Keynesian Economics

Posted by PITHOCRATES - October 14th, 2013

Economics 101

(Originally published February 20th, 2012)

John Maynard Keynes said if the People aren’t Buying then the Government Should Be

Keynesian economics is pretty complex.  So is the CliffsNotes version.  So this will be the in-a-nutshell version.  Keynesian economics basically says, in a nut shell, that markets are stupid.  Because markets are full of stupid people.  If we leave people to buy and sell as they please we will continue to suffer recession after recession.  Because market failures give us the business cycle.  Which are nice on the boom side.  But suck on the bust side.  The recession side.  So smart people got together and said, “Hey, we’re smart people.  We can save these stupid people from themselves.  Just put a few of us smart people into government and give us control over the economy.  Do that and recessions will be a thing of the past.”

Well, that’s the kind of thing governments love to hear.  “Control over the economy?” they said.  “We would love to take control of the economy.  And we would love to control the stupid people, too.  Just tell us how to do it and our smart people will work with your smart people and we will make the world a better place.”  And John Maynard Keynes told them exactly what to do.  And by exactly I mean exactly.  He transformed economics into mathematical equations.  And they all pretty much centered on doing one thing.  Moving the demand curve.  (A downward sloping graph showing the relationship between prices and demand for stuff; higher the price the lower the demand and vice versa).

In macroeconomics (i.e., the ‘big picture’ of the national economy), Keynes said all our troubles come from people not buying enough stuff.  That they aren’t consuming enough.  And when consumption falls we get recessions.  Because aggregate demand falls.  Aggregate demand being all the people put together in the economy out there demanding stuff to buy.  And this is where government steps in.  By picking up the slack in personal consumption.  Keynes said if the people aren’t buying then the government should be.  We call this spending ‘stimulus’.  Governments pass stimulus bills to shift the demand curve to the right.  A shift to the right means more demand and more economic activity.  Instead of less.  Do this and we avoid a recession.  Which the market would have entered if left to market forces.  But not anymore.  Not with smart people interfering with market forces.  And eliminating the recession side of the business cycle.

Keynesians prefer Deficit Spending and Playing with the Money Supply to Stimulate the Economy

Oh, it all sounds good.  Almost too good to be true.  And, as it turns out, it is too good to be true.  Because economics isn’t mathematical.  It’s not a set of equations.  It’s people entering into trades with each other.  And this is where Keynesian economics goes wrong.  People don’t enter into economic exchanges with each other to exchange money.  They only use money to make their economic exchanges easier.  Money is just a temporary storage of value.  Of their human capital.  Their personal talent that provides them business profits.  Investment profits.  Or a paycheck.  Money makes it easier to go shopping with the proceeds of your human capital.  So we don’t have to barter.  Exchange the things we make for the things we want.  Imagine a shoemaker trying to barter for a TV set.  By trading shoes for a TV.  Which won’t go well if the TV maker doesn’t want any shoes.  So you can see the limitation in the barter system.   But when the shoemaker uses money to buy a TV it doesn’t change the fundamental fact that he is still trading his shoemaking ability for that TV.  He’s just using money as a temporary storage of his shoemaking ability.

We are traders.  And we trade things.  Or services.  We trade value created by our human capital.  From skill we learned in school.  Or through experience.  Like working in a skilled trade under the guidance of a skilled journeyperson or master tradesperson.  This is economic activity.  Real economic activity.  People getting together to trade their human capital.  Or in Keynesian terms, on both sides of the equation for these economic exchanges is human capital.  Which is why demand-side economic stimulus doesn’t work.  Because it mistakes money for human capital.  One has value.  The other doesn’t.  And when you replace one side of the equation with something that doesn’t have value (i.e., money) you cannot exchange it for something that has value (human capital) without a loss somewhere else in the economy.  In other words to engage in economic exchanges you have to bring something to the table to trade.  Skill or ability.  Not just money.  If you bring someone else’s skill or ability (i.e., their earned money) to the table you’re not creating economic activity.  You’re just transferring economic activity to different people.  There is no net gain.  And no economic stimulus.

When government spends money to stimulate economic activity there are no new economic exchanges.  Because government spending is financed by tax revenue.  Wealth they pull out of the private sector so the public sector can spend it.  They take money from some who can’t spend it and give it to others who can now spend it.  The reduction in economic activity of the first group offsets the increase in economic activity in the second group.   So there is no net gain.  Keynesians understand this math.  Which is why they prefer deficit spending (new spending paid by borrowing rather than taxes).  And playing with the money supply.

The End Result of Government Stimulus is Higher Prices for the Same Level of Economic Activity

The reason we have recessions is because of sticky wages.  When the business cycle goes into recession all prices fall.  Except for one.  Wages.  Those sticky wages.  Because it is not easy giving people pay cuts.  Good employees may just leave and work for someone else for better pay.  So when a business can’t sell enough to maintain profitability they cut production.  And lay off workers.  Because they can’t reduce wages for everyone.  So a few people lose all of their wages.  Instead of all of the people losing all of their wages by a business doing nothing to maintain profitability.  And going out of business.

To prevent this unemployment Keynesian economics says to move the aggregate demand curve to the right.  In part by increasing government spending.  But paying for this spending with higher taxes on existing spenders is a problem.  It cancels out any new economic activity created by new spenders.  So this is where deficit spending and playing with the money supply come in.  The idea is if the government borrows money they can create economic activity.  Without causing an equal reduction in economic activity due to higher taxes.  And by playing with the money supply (i.e., interest rates) they can encourage people to borrow money to spend even if they had no prior intentions of doing so.  Hoping that low interest rates will encourage them to buy a house or a car.  (And incur dangerous levels of debt in the process).  But the fatal flaw in this is that it stimulates the money supply.  Not human capital.

This only pumps more money into the economy.  Inflates the money supply.  And depreciates the dollar.  Which increases prices.  Because a depreciated dollar can’t buy as much as it used to.  So whatever boost in economic activity we gain will soon be followed by an increase in prices.  Thus reducing economic activity.  Because of that demand curve.  That says higher prices decreases aggregate demand.  And decreases economic activity.  The end result is higher prices for the same level of economic activity.  Leaving us worse off in the long run.  If you ever heard a parent say when they were a kid you could buy a soda for a nickel this is the reason why.  Soda used to cost only a nickel.  Until all this Keynesian induced inflation shrunk the dollar and raised prices through the years.  Which is why that same soda now costs a dollar.

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Saving, Investing and the Paradox of Thrift

Posted by PITHOCRATES - August 12th, 2013

Economics 101

(Originally published August 27th, 2012)

Healthy Sales can Support just about any Bad Decision a Business Owner Makes

“Industry, Perseverance, & Frugality, make Fortune yield.”  Benjamin Franklin (1744).  He also said, “A penny saved is a penny earned.”  Franklin was a self-made man.  He started with little.  And through industry, perseverance and frugality he became rich and successful.  He lived the American dream.  Which was having the liberty to work hard and succeed.  And to keep the proceeds of his labors.  Which he saved.  And all those pennies he saved up allowed him to invest in his business.  Which grew and created more wealth.

Frugality.  And saving.  Two keys to success.  Especially in business.  For the business that starts out by renting a large office in a prestigious building with new furniture is typically the business that fails.  Healthy sales can support just about any bad decision a business owner makes.  While falling sales quickly show the folly of not being frugal.  Most businesses fail because of poor sales revenue.  The less frugal you’ve been the greater the bills you have to pay with those falling sales. Which speeds up the failing process.  Insolvency.  And bankruptcy.  Teaching the important lesson that you should never take sales for granted.  The importance of being frugal.  And the value of saving your pennies.

