless there is this amount of investment, the receipts of the entrepreneurs will be less than is required to induce them to offer the given amount of employment. It follows, therefore, that given what we shall call the community’s propensity to consume, the equilibrium level of employment, i.e., the level at which there is no inducement to employers as a whole either to expand or to contract employment, will depend on the amount of current investment. The amount of current investment will depend, in turn, on what we shall call the inducement to invest; and the inducement to invest will be found to depend on the relation between the schedule of the marginal efficiency of capital and the complex of rates of interest on loans of various maturities and schedules.
Thus, interest rates determine investment levels which determine aggregate employment levels. If there is insufficient employment, i.e., if there exists less than full employment, turn down the complex of rates of interest on loans of various maturities and schedules, which will eventually bleed into expanding investment, which will increase aggregate employment levels, decreasing unemployment.
But there is a bit of subterfuge going on here. What Keynes is really after is decreasing the real wage rate as a relative matter by making the “investment” of hiring a new employee roughly equal to the return on investments otherwise available. He advocates doing so by lowering real returns and not lowering real wages, but doesn’t ignore the impact that the inflation attendant to an expansive monetary posture would have on lowering real wages (presuming wages remain more or less fixed on a nominal basis), from Chapter 19, Book V, page 264, where he discusses in detail the implications of his prescriptions on money wages:
Since a special reduction of money wages is always advantageous to an individual entrepreneur or industry, a general reduction (though its actual effects are different) may produce an optimistic tone in the minds of entrepreneurs, which may break through a vicious circle of unduly pessimistic estimates of the marginal efficiency of capital and set things moving again on a more normal basis of expectation. On the other hand, if the workers make the same mistake as their employers about the effects of a general reduction, labor troubles may offset this favorable factor; apart from which, since there is, as a rule, no means of securing a simultaneous and equal reduction of money-wages in all industries, it is in the interest of all workers to resist a reduction in their own particular case. In fact, a movement by employers to revise money-wage bargains downward will be much more strongly resisted than a gradual and automatic lowering of real wages as a result of rising prices. (Emphasis supplied.)
This is the essence of how his prescriptions work. The lowering of interest rates is accomplished through the vehicle of expanded money supply, which causes inflation, but since wage rates and the labor/employment relation are relatively static, there is a reduction in real, inflation-adjusted wages sufficient to clear the labor markets as all other prices rise. This was/is precisely the strategy employed by Alan Greenspan and Ben Bernanke, and advocated by Paul Krugman. The only difference between Greenspan/Bernanke and Krugman is to whom the benefits of lowered wage rates and expanded employment should be directed. Greenspan/Bernanke represent those who believe that economic growth depends on the willingness of capitalists to invest and hire, and that lowering the real wage rate will incentivize capitalist investment, which will incidentally expand employment. Keynes was mainly in this camp. Krugman believes (if only perhaps subconsciously) that lowered real wages will expand employment, and that economic growth depends on expanded employment. Keynes believed the employment/economic growth relationship is only a corollary to the condition of lower marginal capital returns, which is achieved through lowered interest rates, which makes real wages relatively lower.
Though Keynes sought to overturn the laissez faire classicists’ hold on economic theory by pointing out why economic systems need active management, he only managed to achieve the same result as the classicists by means other than simply allowing the pricing mechanism in the labor markets to work. Both Keynes and the classicists understood that the cure for unemployment was lower wage rates, Keynes simply developed a mechanism that minimized the friction inherent to getting them there. Keynes believed in the price mechanism for allocating resources, but discovered a way of employing the price mechanism (through inflation) to lower wage rates that would quell the potential for labor unrest. This reduced potential for unrest forms the basis for why he believed his system was better than simply allowing wages to decline as the laissez faire economists advocated.
Keynes was upper class British, and his identification with British aristocracy pokes through in The General Theory, which can be viewed from the aristocratic perspective as basically a vast effort to devise a strategy of duping the lower classes into believing they weren’t worse off as their real wages decline. There is nothing the British revere more than order and hierarchy, and an orderly decline in real wages that would put the unruly masses back to work such as Keynes provided is just the thing a British mind of the age would think ideal. Laissez faire is a French term literally meaning “to let or allow (laissez) to do (faire)”. This is not something any upper crust Brit could countenance. While the French, after the Revolution, might have been willing to “let it be” like Sir Paul McCartney and his band advocated from across the Channel a few years after both Napoleon and Keynes, the Brits had built an empire on making it be. So Keynes, whose program accomplished precisely the same ends as the do-nothing laissez faire classicists but proactively, with a stiff British upper lip, enjoyed accolades for having finally given hyperactive British economic managers something to do so that it would appear they were, as always, firmly in control. Central banking has ever since been nothing more than a grand delusion generation machine.
Will the Keynes prescription work this time around? Only time will tell, but there are a number of reasons to believe it has a very limited domain in which it is effective, and that the ills besetting the US economy lie outside, or at least on the far reaches, of its effectiveness.
