Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
Virgin Media Fibre Broadband Installation - What to Expect, Quality of Wiring, Service etc. - 21st Jun 21
Feel the Inflationary Heartbeat - 21st Jun 21
The Green Superfuel That Could Disrupt Global Energy Markers - 21st Jun 21
How Binance SCAMs Crypto Traders with UP DOWN Coins, Futures, Options and Leverage - Don't Get Bogdanoffed! - 20th Jun 21
Smart Money Accumulating Physical Silver Ahead Of New Basel III Regulations And Price Explosion To $44 - 20th Jun 21
Rambling Fed Triggers Gold/Silver Correction: Are Investors Being Duped? - 20th Jun 21
Gold: The Fed Wreaked Havoc on the Precious Metals - 20th Jun 21
Investing in the Tulip Crypto Mania 2021 - 19th Jun 21
Here’s Why Historic US Housing Market Boom Can Continue - 19th Jun 21
Cryptos: What the "Bizarre" World of Non-Fungible Tokens May Be Signaling - 19th Jun 21
Hyperinflationary Expectations: Reflections on Cryptocurrency and the Markets - 19th Jun 21
Gold Prices Investors beat Central Banks and Jewelry, as having the most Impact - 18th Jun 21
Has the Dust Settled After Fed Day? Not Just Yet - 18th Jun 21
Gold Asks: Will the Economic Boom Continue? - 18th Jun 21
STABLE COINS PONZI Crypto SCAM WARNING! Iron Titan CRASH to ZERO! Exit USDT While You Can! - 18th Jun 21
FOMC Surprise Takeaways - 18th Jun 21
Youtube Upload Stuck at 0% QUICK FIXES Solutions Tutorial - 18th Jun 21
AI Stock Buying Levels, Ratings, Valuations Video - 18th Jun 21
AI Stock Buying Levels, Ratings, Valuations and Trend Analysis into Market Correction - 17th Jun 21
Stocks, Gold, Silver Markets Inflation Tipping Point - 17th Jun 21
Letting Yourself Relax with Activities That You Might Not Have Considered - 17th Jun 21
RAMPANT MONEY PRINTING INFLATION BIG PICTURE! - 16th Jun 21
The Federal Reserve and Inflation - 16th Jun 21
Inflation Soars 5%! Will Gold Skyrocket? - 16th Jun 21
Stock Market Sentiment Speaks: Inflation Is For Fools - 16th Jun 21
Four News Events That Could Drive Gold Bullion Demand - 16th Jun 21
5 ways that crypto is changing the face of online casinos - 16th Jun 21
Transitory Inflation Debate - 15th Jun 21
USDX: The Cleanest Shirt Among the Dirty Laundry - 15th Jun 21
Inflation and Stock Market SPX Record Highs. PPI, FOMC Meeting in Focus - 15th Jun 21
Stock Market SPX 4310 Right Around the Corner! - 15th Jun 21
AI Stocks Strength vs Weakness - Why Selling Google or Facebook is a Big Mistake! - 14th Jun 21
The Bitcoin Crime Wave Hits - 14th Jun 21
Gold Time for Consolidation and Lower Volatility - 14th Jun 21
More Banks & Investors Are NOT Believing Fed Propaganda - 14th Jun 21
Market Inflation Bets – Squaring or Not - 14th Jun 21
Is Gold Really an Inflation Hedge? - 14th Jun 21
The FED Holds the Market. How Long Will It Last? - 14th Jun 21
Coinbase vs Binance for Bitcoin, Ethereum Crypto Trading & Investing During Bear Market 2021 - 11th Jun 21
Gold Price $4000 – Insurance, A Hedge, An Investment - 11th Jun 21
What Drives Gold Prices? (Don't Say "the Fed!") - 11th Jun 21
Why You Need to Buy and Hold Gold Now - 11th Jun 21
Big Pharma Is Back! Biotech Skyrockets On Biogen’s New Alzheimer Drug Approval - 11th Jun 21
Top 5 AI Tech Stocks Trend Analysis, Buying Levels, Ratings and Valuations - 10th Jun 21
Gold’s Inflation Utility - 10th Jun 21
The Fuel Of The Future That’s 9 Times More Efficient Than Lithium - 10th Jun 21
Challenges facing the law industry in 2021 - 10th Jun 21
SELL USDT Tether Before Ponzi Scheme Implodes Triggering 90% Bitcoin CRASH in Cryptos Lehman Bros - 9th Jun 21
Stock Market Sentiment Speaks: Prepare For Volatility - 9th Jun 21
Gold Mining Stocks: Which Door Will Investors Choose? - 9th Jun 21
Fed ‘Taper’ Talk Is Back: Will a Tantrum Follow? - 9th Jun 21
Scientists Discover New Renewable Fuel 3 Times More Powerful Than Gasoline - 9th Jun 21
How do I Choose an Online Trading Broker? - 9th Jun 21
Fed’s Tools are Broken - 8th Jun 21
Stock Market Approaching an Intermediate peak! - 8th Jun 21
Could This Household Chemical Become The Superfuel Of The Future? - 8th Jun 21
The Return of Inflation. Can Gold Withstand the Dark Side? - 7th Jun 21
Why "Trouble is Brewing" for the U.S. Housing Market - 7th Jun 21
Stock Market Volatility Crash Course (VIX vs VVIX) – Learn How to Profit From Volatility - 7th Jun 21
Computer Vision Is Like Investing in the Internet in the ‘90s - 7th Jun 21
MAPLINS - Sheffield Down Memory Lane, Before the Shop Closed its Doors for the Last Time - 7th Jun 21
Wire Brush vs Block Paving Driveway Weeds - How Much Work, Nest Way to Kill Weeds? - 7th Jun 21
When Markets Get Scared and Reverse - 7th Jun 21
Is A New Superfuel About To Take Over Energy Markets? - 7th Jun 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Why Economic Policies Inspired by the Great Depression Fail