Saving and frugality also hold true in our personal lives.  Especially when we start buying things.  Like big houses.  And expensive cars.  As a new household starting out with husband and wife gainfully employed the money is good.  The money is plentiful.  And the money can be intoxicating.  Because it can buy nice things.  And if we are not frugal and we do not save for a rainy day we are in for a rude awakening when that rainy day comes.  For if that two income household suddenly becomes a one income household it will become very difficult to pay the bills.  Giving them a quick lesson in the wisdom of being frugal.  And of saving your pennies.

The Money People borrow to Invest is the Same Money that Others have Saved

Being frugal lets us save money.  The less we spend the more we can put in the bank.  What we’re doing is this.  We’re sacrificing short-term consumption for long-term consumption.  Instead of blowing our money on going to the movies, eating out and taking a lot of vacations, we’re putting that money into the bank.  To use as a down payment on a house later.  To save for a dream vacation later.  To put in an in-the-ground pool later.  What we’re doing is pushing our consumption out later in time.  So when we do spend these savings later they won’t make it difficult to pay our bills.  Even if the two incomes become only one.

Sound advice.  Then again, Benjamin Franklin was a wise man.  And a lot of people took his advice.  For America grew into a wealthy nation.  Where entrepreneurs saved their money to build their businesses.  Large savings allowed them to borrow large sums of money.  As bank loans often required a sizeable down payment.  So being frugal and saving money allowed these entrepreneurs to borrow large sums of money from banks.  Money that was in the bank available to loan thanks to other people being frugal.  And saving their money.

To invest requires money.  But few have that kind of money available.  So they use what they have as a down payment and borrow the balance of what they need.  The balance of what they need comes from other people’s savings.  Via a bank loan.  This is very important.  The money people borrow to invest is the same money that others have saved.  Which means that investments are savings.  And that people can only invest as much as people save.  So for businesses to expand and for the economy to grow we need people to save their money.  To be frugal.  The more they save instead of spending the greater amount of investment capital is available.  And the greater the economy can grow.

The Paradox of Thrift states that Being Frugal and Saving Money Destroys the Economy

Once upon a time this was widely accepted economics.  And countries grew wealthy that had high savings rates.  Then along came a man named John Maynard Keynes.  Who gave the world a whole new kind of economic thought.   That said spending was everything.  Consumption was key.  Not savings.  Renouncing centuries of capitalism.  And the wise advice of Benjamin Franklin.  In a consumption-centered economy people saving their money is bad.  Because money people saved isn’t out there generating economic activity by buying stuff.  Keynes said savings were nothing more than a leak of economic activity.  Wasted money that leaks out of the economy and does nothing beneficial.  Even when people and/or businesses are being frugal and saving money to avoid bankruptcy.

In the Keynesian world when people save they don’t spend.  And when they don’t spend then businesses can’t sell.  If businesses aren’t selling as much as they once were they will cut back.  Lay people off.  As more businesses suffer these reductions in their sales revenue overall GDP falls.  Giving us recessions.  This is the paradox of thrift.  Which states that by doing the seemingly right thing (being frugal and saving money) you are actually destroying the economy.  Of course this is nonsense.  For it ignores the other half of saving.  Investing.  As a business does to increase productivity.  To make more for less.  So they can sell more for less.  Allowing people to buy more for less.  And it assumes that a higher savings rate can only come with a corresponding reduction in consumption.  Which is not always the case.  A person can get a raise.  And if they are satisfied by their current level of consumption they may save their additional income rather than increasing their consumption further.

Many people get a raise every year.  Which allows them to more easily pay their bills.  Pay down their credit cards.  Even to save for a large purchase later.  Which is good responsible behavior.  The kind that Benjamin Franklin would approve of.  But not Keynesian economists.  Or governments.  Who embrace Keynesian economics with a passion.  Because it gives them a leading role.  When people aren’t spending enough money guess who should step in and pick up that spending slack?  Government.  So is it any wonder why governments embrace this new kind of economic thought?  It justifies excessive government spending.  Which is just the kind of thing people go into government for.  Sadly, though, their government spending rarely (if ever) pulls a nation out of a recession.  For government spending doesn’t replicate what has historically created strong economic growth.  A high savings rate.  That encourages investment higher up in the stages of production.  Where that investment creates jobs.  Not at the end of the stages of production.  Where government spending creates only inflation.  Deficits.  And higher debt.  All things that are a drag on economic activity.

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Keynesian Economics is as Corrupt and Immoral as is Crony Capitalism

Posted by PITHOCRATES - May 5th, 2013

Week in Review

Before John Maynard Keynes came along the established economic thought was classical economics.  Those principles that made America the number one economic power in the world.  A sound money like the gold standard gave you.  Low tax rates to encourage economic risk taking.  Responsible government spending for only those things a federal government should be doing.  And only spending what that minimal federal tax revenue could pay for.  Little government intervention into the private sector economy.  And thrift.  People spending money very cautiously.  And saving as much as they possible could.  To save for the future.  While providing investment capital for businesses.

These policies made the United States the number one economic power in the world.  Laissez-faire capitalism.  Tried and proven for over a century in the U.S.  But then government got big in the beginning of the Twentieth Century.  The progressives came into the government.  And they needed a new way to lie to and deceive the American people.  And then came along John Maynard Keynes.  The answer to their dreams.  Whose Keynesian economics has destroyed nation after nation with his assault on classical economics.  And now debt crises from excessive government spending in the Twentieth Century have plagued Greece, Italy, Spain, Portugal, Ireland, the United Kingdom, Japan, the United States, and other nations that dared to embrace Keynesian economics.

President Obama’s economic recovery has been horrible because he embraces Keynesian economics.  He lied like a good Keynesian to the American people to pass his stimulus.  It did nothing.  As predicted by everyone that isn’t a Keynesian.  He continues to destroy the American economy with near zero interest rates.  Destroying our savings.  Creating stock market bubbles while the labor force participation rate falls to its lowest since the Seventies.  And caused the federal debt to soar to levels that we can never pay down.  Putting us on the road to Greece.  All because of the corrupt economic school of thought John Maynard Keynes gave us.  That governments everywhere are using to increase their size and power.  To elevate the government class into a new aristocracy.  That lives very well thanks to those people beneath them.  The working class.  That works longer while earning less.  Like the nobility and peasants of old.  And a little Orwellian.  As they built this upon a house of lies.  Beginning with changing the meaning of words (see Two Sides of the Same Debased Coin by Hunter Lewis posted 5/2/2013 on Ludwig von Mises Institute).

When we turn to Keynes’s economics, perhaps the most fantastic self-contradiction was that an alleged savings glut, too much supposed idle cash, could be cured by flooding the economy with more cash, newly printed by the government. Perhaps even more bizarrely, Keynes says that we should call this new cash “savings” because it represents “savings” just as genuine as “traditional savings.” That is, the money rolling off the government printing presses is in no way different from the money we earn and choose not to spend.

All this new “savings” enters the economy through the mechanism of low interest rates. At this point, Keynes further confounds his forerunners and elders by arguing that it is not high interest rates, as always thought, but rather low interest rates, that increase savings, even though we started by positing too much savings in the first place.

Keynes’s followers echo this even today. Greenspan, Bernanke, and Krugman have all written about a savings glut which is supposed to be at the root of our troubles, and have proposed more money and lower interest rates as a remedy, although they no longer call the new money “genuine savings.” They prefer quantitative easing and similar obscure euphemisms…

The General Theory does argue that interest rates could and should be brought to a zero level permanently (that’s pages 220–21 and 336)…

Keynesians hate savings.  They don’t want people saving their money.  They want them to spend every last dime.  And then borrow more money to spend when they run out of their own.  Because consumer spending is everything to them.  Spending is what drives economic activity.  And any money they save they don’t spend.  And drain out of the economy.  Which is why they want zero interest rates.  Or even negative interest rates.  To discourage people from saving.  For if you lose purchasing power when you put your money in the bank you might as well spend it now.  And generate economic activity.

