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Sensible People See Through Keynesian Economics, But Not Economists

Economics / Elliott Wave Theory Mar 08, 2010 - 04:25 AM GMT

By: Gary_North

Economics

Best Financial Markets Analysis ArticleFour images provide the conceptual tools to refute Keynesian economics: the gun, the wallet, the IOU, and the printing press. Recall them every time you read a Keynesian promotion of the latest government-spending plan. Let me explain.


Think of yourself as engaged in a public debate. If you want to undermine an intellectual opponent in a debate, find his system's central weak point and latch onto it like a bulldog. Never let it go. Make sure the audience leaves the debate with your refutation in their minds.

In preparing for a debate, remember this principle of effective communication: "It is easier to forget a formula than a mental image."

Academic economists love formulas. This is their great vulnerability. Unlike formulas in physics, economists' formulas conceal profound conceptual errors that simple mental images reveal as utter nonsense. The average person can readily comprehend these errors through the use of simple mental images. But academic economists are deliberately trained in graduate school to ignore these images. They are easily blinded by formulas. This puts them at a disadvantage in public debate, especially when debating members of the one school of economics that does not use formulas: Austrian School economics. I will now offer a demonstration of this principle of debate.

KEYNESIANISM'S CENTRAL FORMULA

The account of Keynesian economics on Wikipedia is a good place to begin. Here, we read of the textbook Keynesian formula:

In scientific notation, the Keynesian Formula consists of the following make-up:

C + I + G + X – M = Y(GDP)

which means:

Consumption + Investment + Government Spending + Exports – Imports = Gross Domestic Product

This is standard stuff. Start here.

Spending is the heart of Keynesian economics – aggregate spending. Consumption (C) is a series of society-wide individual allocation decisions. Investment (I) is a series of society-wide individual allocation decisions. Exports (X) are a series of society-wide individual allocation decisions. It is the same for imports.

Government spending is an allocation decision of a different kind. "See this gun? See where it is pointed? Hand over your wallet."

The student can see that total spending is based on all the letters of the formula. C, I, X, and M all begin with the original owners of resources. But G does not begin with the original owners. G begins with the new owner after multiple transactions with the gun.

G does not create. G confiscates. G cannot spend anything that it did not extract from consumers or investors.

C, I, X, and M are based on production. They are creative forces. G is based on confiscation. It is not a creative force. Everything spent by G comes at the expense of C, I, X, or M. When G spends, it does so at the expense of the others.

A bright student is smart enough to figure out what most people do when constantly threatened with robbers with guns, even if the robbers carry badges. They will not put all of their money in their wallets. They will hide some of their currency. They will not spend it. People who carry badges and guns call this currency hoarding. This is a Very Bad Thing, we are assured.

BORROWING FROM PETER TO SUBSIDIZE PAUL

Here is where Keynes came to the rescue of governments everywhere. He has the government offer to write IOU's that pay interest. "Put away the guns. Write IOU's."

Only very clever students will ask these two obvious questions:

  1. Where will the government get the money to pay off the loans with interest?
  2. Where will people get the money to lend to the government?

The politicians' answers to the first question is easy: (1) we will hire more men with badges and guns; (2) we will write more IOU's. But these are not answers. They are variations of kick the can.

Then Keynes added this: "print more money." He specifically taught that real wages would fall along with purchasing power in times of price inflation. Labor union members would accept these lower wages, he taught. This would lead to greater employment: lower wages mean more labor demanded. He implicitly assumed that labor union members are stupid, and so are the economists they hire to negotiate.

What about the second question? Where will lenders get the money? Keynes' answer made superficial sense back when people hoarded gold (United States) or currency (everywhere else). That was true prior to the FDIC (1934). After 1934 in the USA, the argument made no sense. Currency hoarders started to deposit their money in banks. The banks then lent this money. Henceforth, the government could write lots of IOU's and run large deficits, but the money it received as loans came from the bank accounts of lenders. The borrowers at the banks of these lenders would be shut out.

Aggregate spending would not change. Keynesian theory collapses.

Even in the first case – currency hoarding – the argument made no economic sense in 1933. When prices fall in response to hoarding – an increased demand for currency – the currency gets spent. Sellers say: "Have I got a deal for you!" Former hoarders spend. If prices are flexible downward – and in a free market, they are – then government does not need to write IOU's to get people spending again. It needs to remove legal restrictions on making good deals: tariffs, quotas, and price floors.

Once a student understands this, the teacher can move from logic to rhetoric: persuasion through imagery.

SUBSTITUTE IMAGES FOR FORMULAS

Here is the Wiki entry for government spending.

Government spending or government expenditure consists of government purchases, which can be financed by seigniorage, taxes, or government borrowing. It is considered to be one of the major components of gross domestic product.

John Maynard Keynes was one of the first economists to advocate government deficit spending as part of a fiscal policy to cure an economic contraction. In Keynesian economics, increased government spending is thought to raise aggregate demand and increase consumption.

Here, I suggest the following. Ask the question again: "How does the government get the money out of the lenders' wallets or bank accounts without reducing their spending?"

Keep mentioning the wallet. People understand wallets. They do not really understand formulas. Keep mentioning the printing press. They understand counterfeiting.

The student should always have a mental image of a gun, a wallet, an IOU, and a printing press. A formula does not convey knowledge effectively. A mental picture does. People forget formulas faster than they forget mental pictures.

The heart of Keynesian is economics is here: the attribution of autonomous economic productivity to the agency with the gun. Somehow, government can increase aggregate spending (1) without producing anything new and (2) without reducing spending somewhere else in the economy. Keynes never explained how this is possible. Neither have his disciples.

Here is the heart of the Keynesian error: "G can be increased without subtracting from C, I, X, and M." It is easy to show this from the formula. But it's still a formula. Try to turn the formula into a mental image.

Tell the student, "When you see G, think 'gun.'" This mental image undermines the authority of the formula.

A grifter is a con man who uses fake promises as a way to scam victims. If more students knew what a grifter is, you could say: "When you see G, think 'gun,' 'grifter,' and 'graft.'"

The student thinks, "This can't be all there is to Keynesian economics." But it is. He thinks, "Someone would have pointed this out in 1936 if this were all there is to it." Hardly anyone did. The few who did were not believed after 1948, the year Paul Samuelson's economics textbook was published.

How could this be the case? Because of what George Orwell observed in 1946, the same year that Keynes died. "To see what is in front of one's nose needs a constant struggle."

Be the child at the parade, crying out: "The emperor has no clothes." Start with the simplest explanation – visual – at the heart of Keynes' colossal error. Don't let go.

Start with the gun, the wallet, the IOU, and the printing press. The formula is merely window dressing for economists.

For more information, come here.

    Gary North [send him mail ] is the author of Mises on Money . Visit http://www.garynorth.com . He is also the author of a free 20-volume series, An Economic Commentary on the Bible .

    http://www.lewrockwell.com

    © 2010 Copyright Gary North / LewRockwell.com - All Rights Reserved
    Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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Comments

Maarten
09 Mar 10, 00:02
After Tax?

"Here is the heart of the Keynesian error: "G can be

increased without subtracting from C, I, X, and M.""

Aren't C, I, X and M, calculated AFTER tax? Then it does of make sense to add this to GDP as G, since G would be the tax revenue deducted.


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