If you were going to turn to only one economist to understand the problems facing the economy, there is little doubt that the economist would be John Maynard Keynes. Although Keynes died more than a half-century ago, his diagnosis of recessions and depressions remains the foundation of modern macroeconomics. His insights go a long way toward explaining the challenges we now confront. According to Keynes, the root cause of economic downturns is insufficient aggregate demand. When the total demand for goods and services declines, businesses throughout the economy see their sales fall off. Lower sales induce firms to cut back production and to lay off workers. Rising unemployment and declining profits further depress demand, leading to a feedback loop with a very unhappy ending. The situation reverses, Keynesian theory says, only when some event or policy increases aggregate demand. The problem right now is that it is hard to see where that demand might come from. – New York Times
Dominant Social Theme: Keynes will guide us as he did in the 1930s.
Free-Market Analysis: Keynes' reputation had gone into serious decline but now for some reason the master of economic misinformation is making a comeback. Keynes was a member of what is called the Bloomsbury Group, a retinue of the British elite determined to bring socialism to that land without alarming any of the denizens. To that end they adopted a fairly subversive approach, one that they celebrated by creating a stained glass window of a wolf in sheep's clothing that still sits in the summer cottage of two of the leaders of the group.
Here is free-market economist Murray Rothbard on Keynes:
John Maynard Keynes, the man-his character, his writings, and his actions throughout life-was composed of three guiding and interacting elements. The first was his overweening egotism, which assured him that he could handle all intellectual problems quickly and accurately and led him to scorn any general principles that might curb his unbridled ego. The second was his strong sense that he was born into, and destined to be a leader of, Great Britain's ruling elite. Both of these traits led Keynes to deal with people as well as nations from a self perceived position of power and dominance. The third element was his deep hatred and contempt for the values and virtues of the bourgeoisie, for conventional morality, for savings and thrift, and for the basic institutions of family life.
Keynes' most famous is the "General Theory" a fairly incomprehensible tome that won worldwide acceptance in the 1930s mainly because it proposed action in the face of the depression and was generous in giving government a role in that action, which predisposed government officials to adopt Keynesian rhetoric and perspectives even if they did not entirely understand them.
Keynes, as the New York Times article, above, points out, basically postulates that depressions are caused by a lack of spending and that an antidote to economic slowdowns is more spending. Also, according to Keynes, it apparently doesn't matter where the spending came from. It could come from government as well as the private sector.
According to Keynes, the root cause of economic downturns is insufficient aggregate demand. When the total demand for goods and services declines, businesses throughout the economy see their sales fall off. Lower sales induce firms to cut back production and to lay off workers. Rising unemployment and declining profits further depress demand, leading to a feedback loop with a very unhappy ending. The situation reverses, Keynesian theory says, only when some event or policy increases aggregate demand. The problem right now is that it is hard to see where that demand might come from. The economy's output of goods and services is traditionally divided into four components: consumption, investment, net exports and government purchases. Any expansion in demand has to come from one of these four. But in each case, strong forces are working to keep spending down. (NYT)
It is government purchases that doubtless attracted many in government to Keynes. The idea that government could stimulate the economy through government purchases (of goods, services and even labor) helped provide leaders during the 1930s with what seemed to be a well-thought theoretical framework for intervention. Keynes was a favorite economist of Franklin Delano Roosevelt, for instance, and his theories can be seen as providing justification for Roosevelt's New Deal make-work programs.
In free-market economics, central banks lie at the heart of business cycle distortions that give rise to recessions and even depressions. Central banks print too much money and thus cause mal-investments that must eventually be cleared from the economy. Keynes, who was a central banker himself, does not seem to deal directly with the issue of central banking power but instead attributes economic pull backs to a lack of "aggregate demand" without ever defining what caused a lack of demand to begin with. A lagging of "animals spirits" was one justification he put forth, for instance.
Free-market economists these days see Keynes' theories as offering somewhat facile and overly complex rationales for government intervention in the macro- and even micro-economy. Since Keynes himself was drawn to power and enjoyed being engaged with powerful people at the highest levels of government (and occasionally industry) it is not surprising that Keynes would provide a bureaucratic-friendly theory of economics. The trouble is that Keynes' theories, when scrutinized, seem little grounded in the reality of the marketplace. To use his approaches as a recipe for dealing with economic downturns is therefore questionable at best and disastrous at worst.
The insistent injections of capital now coming from all corners of the earth are justified by Keynesian economics. U.S. Treasury Secretary Hank Paulson is a Keynesian as apparently is Federal Reserve chairman Ben Bernanke. US President-Elect Barack Obama is also apparently a Keynesian and is preparing a massive make-work program for the United States. All of this frenetic activity will likely do nothing more than prolong the downturn as these actions are based on a flawed theory of economics.
Keynes' essentially never deals with the creation of money and its distortive effects. He called gold a "barbarous relic" and his goal, from an economic standpoint, was to justify central-bank paper money backed only by the faith and credit of issuing governments. His theories of aggregate demand propose the printing of more and more money when a downturn comes and the result, from a free market standpoint, will only be more and more inflation, since inflation is a monetary phenomenon (something else Keynes did not seem to recognize).
Keynes' odd and intricate theories would seem once more to be in fashion in government circles around the world. If they are fully or even partially implemented early in the 21st century, the result can only be, according to free-market thinkers, a good deal more inflation and prolongation of the misery of recession or even depression. Stock markets will remain flat, unemployment will rise and wages will stagnate even as prices rise precipitously. The only asset class that will do well in such an environment, ironically, is money metals. In this instance, history would seem to be providing us with the ultimate irony as the very assets that Keynes despised – gold and silver – are the most enhanced in value by the enthusiastic application of his approach. And, yes, it looks like they will be.