This is, of course, a ‘live for the day and screw the future’ mentality.  For if people spend all of their money going out to dinner, buying new cars, going on more vacations, running up their credit cards, etc., that will create a lot of economic activity.  But when these people retire they will have to live like paupers.  Because they didn’t save for their retirement.  Even if someone loses their job and is out of work for a few months if they have no savings they will struggle to pay their mortgage or rent.  Struggle to put food on the table.  They will struggle to pay their utility bills.  And their credit card bills.  This is the problem of living as if your income stream will never end.  It sometimes does end.  And if you didn’t bank a rainy day fund you could find yourself suffering some extreme hardship as you can no longer afford to live like you once did.

Keynesians once called printed money ‘savings’.  Today they call tax cuts ‘spending’.  A little Orwellian doublespeak.  Change the meanings of words.  So they can fool the people into believing that the government printing money and depreciating the currency is the same thing as you working hard and saving for your retirement.  And not taking more of your hard-earned paycheck is irresponsible government spending.  The only government spending, incidentally, they find irresponsible.  This is a fundamental tenet of Keynesian economics.  Deceiving the people.  So politicians can continue to recklessly spend money they don’t have to buy votes for the next election.  And to reward their campaign contributors with the favors of crony capitalism.

These Romney advisors also, of course, believed in the fairy tale of borrow-and-spend stimulus. It is usually forgotten that Keynes assured us that each dollar of such stimulus would produce as much as twelve dollars of growth and not less than four dollars. Even the most ardent Keynesians have, of course, been unable to demonstrate as much as one dollar. How did Keynes know that you would get four dollars at least? He didn’t. He told the governor of the Bank of England, Norman Montague, that his ideas were “a mathematical certainty” but that was just a crude bluff.

What is empirically verifiable is that all debt, private or public, has been generating less and less growth for decades. In the ten years following 1959, the official figures say that you got 73 cents in growth for each dollar borrowed. By the time of the Crash of ’08, that was down to 19 cents. And I expect it was really negative by then and is deeply negative now.

Keynes lied.  But that lie sanctioned governments to expand into the private sector economy.  So they embraced the lie.  And continue the lie.  Because none of these politicians want to give up the good life and get a real job.  They like it the old fashioned way.  Before the Founding Fathers had to muck it up with their attacks on the nobility.  They like being part of the aristocracy.  To live better than any of the poor schmucks that work a 40-hour week.  They just want to take a percentage of that poor schmuck’s earnings for themselves.  Rub elbows with the beautiful people.  And laugh at the working class.

The idea that you can take a dollar from the taxpayer, run it through a costly bureaucracy that a portion of that dollar has to pay for and think you’re going to generate more than a dollar in economic activity is absurd.  By the time that dollar reenters the economy the government has skimmed so much off the top that any economic activity it generates is negligible.  Now compare that to how the taxpayer who earned that dollar spends it.  He or she spends a dollar out of that dollar.  Because they’re not putting it through a costly bureaucracy before they spend it.

Which begs this question.  If a wage earner gets more economic activity when spending that money why not let that wage earner keep more of his or her money to spend?  For each additional dollar they can keep they can generate another dollar of economic activity.  Not the 19 cents the government will be lucky to generate from it.  Ah, well, if they can keep their money they may just do something responsible with it.  Like save it.  Which Keynesians hate.  And the government won’t be able to skim at least 81 cents from each dollar if they don’t tax it away.  Which Keynesians hate even more.

The common theme [of Keynesian Economics] is that market prices don’t matter…

Is this, then, the essence of Keynesianism, its blind destruction of the price mechanism on which any economy depends, as Mises demonstrated? Yes. But there may be an even deeper essence…

For the Victorians, spending within your means and avoiding debt were not just financial principles. They were moral principles. Keynes, who was consciously rebelling against these same Victorians, described their “copybook morality” as “medieval [and] barbarous.” He told his own inner circle that “I remain, and always will remain an immoralist…”

So, in conclusion, when we strip down Keynesianism to its essence, the relationship to crony capitalism becomes even clearer. Crony capitalism represents both a corruption of capitalism and a corruption of morals. Keynesianism also represents both a corruption of economics and a corruption of morals. Crony capitalism and Keynesianism are just two sides of the same debased coin.

The price mechanism allocates scarce resources that have alternative uses.  Through the laws of supply and demand.  Guaranteeing that the people who most want a resource—and are willing to pay more for it than others—will get that resource.  While those who don’t want that resource as badly are not willing to pay the higher prices others are willing to pay.

This is capitalism.  This is what enables you to go out and buy the things you want.  Because the price mechanism has automatically allocated millions upon millions of resources in the economy to get them into the things people most want to buy.  Crony capitalism smashes this apart.  By distorting market forces.  With government fiat.  Which allocates those resources first to their close friends who, in return, favor their friends in government with generous campaign contributions.  Or gifts of gratitude.  While others must pay a higher price.  If they can even get these resources at all.  Which they might not be able to do if they don’t please someone in government who has power over these resources.

This is crony capitalism.  Corrupt.  And immoral.  Just as is Keynesian economics.  Unlike the classical economics that made this country the number one economic power in the world.  Thanks to the gold standard, low taxes, low government spending, little government intervention into the private sector economy and thrift.  Things that kept a government moral.  However hard they may try not to be.

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Why the Democrats won’t Privatize Social Security

Posted by PITHOCRATES - January 24th, 2013

Politics 101

FDR Transformed the Country because he had a Great Crisis to Exploit like the Great Depression

Once upon a time in a place that seems far, far away there was once a people that saved for retirement.  The savings rate was so high in this mystical land that businesses were able to borrow money at low interest rates to expand their business.  And there was great employment.  Then came an evil ogre who hated savings.  And responsible behavior.  He saw money saved as money leaked out of the economy.  Hurting economic activity.  His motto was spend don’t save.  And don’t worry about how you will take care of yourself in retirement.  So this evil ogre set out to destroy savings and responsible behavior.

That evil ogre’s name was John Maynard Keynes.  Who empowered governments with his inflationary monetary policies.  Allowing governments to spend a lot of money.  Giving them a lot of power.  By getting as many people dependent on the government as possible.  Keynes met with Franklin Delano Roosevelt during the Great Depression.  To offer him ideas of how to spend his way out of the Great Depression.  FDR didn’t think much of Keynesian economics.  For he did try to maintain the gold standard.  But he loved spending money.  And getting people dependent on the government.

FDR gave us Big Government.  He did the things Woodrow Wilson wanted to do.  But Wilson couldn’t because he didn’t have a crisis like the Great Depression to exploit.  FDR did.  And he was able to transform the country because of it.  People saved less.  And government spent more.  Which led to deficit spending, massive debt and inflation.  And perhaps the cruelest thing he did was impoverish the retiring class.  By taking their wealth through taxes and inflation.  And making them dependent on a meager Social Security benefit.

Social Security Contributions would create a Bigger Nest Egg if Invested in the Private Sector

After seeing so many poor, hungry, homeless, etc., during the Great Depression government did something.  They punished those who saved responsibly for their retirement.  By redistributing their wealth to those who didn’t.  It seemed fair and just and kind.  And there was an element of that in providing a social safety net for our most vulnerable people.  But that wasn’t the intent of Social Security.  FDR wanted to transform the country.  Which he did.  And today they forecast Social Security will go bankrupt in the coming years.  Requiring ever more wealth redistribution.  All while making Social Security recipients live a more impoverished retirement than they would have.  Had they saved for their own retirement.  A true transformation of the richest country in the world.