Economics / Economic Theory May 03, 2010 - 03:12 AM GMT

By: Gerard_Jackson

Economics

Best Financial Markets Analysis ArticleThe latest quarterly survey by the National Association for Business Economics reports that the stimulus did not promote recovery. (In case you didn't know, the country's phony media are frantically pushing the idea that happy days are on the way, something they would never do under a Republican administration.) Any conundrum here is a direct result of fallacious economic reasoning. The idea that the level of output and employment is a function of aggregate spending was a very old fallacy that Keynes successfully resurrected and which is now part of orthodox economic theory even though it has been thoroughly refuted by experience.


If the spending approach is correct then it follows that a significant reduction in spending would quickly cause output to contract and unemployment to rise. It also follows that if the demand for labour keeps rising after spending is slashed then there must be something seriously wrong with the theory. Very few people realise America actually experienced this phenomenon.

During WWII economists fretted that once peace returned and military spending severely curbed the country would return to the same levels of unemployment that prevailed in the 1930s. Paul Samuelson for one expected an unemployment rate of 8 million. Their solution was what became the fashionable Keynesian nostrum of maintaining government spending.

Despite the fears and objections of these economists post-war spending was indeed drastically slashed. The fiscal years 1944 to 1947 saw spending dive from $95 billion to $36 billion -- a $59 billion cut, an astounding 62 per cent reduction. (During the same period defence spending fell by about 76 per cent.) To the utter surprise of these Keynesians, instead of the economy rapidly sinking into depression with unemployment rocketing to 8 million or so it boomed and full employment was maintained at under 4 per cent.

This achievement is all the more amazing when we consider that at the same time "fourteen million World War II servicemen [had] returned to civil life". (Harry Truman, State of the Union, 6 January1947.) Now Keynesians tend to treat surpluses as contractionary and yet the US budget went into surplus in 1947 where it remained until 1950. (Incidentally, students won't find any of these facts in any economics textbook.)

