On the Inevitable Failure of Keynesian Intervention
If you haven’t read my previous musings on economics, start here. I should reiterate that I am not a professional economist. What follows are my personal attempts to understand the world we live in. I am, as always, eager to learn and welcome any sincere and thoughtful critiques.
What is a bust? A simplified way to view a bust is as a monetary collapse. At the start of a bust there is an object that holds some perceived value. At the end of that bust the perceived value has been lost and with it the ability to use that value as a foundation for economic exchange. Has anything real changed? Are there less people with less skills or less stuff? No. Has anything real and physical been destroyed? No. The only thing lost is perceived value, essentially money. There is, however, a very real impact as a result, as a reduction in the money supply creates a contraction that debilitates economic exchange.
So what do we do about a bust, as a society? There are some who argue that we should do nothing. They argue that booms and busts are a natural part of the business cycle. This argument generally collapses to “don’t mess with nature”. Except that economics aren’t natural. Economics are built on a foundation of thousands of laws and conventions, on currency, debt, and many other technologies invented and implemented by humankind. Economics are an invention. If I may move forward assuming that our system of economics is an engineered technology, then there is an optimal response to driving that engineered system in a direction we, as humans, find preferable. While it’s possible that “do nothing” is the optimal response, it’s worth examining the alternatives.
The obvious response to a monetary collapse is monetary stimulation. This is a simplified description of the Keynesian approach to recession recovery. The government uses monetary policy to lower interest rates and make lending more appealing, which theoretically increases the current money supply in the form of credit. The government uses fiscal policy in the form of increased spending or reduced taxes, creating an inflationary effect to counter the deflationary effect caused by the monetary collapse. There’s a certain common sense to this, assuming you aren’t dealing with stagflation as seen in the 1970s, which isn’t a classic bust and warrants its own discussion. However, if we assume that my previous analysis is correct, and that the boom and bust cycle is the result of a natural flow of money supply from the markets of real goods and services to the investment sector, then how does this Keynesian approach hold up? In short, not well.
First let’s touch on monetary policy. The problem is that monetary policy is almost certainly neutral to the issue at hand. Does lowering nominal interest rates stimulate the economy? A majority of economists believe it does, but many also believe that it does not. Either way it does nothing to address the root cause of the boom and bust cycle. At best it is a temporary measure that stimulates the economy now at the expense of an equal and opposite economic contraction later, hopefully after the economy has recovered.
Next we turn our attention to fiscal policy. When the government increases spending it rarely does so without going into debt. Conventional wisdom says that “printing money” leads to hyperinflation, which is undeniably bad for the economy. However, when the government goes into debt, that debt, being debt, ultimately belongs to the investment sector. The additional spending adds money to the economy of goods and services, bolstering the share of the money supply present in that part of the economy, but eventually it must be paid back to the investment sector. The monetary flow hasn’t been reversed or halted, it’s only been diverted onto the shoulders of government to give the rest of the economy a temporary break. When the time comes to pay back that debt it is done through taxes. Taxing the investment sector is frowned upon by conventional wisdom, so those taxes must come from the rest of the economy. When the government finally goes about repaying that debt, it will quite literally be funneling money from the rest of the economy into the investment sector, completely reversing any benefit to the money supply that was gained by deficit spending in the first place. This growing imbalance in the money supply between the investment sector and the rest of the economy will inevitably lead to a further bust. The huge amount of debt held by governments is direct evidence for and an example of the massive imbalance in money supply that already exists between the investment sector and the rest of the economy.
The alternative method of stimulating the economy is to lower taxes. Conventional wisdom argues that these tax break should go to the wealthy, the job creators, the ones investing in the economy to help it grow. Which would make sense to a degree if there weren’t enough investors to invest in things. However, a bust isn’t caused by a shortage of investment. History shows that the wealthiest investors come out of a recession incredibly well. If my prior theory is correct then a bust is caused by is an overabundance of investment. A bust is the correction of that overabundance. Lowering taxes on investors is just another way to facilitate the flow of funds into the investment sector and set the stage for another boom and bust.
Ultimately, while Keynesian fiscal intervention works in the short term, it does absolutely nothing in the long term to address the flow of money into the investment sector and, in many ways, exacerbates the causes of the boom and bust cycles. If this analysis is correct, then our recovery from the 2008 recession through the use of Keynesian intervention is only setting the groundwork for another recession within the next 10 or 20 years. This, however, is not the fault of intervention. It is, rather, the fault of conventional wisdom.