So let’s look at the numbers.  Your Social Security contributions are technically saved in a ‘retirement account’ that accrues interest.  Each payroll period both employer and employee contribute to this ‘retirement account’.  Via a tax rate on a person’s gross pay up to a maximum amount (see Historical Payroll Tax Rates).  So let’s see what this would have done in the private sector.  Year by year.  With the following assumptions.  The worker enters the workforce at 18 and works until retiring at age 65.  The worker earns the maximum amount for Social Security taxes.  So all of his or her earnings are subject to the Social Security tax.  With each successive year we add the current contribution to the running balance in his or her retirement account.  The annual balance earns interest at 6% (including anywhere from 2-4% real return on their retirement investment and the rest of that 6% accounts for inflation).  The following chart shows the beginning 5 years and the final 5 years.

Here we can see the power of compound interest.  As we earn interest on both our contributions and the previous interest we earned.  Note that the total contributions for 48 years of work total $282,608.38.  Which earned a total of $540,413.12 in interest.  Bringing the retirement nest egg up to $823,021.50.  Again, this is assuming that the Social Security contributions were actually private retirement savings.  That thing John Maynard Keynes hated.  So this is what a retiree would have to live on in retirement.  Had his or her money not gone to the government.

The Purpose of Social Security was to make People Dependent on Government and Redistribute Wealth

Now let’s look at what kind of retirement that nest egg will provide.  Starting with some more assumptions.  Let’s say the retiree lives 35 years in retirement.  Reaching a grand old age of 100.  Not your typical retirement.  But one this retirement nest egg can provide.  For someone with fairly modest means.  Each year the retiree lives on $53,553.  At the end of the year they earn interest on their remaining balance.  Which helps to stretch that $823,021.50 over those 35 years.  The following chart shows the beginning 5 years and the final 5 years of that retirement.

Note how that $282,608.38 in retirement contributions can provide $1,874,355 in retirement payments.  Again, that’s the miracle of compound interest.  So what kind of retirement would Social Security have provided?  Someone who retires after working till age 65 who was earning $110,100 near retirement will receive approximately $24,720 annually in retirement.  Over 35 years of retirement that comes to $865,200 in retirement benefits.  Which is $1,009,155 less than someone would get investing in a private sector retirement plan.  Or a reduction of 53.8%.  Which is what people lose when letting the government provide for their retirement.  So Social Security is a very poor retirement plan.  Besides going bankrupt.  Which is why the Republicans want to give younger workers the option to opt out of Social Security and provide for their own retirement.  Which makes sense.  And would probably increase their quality of life in retirement.  As shown above.  So why are the Democrats so opposed to privatization of Social Security?

Because the purpose of Social Security was not to provide a quality retirement.  It was to make people dependent on government.  To redistribute wealth.  Increasing the power of government.  And for those things Social Security is a resounding success.  But there is one other thing why Democrats oppose privatizing Social Security.  What would happen if the person that built up that $823,021.50 nest egg died 5 years into retirement?  Who would get the remaining $781,392.18?  The retiree’s family.  Whereas if a Social Security beneficiary dies 5 years into retirement the government keeps their money.  To spend as they please.

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The Federal Reserve, Roaring Twenties, Stock Market Crash, Banking Crises, Great Depression and John Maynard Keynes

Posted by PITHOCRATES - September 25th, 2012

History 101

The Federal Reserve increased the Money Supply to Lower Interest Rates during the Roaring Twenties

Benjamin Franklin said, “Industry, perseverance, & frugality, make fortune yield.”  He said that because he believed that.  And he proved the validity of his maxim with a personal example.  His life.  He worked hard.  He never gave up.  And he was what some would say cheap.  He saved his money and spent it sparingly.  Because of these personally held beliefs Franklin was a successful businessman.  So successful that he became wealthy enough to retire and start a second life.  Renowned scientist.  Who gave us things like the Franklin stove and the lightning rod.  Then he entered his third life.  Statesman.  And America’s greatest diplomat.  He was the only Founder who signed the Declaration of Independence, Treaty of Amity and Commerce with France (bringing the French in on the American side during the Revolutionary War), Treaty of Paris (ending the Revolutionary War very favorably to the U.S.) and the U.S. Constitution.  Making the United States not only a possibility but a reality.  Three extraordinary lives lived by one extraordinary man.

Franklin was such a great success because of industry, perseverance and frugality.  A philosophy the Founding Fathers all shared.  A philosophy that had guided the United States for about 150 years until the Great Depression.  When FDR changed America.  By building on the work of Woodrow Wilson.  Men who expanded the role of the federal government.  Prior to this change America was well on its way to becoming the world’s number one economy.   By following Franklin-like policies.  Such as the virtue of thrift.  Favoring long-term savings over short-term consumption.  Free trade.  Balanced budgets.  Laissez-faire capitalism.  And the gold standard.  Which provided sound money.  And an international system of trade.  Until the Federal Reserve came along.

The Federal Reserve (the Fed) is America’s central bank.  In response to some financial crises Congress passed the Federal Reserve Act (1913) to make financial crises a thing of the past.  The Fed would end bank panics, bank runs and bank failures.  By being the lender of last resort.  While also tweaking monetary policy to maintain full employment and stable prices.  By increasing and decreasing the money supply.  Which, in turn, lowers and raises interest rates.  But most of the time the Fed increased the money supply to lower interest rates to encourage people and businesses to borrow money.  To buy things.  And to expand businesses and hire people.  Maintaining that full employment.  Which they did during the Roaring Twenties.  For awhile.

The Roaring Twenties would have gone on if Herbert Hoover had continued the Harding/Mellon/Coolidge Policies

The Great Depression started with the Stock Market Crash of 1929.  And to this date people still argue over the causes of the Great Depression.  Some blame capitalism.  These people are, of course, wrong.  Others blamed the expansionary policies of the Fed.  They are partially correct.  For artificially low interest rates during the Twenties would eventually have to be corrected with a recession.  But the recession did not have to turn into a depression.  The Great Depression and the banking crises are all the fault of the government.  Bad monetary and fiscal policies followed by bad governmental actions threw an economy in recession into depression.

A lot of people talk about stock market speculation in the Twenties running up stock prices.  Normally something that happens with cheap credit as people borrow and invest in speculative ventures.  Like the dot-com companies in the Nineties.  Where people poured money into these companies that never produced a product or a dime of revenue.  And when that investment capital ran out these companies went belly up causing the severe recession in the early 2000s.  That’s speculation on a grand scale.  This is not what happened during the Twenties.  When the world was changing.  And electrifying.  The United States was modernizing.  Electric utilities, electric motors, electric appliances, telephones, airplanes, radio, movies, etc.  So, yes, there were inflationary monetary policies in place.  But their effects were mitigated by this real economic activity.  And something else.

President Warren Harding nominated Andrew Mellon to be his treasury secretary.  Probably the second smartest person to ever hold that post.  The first being our first.  Alexander Hamilton.  Harding and Mellon were laissez-faire capitalists.  They cut tax rates and regulations.  Their administration was a government-hands-off administration.  And the economy responded with some of the greatest economic growth ever.  This is why they called the 1920s the Roaring Twenties.  Yes, there were inflationary monetary policies.  But the economic growth was so great that when you subtracted the inflationary damage from it there was still great economic growth.  The Roaring Twenties could have gone on indefinitely if Herbert Hoover had continued the Harding and Mellon policies (continued by Calvin Coolidge after Harding’s death).  There was even a rural electrification program under FDR’s New Deal.  But Herbert Hoover was a progressive.  Having far more in common with the Democrat Woodrow Wilson than Harding or Coolidge.  Even though Harding, Coolidge and Hoover were all Republicans.

