Feb 05

Blame Keynesian Economics

Posted by Kristjan Velbri | Posted in Economy | Posted on 05-02-2009

This is the second article in the capitalism series. Here are the previous ones: The Breaking Point of the Current Economic System, In Defense of Capitalism.

Unites States dollarThe current economic system failed due to many mistakes in the underlying economics theory. First of all, the current economic system is not based on sound money, as discussed in the previous post. This makes free capitalism impossible, as the creation of new money always creates inflation and makes saving, one of the supposed pinnacles of a capitalist society, impossible as the money deteriorates in value over time. But the current system is also heavily reliant on Keynesian economics, whereby the state is responsible for improving the stability of the private sector, and thus the whole economy.

The evil of inflation

Inflation is the depreciation of a currency due to increased supply. Inflation has a direct impact on prices, as more money + same amount of goods as before = higher prices. But the prices are only relatively higher, reflecting only the increased supply of currency. Due to the fact that the Federal Reserve and other central banks can print as much money as they deem necessary, there is really no protection from inflation. One cannot predict it and one cannot even hope to measure it, because over time the US government has changed the computation methods for CPI (consumer price index) and PPI (producer price index) to reflect the needs of the Treasury Department not the real inflation, thus making sure that the interest rate at which the US government borrows money is kept as low as possible.

The creation of new money (which some like to think is new wealth) debases the value of money that was in the system before, hence making saving money ridiculous. This has led to the creation of mutual funds, hedge funds and pension funds of all sorts. People trust their money with the bankers because they know that inflation is going to eat it up anyway. And although there is inherently nothing wrong with people investing their money in stocks, bonds and other securities, it is wrong if this is an inescapable situation. Think of this way: you are given two options:
1) lose money for sure (through inflation) by doing nothing, ie. Keeping your money on a savings account; or
2) trust your money with the bankers, who will grow your money and take care of it like it was their own child, while also filling their pockets with fees and bonuses and also retaining the option of a complete failure (there are plenty of examples of market crashes)

Usually, the people look at those two options as if they were the only ones, leaving out the third option, which would look something like this:
3) establish a new gold standard and make it a free choice as whether to save or invest

The evil of Keynes

According to Keynesian economics, which the US has been using for the past half century, the state should stimulate economic growth and improve stability in the private sector – through, for example, adjusting interest rates and taxation and funding public projects [1].

People are so accustomed to this kind of interpretation of the government’s role in society that they are no longer able to see the inherent flaws in this kind of argument. They no longer have criticism for this kind of behavior, but they most certainly should. By wanting to improve stability, the state creates many programs, which are thought of as temporary at first. But over time, these turn into long-term money drainers, which become a burden to state, which in turn has to find new ways to fund it’s budget, which leads to higher taxes, direct and indirect. The Federal Reserve system in a gift for the politicians of today, because it allows them to spend money that they don’t have – they can just print it if they need it. It is the lack of a gold standard that gives the state the means to increase spending without consent form the voters.

At first, the state’s problems are few, but over time they accumulate as the state, or rather the politicians who are after our votes, suddenly find that the state now has to increase funding for public health, education and even manufacturing (GM and Chrysler bailouts). For the easily distracted voter, this might seem like a good idea as the wealth is recycled in society and given to those in need. But this kind of argumentation lacks in common logic! By creating taxpayer funded public programs, the state essentially become a central planner. The fault of central planning is that it doesn’t consider any kind of limits. The Soviet manufacturing industry is a great example of this because the state owned all resources and manufacturing capabilities. It didn’t see the need to improve, to increase efficacy and quality. It didn’t have to because the state was omnipotent and capitalism or any other form of private enterprise was prohibited. This created huge waste and low quality products. But it is the same with state funded programs because when a state program runs out of funds, it can always tax its citizens or print new money.

Because the constitution or any other document does not limit government spending, it can increase spending ad infinitum. Because the state has taken upon itself the power of taxation, it can fund its programs without having to think of constraints. In a company, this would be quite different as it could only spend the money that it already has; or in the case of a loan, it could only spend the borrowed amount considering it’s ability to repay it in the future.

What all of this comes down to is liberty. I agree that the state should collect some taxes, to fund the police and firefighters, but this should be done on the local level and the amount of taxes that the state can collect should be limited. Roads and bridges aren’t built when and where they are needed, they are built according to the interests of political parties. Isn’t it strange that the road repair season always starts just before the elections?

According to Keynesian economics, the people at the Federal Reserve and in the government are always smarter than the market, thereby granting them the permission to control the economy. In reality, the market is way more complicated than the politicians would like to admit and one cannot hope to fix anything by increased state spending. But the politicians won’t admit this, because this would make the irrelevant, what they really are in terms of economics.

The use of Keynesian economics models has made each and every recession worse than the one before it. The state has been all over the place with its spending, never even thinking about letting the mistakes correct themselves. The Unites States government has been able to shorten the previous recession since WWII due to its spending, but in the long run, this kind of action is only going to make the end game so much worse. The spending will end with a dollar crisis, pulling the whole world down with it, because the dollar is the reserve currency of choice for most central banks, accounting for 64% of world reserves in 2007 [2]. This will hopefully lead to the creation of a new gold standard.

1.    definition from Wikipedia: http://en.wikipedia.org/wiki/Keynesian_economics
2.    from wikipedia according to IMF and ECB statistics http://en.wikipedia.org/wiki/Reserve_currency#Global_currency_reserves
Image courtesy: Federal Reserve

Post to Twitter Post to Digg Post to Ping.fm Post to Reddit Post to StumbleUpon

Related Posts

Comments (4)

[...] Blame Keynesian Economics [...]

[...] presents Blame Keynesian Economics posted at Personal Development for Awesome People, saying, “Keynesian economics will lead the [...]

[...] Blame Keynesian Economics [...]

[...] presents Blame Keynesian Economics posted at Personal Development for Awesome People, saying, “Keynesian economics will lead the [...]