The first problem is that the US is not a closed economic system. Wage rates in the US may decline as a relative matter with inflationary domestic monetary policies, but if they remain elevated relative to US trading partners (China, et al), they might not decline enough that the domestic labor market clears. This is compounded by the unusual situation today that worldwide economic calamity causes a rush to safe-haven dollars, which increases the value of dollars, and thereby increases US wages relative to its trading partners. Perhaps if the US started paying its workers in pesos or Yuan, American workers could finally enjoy full employment after several dismal years.
The second problem is that the US government has effectively eliminated much need for labor unions by the codification of many of their major imperatives into protections for workers that now apply to everyone in an employment relationship. There are rules governing everything from worker safety to discrimination to the permissible number of hours that may be worked in a week’s time, all intended to insure some basic level of humanity between workers and employers that only sparingly existed at the times Keynes wrote The General Theory. While these protections are undoubtedly humane and helpful to the lot of the average worker, they still increase the cost of employing a worker, and it is the cost of employing a worker that must decline in the face of an oversupplied labor market, if the labor market is to clear. In so far as trading partners don’t operate under these same domestic rules and restrictions, their workers are more competitively priced.
Third is that beyond the zero boundary of interest rates, expansive monetary policy loses its inflationary push. This is obvious with Japan’s experience of decades of zero interest rates accompanying no, or even negative, inflation rates. Japan has also had the problem of a strong Yen to deal with (exactly how the Yen remains so strong is not exactly clear—I challenge any economist to offer a logically sound explanation), but it is clearly the case that monetary (and even fiscal) policy becomes something of an afterthought at some level of operation. In the US, as the Federal Reserve has stoked the inflationary fires with its ZIRP and QE’s I, II, and now, III, the main result has been a decline in monetary velocity. Prices remain about the same, at least for domestic goods, and if you have a situation where there is more money but roughly the same amount of goods and services, the money has to be carrying less momentum. The animal spirits that will turn over a dollar several times during good times don’t necessarily get reanimated during a contraction in demand just because more dollars are supplied for the turning.
Fourth is a corollary of the second problem with Keynesian economics these days. The US, and especially Western Europe, and even Japan, have spent the post-War fat years lavishing ever more in the way of social benefits on their populations. The social welfare state (in the US, at least 50 million people are on some form of Social Security; millions more collect unemployment insurance, and millions more benefit from food stamps and plain old welfare) ameliorates the hunger that might otherwise obtain with lack of work. Life is no longer the struggle that capitalists so desperately need in order that they might exploit the survival and propagation imperatives of job seekers. Fewer and fewer work because work is not necessary to achieve some subsistence form of existence. The calculus for the potential employee is altered through social welfare programs in much the same manner as the codification of employee protections has modified the calculus for the potential employer. For the employee, the social welfare state means that the benefits to be gained by working often only marginally exceed those that might be achieved without lifting a finger. For the employer, the marginal revenue of an additional employee must exceed the soft costs of the heavily regulated relationship, as well as those explicitly remunerative costs associated with his hiring.
The last major impediment is the eight hundred pound gorilla nobody cares to discuss: Demographics. In the US, the cohort of baby boomers is aging. Their kids are not having kids at anything the rate their parents did. The median age is marching ever higher. Excepting immigration, the US population would be stagnant, and much older, which is to say, the US population responsible for the vast majority of its growth and wealth is growing old and dying off. In Europe and Japan, which don’t as robustly allow immigration (or admit any, as in Japan), the population already is old and declining. Old people are not generally the people upon whom an economic system can count for its vibrancy. Economic growth without population growth in an already rich economic system is virtually impossible. Keynes realized this, but in his day, there was no problem with the fecundity of the population. Riven through his analysis was an unspoken assumption that populations would ceaselessly grow, or at least would ceaselessly grow until the long run, when it wouldn’t matter, as we’d all be dead. Here’s some of what Keynes said on the matter of age and demographics, the first is from Essays in Persuasion (1931):
Most men love money and security more, and creation and construction less, as they get older.
And this, from The Economic Consequences of the Peace (1919):
The great events of history are often due to secular changes in the growth of population and other fundamental economic causes, which, escaping by their gradual character the notice of contemporary observers, are attributed to the follies of statesmen or the fanaticism of atheists.
If what the US, Europe and Japan is now experiencing is not secular change in the growth of population, it would be hard to imagine a situation which is. The median age across most of the developed world exceeds 40; in Japan it is almost 45; the US, with its young and fertile immigrant cohort, is in relatively less dire straits for now, with a median age of roughly 37. Money and security, not creation and construction, are the abiding prerogatives of a great many of the developed world’s population, and the number grows each day.