Activist Intervention into Market Forces turned a Recession into the Great Depression

One of the things that happened in the Twenties was a huge jump in farming mechanization.  The tractor allowed fewer people to farm more land.  Producing a boom in agriculture.  Good for the people.  Because it brought the price of food down.  But bad for the farmers.  Especially those heavily in debt from mechanizing their farms.  And it was the farmers that Hoover wanted to help.  With an especially bad policy of introducing parity between farm goods and industrial goods.  And introduced policies to raise the cost of farm goods.  Which didn’t help.  Many farmers were unable to service their loans with the fall in prices.  When farmers began to default en masse banks in farming communities failed.  And the contagion spread to the city banks.  Setting the stage for a nation-wide banking crisis.  And the Great Depression.

One of the leading economists of the time was John Maynard Keynes.  He even came to the White House during the Great Depression to advise FDR.  Keynes rejected the Franklin/Harding/Mellon/Coolidge policies.  And the policies favored by the Austrian school of economics (the only people, by the way, who actually predicted the Great Depression).  Which were similar to the Franklin/Harding/Mellon/Coolidge policies.  The Austrians also said to let prices and wages fall.  To undo all of that inflationary damage.  Which would help cause a return to full employment.  Keynes disagreed.  For he didn’t believe in the virtue of thrift.  He wanted to abandon the gold standard completely and replace it with fiat money.  That they could expand more freely.  And he believed in demand-side solutions.  Meaning to end the Great Depression you needed higher wages not lower wages so workers had more money to spend.  And to have higher wages you needed higher prices.  So the employers could pay their workers these higher wages.  And he also encouraged continued deficit spending.  No matter the long-term costs.

Well, the Keynesians got their way.  And it was they who gave us the Great Depression.  For they influenced government policy.  The stock market crashed in part due to the Smoot Hawley Tariff then in committee.  But investors saw the tariffs coming and knew what that would mean.  An end to the economic boom.  So they sold their stocks before it became law.  Causing the Stock Market Crash of 1929.  Then those tariffs hit (an increase of some 50%).  Then they doubled income tax rates.  And Hoover even demanded that business leaders NOT cut wages.  All of this activist intervention into market forces just sucked the wind out of the economy.  Turning a recession into the Great Depression.

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Great Depression, FDR, New Deal, John Maynard Keynes, Labor Unions, Collusion, Unemployment, Lend-Lease and Stages of Production

Posted by PITHOCRATES - September 11th, 2012

History 101

FDR increased the Power of Labor Unions and allowed Big Corporations to Collude with Each Other

Those in mainstream economics (i.e., Keynesian economics) studied the Great Depression and determined that the problem was a lack of spending.  Which is why they cheer FDR and his New Deal programs.  Because the New Deal spent enormous amounts of money.  And according to prevailing Keynesian thought that was all that was needed to end the Great Depression.  Spending.  And if the private sector wasn’t going to spend money then the government could.  And the government’s spending could replace all that economic activity that disappeared when the private sector stopped spending.  So the government spent.  But in those 10 to 15 years they failed to pull the nation out of the Great Depression.

According to Keynesian thought, and John Maynard Keynes himself who visited FDR in the White House, the government needed to spend money.  Even money they didn’t have.  Keynes urged the president to deficit spend.  To run huge deficits in the short term to kick-start the economy.  Keynes showed that it was the only way with a lot of figures and math.  FDR later said Keynes was more a mathematician than an economist.  Still, FDR spent.  But he did even more.  Believing part of the reason for the lack of spending was the evils of capitalism.  There was just too much competition keeping prices low.  And businesses selling at low prices couldn’t pay high wages.  Ergo to stimulate economic activity FDR wanted to increase the cost of doing business.

FDR increased the power of labor unions to help them negotiate higher wage packages.  And he allowed big corporations to collude with each other so they could raise their prices so they could afford to pay those higher union wages.  These two things really helped workers get better pay.  Some 25% higher they otherwise would have had.  This was a big win for labor.  And for the socialists and communists in America who hated capitalism.  (The 1930s were a time of nationalist, socialist, fascist and communist movements sweeping the world.  And strong elements in the U.S. wanted to join these movements.  The Soviet Union even had agents working inside the Roosevelt administration.)  In fact, they were angry that FDR didn’t take this chance to deliver the deathblow to capitalism once and for all by nationalizing some big industries.  Something FDR wasn’t willing to do.

FDR did Everything in his Power to Increase Wages & Prices because of the Massive Deflation of the Great Depression

Then came the alphabet soup of make-work agencies.  Civilian Conservation Corps (CCC) paid young unemployed men to do landscaping and other outdoor activities.  Tennessee Valley Authority (TVA) paid young men to build dams and other water related activities.  Agricultural Adjustment Act (AAA) raised food prices by paying farmers not to grow crops and to kill off some of their livestock herds instead of bringing them to market.  National Industrial Recovery Act (NIRA) reduced unfair competition by letting big corporations collude with each other to keep their prices high.  Public Works Administration (PWA) was a whole new agency that built roads and bridges.  Works Progress Administration (WPA) paid for more construction work for men, sewing work for women and arts projects for the creatively inclined.  National Labor Relations Act (NLRA) gave more power to unions to keep their wages (and the prices of the things they made) high.  And many other alphabet agencies.

Most of these programs passed between 1933 and 1935.  So FDR put a lot of money into workers’ pockets during the 1930s.  And according to Keynesian economics all that money would cause an explosion in consumer spending.  Thanks to the Keynesian multiplier.  For every dollar a consumer received from the government it would generate up to $5 of new GDP.  Which was probably one of the mathematical equations Keynes discussed that so underwhelmed FDR.  And that formula is 1/(1-MPC).  Where MPC stands for the marginal propensity to consume (and if it’s 0.80 you get a multiplier of 5).  If a person receives $100 and spends $80 then their MPC is 0.80 or 80%.  This is basically trickle-down economics Keynesian style.  If the person above spends that $80 those receiving it will spend $64.  Those who receive $64 will spend $51.20.  And so on until these other people create an additional $400 of economic activity in addition to that original $100.

And FDR couldn’t ask for a better time to spend that money.  During the Great Depression.  He was doing everything in his power to increase wages and prices because of the massive deflation of the Great Depression.  So even though he was trying to raise prices they were still low throughout much of the economy.  Which meant a little bit of money bought a lot of stuff.  Because deflation strengthened the dollar.  Giving it more purchasing power.  Allowing buyers to get a lot of bang for the buck.  Especially those union workers making 25% more than they normally would have been making.  Talk about kick-starting an economy.  It was so easy.  They even had mathematical formulas saying this would end the Great Depression.  The Great Depression was as good as over.

Had President Obama not been Elected the Great Recession would have Ended some time in 2010

The unemployment rate topped out at around 25% in 1933.  Excluding the government make-work, the true unemployment rate didn’t fall below 20% until 1936.  And never got below 14% until 1941.  When America began tooling up to build the instruments of war.  To become the Arsenal of Democracy.  A few things happened during this time to greatly reduce the unemployment rate following 1941.  The war removed a lot of men from the workforce to serve in the military.  The Supreme Court found parts of the New Deal unconstitutional.  And there was a split in organized labor that helped conservatives (Republicans and Democrats) gain power in Congress.  And they shut down some of those liberal New Deal programs.  So while one war began (World War II) another ended (the war on business).