Does that mean we should raise taxes and cut spending during a recession? Don’t be absurd. Correcting the deflationary effect makes sense, but we must question how conventional wisdom would have us do that.
Conventional wisdom says that the government shouldn’t “print money”, but why does it say that? Historical examples include Germany printing money during the Wiemar Republic to pay off its debts. This led to hyperinflation and strangled economic exchange. There are numerous other examples from history. However, these examples tend to have one thing in common. They were a desperate attempt to pull the Government out of debt. No, you can’t pay back a debt by printing money, that’s like trying to accelerate to the speed of light. The more you print the less what you’re printing is worth, and the more you have to print the next time. But we’re not talking about a frantic attempt to escape debt. We’re talking about a controlled stimulation of the economy. We’re talking about replacing collapsed money supply with new freshly printed money supply. This is a very different circumstance. An analogy for this approach is the corporation that issues new stocks as a way to raise capital to invest. A corporation that issues stocks to pay off debts is doomed, but a corporation that issues stocks to reinvest in their company is setting the stage for growth. Government can take the same approach. After all, the fallout from a bust is not a collapse of the means of production. No people were lost. No real engine of the economy was lost. The ability to grow and produce remains. An investment failed, the perception of value was lost, not the means of creating more value. Therefore, it seems absurd to think that a controlled investment in the economy would necessarily lead to immediate hyperinflation. It may lead to eventual inflation as the economy recovers, but that inflationary effect can be countered by balancing taxation with spending after the economy has recovered. As long as the government invests wisely in things that will grow the economy, infrastructure and education particularly come to mind, spending without borrowing makes about as much sense as a corporation issuing new stocks to invest in growth. That is, a lot of sense.
Conventional wisdom also says that when there is a bust we should lower taxes on investors so that they can invest in the economy. But, again, a bust is evidence of over investment. We don’t need more investment, we need to stimulate the economy of goods and services. That is done by lowering taxes on the middle class. Furthermore, a major bust is evidence that the taxation level on investment is not high enough. If the monetary flow imbalance is sufficient to facilitate a bust, then it must be corrected. Correcting it too much could choke investment, but keeping taxes as they are or lowering them is only setting the stage for more dramatic boom and bust cycles. However, in order to facilitate a temporary increase in the money supply the tax break on the working class must be larger than the tax hike on investment, or the tax hike on investment must be delayed.
There are certainly those that would reject all this nonsense about raising investment taxes. The succinct way to put the most common argument against taxes is: “It’s my money”. Taxing investments is bad because investors earned and deserve their money. Some people would read this article and argue that I’m promoting redistribution of wealth. Let me be clear, I’m not. As an engineered system, our economy has an ideal equilibrium point. There is a point at which investment taxes would be too high, discouraging investment, and there is a point at which investment taxes would be too low facilitating a loss of equilibrium in the money supply and a bleeding into the investment sector, causing booms and busts. I’m arguing that our current arrangement errs toward the latter, and that we should find the balance point between the two. If we knowingly establish conditions that do not result in equilibrium, then we are accepting a system that will not sustain a free market. We are, essentially, rejecting the free market as an ideal. However, the “it’s my money” argument isn’t interested in the economy as an engineered system. It’s about morality. Taxes are immoral. The only response to that argument is this: put your money where your mouth is. Do what Ayn Rand suggested; take all your money and go buy yourself a sovereign piece of land somewhere. It won’t be long before you find yourself living in a society that is neither democratic nor a free market. But, like the Amish, you’ll be living a life commensurate with your ‘moral values’. Good for you.
As someone who values the free market ideal, it is in my interest to examine economic systems and attempt to discern the conditions that best promote that ideal. The current conditions, the human engineered system of laws and taxes we live under, facilitates the unceasing flow of the money supply into the investment sector of the economy. Such circumstances simply do not facilitate a free market, they facilitate a collapse of the free market into an either monopolistic or recessionary state. It may be worth examining more deeply whether there is a different set of laws and assumptions that could facilitate a free market without relying on government correction via taxing the investment sector. However, for the time being it seems clear, given my analysis as I understand it, that the contemporary Keynesian approach to recessionary recovery is ultimately and inevitably counterproductive because it does not address the fundamental cause of the boom and bust cycle, namely the flow of the money supply into the investment sector. A superior approach to intervention must involve correcting that fundamental lack of equilibrium. Given the tools currently at our disposal, the best approach would seem to be to stimulate recovery by increasing investments that grow the economy, like infrastructure, education, and working class tax breaks without accruing significant debt while also increasing taxes on investment.