Keynes was once challenged for changing his mind on monetary policy. (The man was notorious for continually changing positions). He tartly replied: "When the facts change, I change my mind. What do you do, sir?" Yet when his disciples were faced by the post-war facts of an enormous drop in government spending accompanied by the restoration of full employment despite mass demobilisation their response was to rationalise them away in terms of their Keynesian paradigm. They did this by conjuring up the phantom of pent up consumer spending.

According to this explanation war-time spending by the government greatly restricted personal consumption which resulted in people accumulating large amounts of financial assets, including savings accounts. When the war ended the use of these assets to demand consumer goods offset the reduction in government spending by maintaining the demand for Labour. This prevented the return of mass unemployment and the emergence of large-scale idle capacity.

Very plausible but utterly false. To begin with, it is estimated that consumer spending only rose by about $14 billion while we know that government spending dropped by $59 billion. Therefore aggregate spending must have contracted by $45 billion. (In fact, figures show a drastic fall in GDP at the time even though there was full employment and a rapid expansion in the production of consumer goods.) The idea that pent up consumer demand was responsible for the post-war recovery does not hold.

For Keynesians supply creates demand. For the classical and other pre-Keynesians demand can come only from production. John Stuart Mill succinctly presented this view when he declared that "demand constitutes supplies". In other words, to demand something one must first offer something up. This would be obvious in a barter economy. Mill's father explained

that consumption is posterior to production, as it is impossible to consume what is not produced. Consumption in the necessary order of things is the effect of production, not production the effect of consumption. (James Stuart Mill, Commerce Defended, C. and R. Baldwin, 1808, p. 79).

Therefore the real pent up demand could only be on the production side. Once the war ended all of the productive capacity that had been devoted to producing war materiel was now directed to the production of consumer goods. This is where the increased demand came from, not postponed consumer demand as asserted by Keynesians. No matter how much is held in the form of financial assets by the public it cannot command an increased quantity of consumer goods unless the capital goods necessary for their production are available. And an increase in the quantity of capital goods can come only from an increase in the quantity of savings.

This leads to the conclusion that the problem in the 1930s was not demand deficiency but withheld capacity. (W. H. Hutt, The Keynesian Episode: A Reassessment, LibertyPress, 1979). Hoover and Roosevelt implemented policies that ensured that production and hence demand would be severely curbed. Maintaining real wage rates significantly in excess of productivity prevented real prices and costs from adjusting to the new monetary conditions resulting in unemployment being kept at a tragically high level.

Irrespective of what Keynesians assert real wages did exceed productivity during this period. The following table clearly shows that the PARW¹ (the inflation adjusted real wage divided by productivity) tracks the unemployment rate. This is precisely what marginal productivity theory predicts. One should also note that GNP started to rise when the real adjusted wage began to fall. (Inflation not only raises nominal GDP it also reduces unemployment by lowering the cost of labour relative to the value of its marginal product².)

Once the country was at war the Roosevelt administration did what every government at war does -- it resorted to the printing press. Now one of the effects of this inflationary induced war-time boom was to cut real wages by allowing them to once again correspond with productivity. When hostilities ceased industry found costs and relative prices were finally being allowed to adjust to real economic conditions. (This process even repealed for a time Roosevelt's minimum wage rate). In Hutt's terminology withheld capacity had been released and it was this discharge of productive power that drove the post-war economic boom.

The lesson for today should be crystal clear. However, I get the feeling that the last thing the Obama administration is interested in is learning anything from economic history let alone allowing the free market to do its work. So I guess Americans will have to put up with Obama and his supporters blaming the market for the present state of the economy instead of political meddling and the Fed's appalling monetary mismanagement.

¹These figures were constructed by me.

²From 1933 to 1937 the wholesale price level rose by 21.5 per cent (Federal Reserve Bulletin, May 1941, p. 453). For the same period the consumer price index rose by about 11 per cent (Historical Statistics of the United States).

By Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes' economics editor.

Copyright © 2010 Gerard Jackson

Gerard Jackson Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in