And how did things progress after they ended their war on business?  Pretty well.  The unemployment rate fell.  To 14.6% in 1940.  To 9.9% in 1942.  To 1.9% in 1943.  To 1.2% in 1944.  Then it soared back up to 1.9% in 1945.  With the war over the unemployment rate rose again.  But nowhere near where it was during FDR’s New Deal 1930s.  From 1948 to 1968 it averaged 4.7%.  Not too bad considering full employment is 5%.  So for the 30 years or so following the end of New Deal policies the economy returned to full employment.  And stayed at full employment.  The conservatives in Congress needed but 4 years to do what FDR couldn’t do in 10 years with his Keynesian, New Deal policies.

Yes, the war helped.  A lot.  It pulled a lot of men out of the workforce.  And American industry ramped up to provide the war material for war.  However, we financed that buildup with deficit spending and American war bonds.  As most of that war material went to our allies via Lend-Lease.  Which means we gave most of it away to allow others to fight the war.  So it was little different than Keynesian spending.  So why did the war spending work when all those alphabet soup make-work agencies didn’t?  Because of the stages of production.  Putting more money into consumers’ hands only helped the retail and wholesale stages.  It did not do anything to stimulate the manufacturing or raw commodities stages.  Especially with those high union wages and lack of competition thanks to the collusion to keep prices high.  All that did was pay the very few who actually had jobs very well.  While making it economically foolish to hire any new workers because of the exceptionally high cost of labor (25% higher than it would have been without the New Deal programs).  That high cost of business just slammed the brakes on economic activity.  Economic activity picked back up only after conservatives in Congress undid some of the damage of the New Deal.  In fact, had it not been for FDR’s New Deal the Great Depression would have ended some 7 years earlier.  Extrapolating this to the Great Recession today one could estimate that the Great Recession would have ended 7 years earlier had it not been for the Keynesian policies of President Obama.  So if the current recession lasts as long as the Great Depression and President Obama wins a second term and continues his anti-business policies the recession will last 7 years longer than it need be.  Or, had President Obama not been elected it would have ended some time in 2010.  Giving us full employment today instead of 14.7% U-6 unemployment.

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Saving, Investing and the Paradox of Thrift

Posted by PITHOCRATES - August 27th, 2012

Economics 101

Healthy Sales can Support just about any Bad Decision a Business Owner Makes

“Industry, Perseverance, & Frugality, make Fortune yield.”  Benjamin Franklin (1744).  He also said, “A penny saved is a penny earned.”  Franklin was a self-made man.  He started with little.  And through industry, perseverance and frugality he became rich and successful.  He lived the American dream.  Which was having the liberty to work hard and succeed.  And to keep the proceeds of his labors.  Which he saved.  And all those pennies he saved up allowed him to invest in his business.  Which grew and created more wealth.

Frugality.  And saving.  Two keys to success.  Especially in business.  For the business that starts out by renting a large office in a prestigious building with new furniture is typically the business that fails.  Healthy sales can support just about any bad decision a business owner makes.  While falling sales quickly show the folly of not being frugal.  Most businesses fail because of poor sales revenue.  The less frugal you’ve been the greater the bills you have to pay with those falling sales. Which speeds up the failing process.  Insolvency.  And bankruptcy.  Teaching the important lesson that you should never take sales for granted.  The importance of being frugal.  And the value of saving your pennies.

Saving and frugality also hold true in our personal lives.  Especially when we start buying things.  Like big houses.  And expensive cars.  As a new household starting out with husband and wife gainfully employed the money is good.  The money is plentiful.  And the money can be intoxicating.  Because it can buy nice things.  And if we are not frugal and we do not save for a rainy day we are in for a rude awakening when that rainy day comes.  For if that two income household suddenly becomes a one income household it will become very difficult to pay the bills.  Giving them a quick lesson in the wisdom of being frugal.  And of saving your pennies.

The Money People borrow to Invest is the Same Money that Others have Saved

Being frugal lets us save money.  The less we spend the more we can put in the bank.  What we’re doing is this.  We’re sacrificing short-term consumption for long-term consumption.  Instead of blowing our money on going to the movies, eating out and taking a lot of vacations, we’re putting that money into the bank.  To use as a down payment on a house later.  To save for a dream vacation later.  To put in an in-the-ground pool later.  What we’re doing is pushing our consumption out later in time.  So when we do spend these savings later they won’t make it difficult to pay our bills.  Even if the two incomes become only one.

Sound advice.  Then again, Benjamin Franklin was a wise man.  And a lot of people took his advice.  For America grew into a wealthy nation.  Where entrepreneurs saved their money to build their businesses.  Large savings allowed them to borrow large sums of money.  As bank loans often required a sizeable down payment.  So being frugal and saving money allowed these entrepreneurs to borrow large sums of money from banks.  Money that was in the bank available to loan thanks to other people being frugal.  And saving their money.

To invest requires money.  But few have that kind of money available.  So they use what they have as a down payment and borrow the balance of what they need.  The balance of what they need comes from other people’s savings.  Via a bank loan.  This is very important.  The money people borrow to invest is the same money that others have saved.  Which means that investments are savings.  And that people can only invest as much as people save.  So for businesses to expand and for the economy to grow we need people to save their money.  To be frugal.  The more they save instead of spending the greater amount of investment capital is available.  And the greater the economy can grow.

The Paradox of Thrift states that Being Frugal and Saving Money Destroys the Economy

Once upon a time this was widely accepted economics.  And countries grew wealthy that had high savings rates.  Then along came a man named John Maynard Keynes.  Who gave the world a whole new kind of economic thought.   That said spending was everything.  Consumption was key.  Not savings.  Renouncing centuries of capitalism.  And the wise advice of Benjamin Franklin.  In a consumption-centered economy people saving their money is bad.  Because money people saved isn’t out there generating economic activity by buying stuff.  Keynes said savings were nothing more than a leak of economic activity.  Wasted money that leaks out of the economy and does nothing beneficial.  Even when people and/or businesses are being frugal and saving money to avoid bankruptcy.

In the Keynesian world when people save they don’t spend.  And when they don’t spend then businesses can’t sell.  If businesses aren’t selling as much as they once were they will cut back.  Lay people off.  As more businesses suffer these reductions in their sales revenue overall GDP falls.  Giving us recessions.  This is the paradox of thrift.  Which states that by doing the seemingly right thing (being frugal and saving money) you are actually destroying the economy.  Of course this is nonsense.  For it ignores the other half of saving.  Investing.  As a business does to increase productivity.  To make more for less.  So they can sell more for less.  Allowing people to buy more for less.  And it assumes that a higher savings rate can only come with a corresponding reduction in consumption.  Which is not always the case.  A person can get a raise.  And if they are satisfied by their current level of consumption they may save their additional income rather than increasing their consumption further.

Many people get a raise every year.  Which allows them to more easily pay their bills.  Pay down their credit cards.  Even to save for a large purchase later.  Which is good responsible behavior.  The kind that Benjamin Franklin would approve of.  But not Keynesian economists.  Or governments.  Who embrace Keynesian economics with a passion.  Because it gives them a leading role.  When people aren’t spending enough money guess who should step in and pick up that spending slack?  Government.  So is it any wonder why governments embrace this new kind of economic thought?  It justifies excessive government spending.  Which is just the kind of thing people go into government for.  Sadly, though, their government spending rarely (if ever) pulls a nation out of a recession.  For government spending doesn’t replicate what has historically created strong economic growth.  A high savings rate.  That encourages investment higher up in the stages of production.  Where that investment creates jobs.  Not at the end of the stages of production.  Where government spending creates only inflation.  Deficits.  And higher debt.  All things that are a drag on economic activity.