There are many other reasons Keynes might no longer be applicable. Of these it should be remarked that post-industrial economic systems are not so dependent on mass labor and huge aggregations of capital as they were in Keynes day, making them less susceptible to fine tuning around the margins. While there is no shortage of capital for heavy industry these days (a problem which occupied Keynes’ analysis almost to the point of obsession), there is perhaps a shortage of capital of the human variety that makes the service industries of the post-industrial world click.
There are a great many more distinctions could be made between Keynes’ economic era and today, but it would take a book-length essay to discuss them all. The critical difference is that Keynes, and all his progeny, had as a foundational premise in all their economic prognostications and predictions that human populations would ceaselessly grow and relentlessly desire more, which would provide the basis for both aggregate and per capita growth. It is an assumption which is implausible on its face, and turns out to be false on the ground. The industrial revolution completely upended the human sexual relationship, freeing women from the oppression of relying on their wombs to secure their economic futures, while generating such fabulous wealth that the spirited human animal became quite domesticated and tranquil. In America at least, society passed from barbarism straight to decadence, without any civilizing interval in between.
It seems to me that Keynes was to economics something like Kant was to philosophy. Immanuel Kant (1724-1804) was a German idealist who wished to rescue philosophy from the atheism, skepticism and materialism of Locke, Berkeley and Hume (among others) but without returning it to its pre-Enlightenment scholastic days, when metaphysical explanations were based on theological mysticism and little more. Keynes wished to save capitalism by muting its excesses through collective, i.e., government action, mainly in the realm of fiscal and monetary policy. Just as Kant wanted to protect the Enlightenment’s intellectual advances, Keynes wished to protect the efficiencies and wealth attendant to a capitalistic, competitive economic system. Kant aimed to carve from the ascendancy of reason a place for the human heart. Similarly, Keynes aimed to carve from the necessarily competitive nature of capitalism some protections from its harshness for the working classes. Kant and Keynes had the same idea in mind—protect the source of wealth, either intellectually or materially, while ameliorating the human costs paid to acquire it.
Neither man was very successful. Kant cleaved a place for the heart by proposing that man is born with an innate sense of morality, from which springs our idea of God, which in fact means it must first have been placed there by God, preserving, so he thought, a place where the emotional impulses that color life with meaning and purpose might harmoniously coexist with reason. But he was wrong. As any parent of a two-year old, a cohort of human beings of particularly uncivilized savagery, well understands, man has no such innate morality. Morality, which is another way of saying enlightened self-interest, must be learned.
Keynes failed as well. There was no way for Keynes to protect the laboring class from the vicissitudes of capitalist competition while at the same time protecting the wealth that capitalism generated, except through delusion, by allowing the pricing mechanism to work, even in labor markets, but only under the cover of an inflationary smoke screen. Keynes succeeded in identifying a method through which capitalism’s inherent instability due to its inherent inequity could be somewhat ameliorated, but formulated what amounted to a slight-of-hand magician’s trick for doing so that depended for its success on deluding the massed laborers who might otherwise foment instability.
The employment problem stretches back to the beginnings of civilization. As soon as man sufficiently developed and refined agriculture so that one man could grow or graze enough food to feed many others, there arose the problem of what to do with the many others he could feed. It is not an oversimplification to observe that the source of the economic problem, once agriculture provided the means to feed a great many with the active engagement of just a few, is what to do with the superfluous people and excess wealth generated by agricultural surpluses. History has seen numerous solutions to the problem. The pyramids in Egypt five thousand years ago, and the wars on the European continent in the last century, to name a couple, each arose out of the ability to feed many more than had to work the land. Keynes offered solutions to this basic economic problem that fit the particular times in which he lived (he even advocated burying bank notes in old mine shafts and engaging laborers to dig them up). There is no reason to think he uncovered some deep and abiding principles through which economic systems might forever more be managed (except perhaps with his insight that people have great difficulty understanding that inflation in everything else except their paychecks amounts to a wage cut, a quirk of human nature which has been true since the beginnings of civilization). In fact, Keynes himself envisioned a day would come when deep and abiding economic principles would not matter so much anymore, writing in 1945, just before his death in 1946:
The day is not far off when the economic problem will take the back seat where it belongs, and the arena of the heart and the head will be occupied or reoccupied, by our real problems — the problems of life and of human relations, of creation and behaviour and religion.
That day seems as far off now as when Keynes first imagined it. As much wealthier as the developed world has become since World War Two, it still can’t seem to live within its means, and is barreling along a fiscally and monetarily suicidal path that will keep the economic problem preeminent for generations to come. Considering that Keynes was wise and prudent for his time, I doubt he would approve of much that has lately been done in his name. There is not much wise about piling debt upon stagnant, aging or declining populations, where the debt burden increases over time as the population declines. There is not much prudent in turning over the reins of governance to an unelected cabal of economic theorists and allowing their imposition of gargantuan schemes of taxation without representation through the desecration of the currency. All these and more have been done in Keynes’ name.
But now you know at least something about the ideas of the defunct economist to whom you are enslaved.