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Production vs. Consumption

Posted by PITHOCRATES - August 20th, 2012

Economics 101

To Prevent another Great Depression Keynes said the Key was Government Spending

John Maynard Keynes was a noted economist who analyzed the Great Depression.  And came to the opinion the problem was that there wasn’t enough consumption.  Consumers weren’t buying enough stuff.  That is, they weren’t spending enough money.  Which is key to consumption.  And a healthy economy.  According to Keynes.  And the people who embraced his economic theories.  What we now call Keynesian economics.

It was a whole new way to look at economics.  Consumption.  Or demand-side economics.  Which said demand created supply.  Contrary to Say’s law.  Which basically stated supply creates demand.  Tomáto.  Tomàto.  To most people.  All they understood was that it was better to have a job than to be unemployed.  Because if you had a job you could buy food for your family.  Pay for heat in the winter.  And pay a doctor if your child was sick.

To prevent another Great Depression Keynes said the key was government spending.  To make up for any decline in consumption.  The government could tax, borrow or print money as necessary to get money to spend.  Putting people to work on government projects.  Building things.  Like roads and bridges.  Or digging ditches.  So when businesses lay off people the government can put them back to work.  And pay them with the money they taxed, borrowed or printed.  These people would then take that money and spend it.  A priming of the economic pump as it were.  That, in theory, will provide consumption until the private sector begins hiring again.  Therefore eliminating recessions once and for all.

Economists attribute about 90% of GDP to Consumer Spending and Government Expenditures

There have been about 12 recessions since Keynes figured out how to end them once and for all.  The recent one being the worst since the Great Depression.  Even surpassing the misery of the Jimmy Carter economy.  A time when the impossible happened.  In the world of Keynesian economics, at least.  Government spending designed to decrease unemployment actually increased unemployment.  It turns out there was a downside to printing money.  Massive inflation.  And rational expectations that printing money will lead to massive inflation.  So while the Keynesian way worked in theory it failed in practice.  And not just once.  But a lot.  Yet it is still the model of most governments.  And it’s what colleges teach their students.  Why?  After it’s been so thoroughly debunked?  The answer to that question brings us back to consumption.  And Gross Domestic Product (GDP).

GDP is a measure of a country’s goods and services during a period of time.  That is, it is a measure of economic activity.  The bigger it is the better the economy.  And the more people that have jobs.  The formula for GDP is the sum of consumption, investments, government expenditures and net exports (exports – imports).  It’s this formula that keeps Keynesian economics alive.  Because of consumption.  And government expenditures.  This formula sanctions government spending because, according to the formula, it increases economic activity.  It is the driver of all stimulus spending.  And the welfare state.  Because government spending puts money ultimately into the pockets of consumers who spend it.  That is, government spending creates private consumption.  And consumption creates jobs (demand creates supply).  In the Keynesian world, that it.  There is only one problem.  The formula leaves out a lot of economic activity.

Using this formula economists report that consumption makes up about 70% of GDP.  And government spending about 20%.  These numbers are huge.  That’s about 90% of GDP attributed to consumer spending and government expenditures.  Which is why Keynesians love this formula.   Because it empowers them to tax, borrow and print so they can spend.  All in the name of creating jobs.  And GDP.  But what about the things people make or do that consumers don’t buy?  Like engineering and design services.  Printing presses and ink.  The extraction of raw materials?  Coal mining.  Blast furnaces making steel for use in manufacturing?  Heavy construction equipment?  Machine tools and production equipment?  Assembly lines?  Robots on the assembly line?  Locomotive engines and rolling stock?  Airplanes?  All the people and equipment in the transportation industry?  Etc.  There is a lot of economic activity that makes things or does things that consumers don’t buy.  So where is it in the GDP formula?  Don’t look for it.  Because it’s just not there.

Intermediate Business Spending accounts for about Half of all Economic Activity

Before Keynes the focus was on production.  Not consumption.  Before Keynes we looked at the stages of production.  All of that economic activity that happens before you can buy anything in a store.  Everything between the extraction of raw materials to the final finished good.  Where millions of workers are engaged in economic activity that a consumer knows nothing about when they buy a consumer good.  If you factor in this economic activity into the GDP equation it changes things.  And it changes it in a way that Keynesians and government officials don’t like.

Consumption is the last stage in the stages of production.  The final step in a flurry of economic activity that preceded it.  If you count up this intermediate business spending it comes to about half of all economic activity.  It’s about twice consumer spending.  And about four times government expenditures.  Greatly reducing the roles of consumption and government expenditures in the GDP equation.  And in the economy.  As well as providing the answer to why Keynes didn’t end recessions once and for all with his new economic theory.  Because his new economic theory was wrong.  You don’t create jobs by giving money to people to spend.  You create jobs by making it easy for businesses to hire people.

So demand does NOT create supply like Keynes said.  Supply creates demand.  Like Say said.  And what’s the conclusion we can draw?  Big activist governments do not help a country’s economy.  They just pull money out of the stages of productions.  Where it can create jobs.  And puts it into government.  Where it creates unemployment and inflation.  As demonstrated by all the big Keynesian governments of Europe.  Those social democracies struggling under the weight of their government spending.  Who borrowed money to sustain that spending.  Bringing on the European sovereign debt crisis.  Because of that GDP equation that said they could tax, borrow and print to spend to their heart’s content.  Thanks to a man named Keynes.

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Keynesian Economics

Posted by PITHOCRATES - February 20th, 2012

Economics 101

John Maynard Keynes said if the People aren’t Buying then the Government Should Be

Keynesian economics is pretty complex.  So is the CliffsNotes version.  So this will be the in-a-nutshell version.  Keynesian economics basically says, in a nut shell, that markets are stupid.  Because markets are full of stupid people.  If we leave people to buy and sell as they please we will continue to suffer recession after recession.  Because market failures give us the business cycle.  Which are nice on the boom side.  But suck on the bust side.  The recession side.  So smart people got together and said, “Hey, we’re smart people.  We can save these stupid people from themselves.  Just put a few of us smart people into government and give us control over the economy.  Do that and recessions will be a thing of the past.”

Well, that’s the kind of thing governments love to hear.  “Control over the economy?” they said.  “We would love to take control of the economy.  And we would love to control the stupid people, too.  Just tell us how to do it and our smart people will work with your smart people and we will make the world a better place.”  And John Maynard Keynes told them exactly what to do.  And by exactly I mean exactly.  He transformed economics into mathematical equations.  And they all pretty much centered on doing one thing.  Moving the demand curve.  (A downward sloping graph showing the relationship between prices and demand for stuff; higher the price the lower the demand and vice versa).

In macroeconomics (i.e., the ‘big picture’ of the national economy), Keynes said all our troubles come from people not buying enough stuff.  That they aren’t consuming enough.  And when consumption falls we get recessions.  Because aggregate demand falls.  Aggregate demand being all the people put together in the economy out there demanding stuff to buy.  And this is where government steps in.  By picking up the slack in personal consumption.  Keynes said if the people aren’t buying then the government should be.  We call this spending ‘stimulus’.  Governments pass stimulus bills to shift the demand curve to the right.  A shift to the right means more demand and more economic activity.  Instead of less.  Do this and we avoid a recession.  Which the market would have entered if left to market forces.  But not anymore.  Not with smart people interfering with market forces.  And eliminating the recession side of the business cycle.

Keynesians prefer Deficit Spending and Playing with the Money Supply to Stimulate the Economy

Oh, it all sounds good.  Almost too good to be true.  And, as it turns out, it is too good to be true.  Because economics isn’t mathematical.  It’s not a set of equations.  It’s people entering into trades with each other.  And this is where Keynesian economics goes wrong.  People don’t enter into economic exchanges with each other to exchange money.  They only use money to make their economic exchanges easier.  Money is just a temporary storage of value.  Of their human capital.  Their personal talent that provides them business profits.  Investment profits.  Or a paycheck.  Money makes it easier to go shopping with the proceeds of your human capital.  So we don’t have to barter.  Exchange the things we make for the things we want.  Imagine a shoemaker trying to barter for a TV set.  By trading shoes for a TV.  Which won’t go well if the TV maker doesn’t want any shoes.  So you can see the limitation in the barter system.   But when the shoemaker uses money to buy a TV it doesn’t change the fundamental fact that he is still trading his shoemaking ability for that TV.  He’s just using money as a temporary storage of his shoemaking ability.

We are traders.  And we trade things.  Or services.  We trade value created by our human capital.  From skill we learned in school.  Or through experience.  Like working in a skilled trade under the guidance of a skilled journeyperson or master tradesperson.  This is economic activity.  Real economic activity.  People getting together to trade their human capital.  Or in Keynesian terms, on both sides of the equation for these economic exchanges is human capital.  Which is why demand-side economic stimulus doesn’t work.  Because it mistakes money for human capital.  One has value.  The other doesn’t.  And when you replace one side of the equation with something that doesn’t have value (i.e., money) you cannot exchange it for something that has value (human capital) without a loss somewhere else in the economy.  In other words to engage in economic exchanges you have to bring something to the table to trade.  Skill or ability.  Not just money.  If you bring someone else’s skill or ability (i.e., their earned money) to the table you’re not creating economic activity.  You’re just transferring economic activity to different people.  There is no net gain.  And no economic stimulus.

When government spends money to stimulate economic activity there are no new economic exchanges.  Because government spending is financed by tax revenue.  Wealth they pull out of the private sector so the public sector can spend it.  They take money from some who can’t spend it and give it to others who can now spend it.  The reduction in economic activity of the first group offsets the increase in economic activity in the second group.   So there is no net gain.  Keynesians understand this math.  Which is why they prefer deficit spending (new spending paid by borrowing rather than taxes).  And playing with the money supply.

The End Result of Government Stimulus is Higher Prices for the Same Level of Economic Activity

The reason we have recessions is because of sticky wages.  When the business cycle goes into recession all prices fall.  Except for one.  Wages.  Those sticky wages.  Because it is not easy giving people pay cuts.  Good employees may just leave and work for someone else for better pay.  So when a business can’t sell enough to maintain profitability they cut production.  And lay off workers.  Because they can’t reduce wages for everyone.  So a few people lose all of their wages.  Instead of all of the people losing all of their wages by a business doing nothing to maintain profitability.  And going out of business.

To prevent this unemployment Keynesian economics says to move the aggregate demand curve to the right.  In part by increasing government spending.  But paying for this spending with higher taxes on existing spenders is a problem.  It cancels out any new economic activity created by new spenders.  So this is where deficit spending and playing with the money supply come in.  The idea is if the government borrows money they can create economic activity.  Without causing an equal reduction in economic activity due to higher taxes.  And by playing with the money supply (i.e., interest rates) they can encourage people to borrow money to spend even if they had no prior intentions of doing so.  Hoping that low interest rates will encourage them to buy a house or a car.  (And incur dangerous levels of debt in the process).  But the fatal flaw in this is that it stimulates the money supply.  Not human capital.

This only pumps more money into the economy.  Inflates the money supply.  And depreciates the dollar.  Which increases prices.  Because a depreciated dollar can’t buy as much as it used to.  So whatever boost in economic activity we gain will soon be followed by an increase in prices.  Thus reducing economic activity.  Because of that demand curve.  That says higher prices decreases aggregate demand.  And decreases economic activity.  The end result is higher prices for the same level of economic activity.  Leaving us worse off in the long run.  If you ever heard a parent say when they were a kid you could buy a soda for a nickel this is the reason why.  Soda used to cost only a nickel.  Until all this Keynesian induced inflation shrunk the dollar and raised prices through the years.  Which is why that same soda now costs a dollar.

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A Keynesian has an Austrian Moment

Posted by PITHOCRATES - January 15th, 2012

Week in Review

There are a few schools of economics.  The Keynesian school gain prominence following World War I.  Governments like it because it justifies big government.  And government interventions into the free market to ‘fix’ market failures.  Using the power of central banking and monetary policy.  And fiscal tax and spend polices.  With such interventions they believe they can eliminate or at least lessen the impact of recessions.  Because the architects of these policies believe they are smarter than market forces.

Another prominent economic school is the Austrian school.  Which favors limited government.  Low taxes.  A sound currency.  And where the government doesn’t use the central bank and monetary policy to manipulate currency and interest rates to interfere with market forces.  For they believe, as history shows, such interventions into market forces results in worse and prolonged recessions.

So that’s just a very brief overview of these two schools.  John Maynard Keynes was a Brit.  And very influential in Europe.  Where his policies are still embraced in these social democracies.  But even these devout Keynesians can have a moment of doubt and waiver in their beliefs.  Even chief correspondents in the most esteemed newspapers (see ‘Strangely Austrian’ posted 1/10/2012 on the Ney York Sun).

In any event, Mr. Rachman notes that Dr. Paul has recalled dining with Hayek and being inspired by Ludwig von Mises, “another economist of the Austrian school.” He writes that this explains Dr. Paul’s “otherwise baffling remark” after the Iowa caucus, in which the Texan said: “I’m waiting for the day when we can say we’re all Austrians now.” He calls Dr. Paul the “purest advocate of a powerful conviction on the American right that the US is afflicted by an over-mighty state.” He notes that “Paulite suspicion of central banks that threaten to debase the currency is powerfully echoed in Germany — where the Hayekian right is horrified by the operation of the European Central Bank . . .”

Mr. Rachman doesn’t predict which trend will set the tone for the new age. But he offers this confession: “Under normal conditions I would probably sign up with the social democratic tendency. The Tea Party is not my cup of tea.* [* His erstwhile king, George III, wasn’t all that crazy about it either.]  But I spent the weekend reading newspaper accounts of the ever more incredible figures that may have to be poured into the bail-outs for banks and countries in Europe. Then I turned the page to read of demands for more protectionism and regulation in the EU. For light relief, I then went to see ‘The Iron Lady’ — the new film about Margaret Thatcher. The whole thing has left me feeling strangely Austrian.”

Strangely, indeed. The importance of the column lies in the fact that Mr. Rachman is not just any scrivener. He is the chief foreign affairs commentator for the leading Keynesian newspaper in England. Here he is kvelling over Ron Paul and the Austrians.

The “we’re all Austrians now” line is a play on what Richard Nixon reportedly said when he decoupled the U.S. dollar from gold in 1971, unleashing double-digit interest rates and inflation.  He said, “I am now a Keynesian in economics.”  Which was a play on what Milton Friedman wrote in 1965, “In one sense, we are all Keynesians now; in another, nobody is any longer a Keynesian.”  Dr. Paul is waiting for the day when those in government abandon the failed policies of Keynesian economics and adopt the policies of the Austrian school.

Margaret Thatcher was British prime minister during the Eighties when Ronald Reagan was the U.S. president.  Who were both adherents to the Austrian school of economics.  And who both saw incredible economic growth when they were in office.  By following those Austrian policies.

After listening to Dr. Paul in the U.S. Republican primary race, reading some articles on the financial problems of Europe and the cost of their bailouts, the European Union’s demand for protectionism and regulation to protect their markets and then seeing the film about the Great Margaret Thatcher Mr. Rachman was given pause for thought.  Which often happens when you actually learn Austrian economics.  Because it makes sense.  And there is a lot of economic history proving the success of these policies.  But will it last?  Probably not.  Because Keynesians just like Keynesian economics so much.  Like a religion.  They accept it on faith.  And want to believe.

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