The Keynesian Failure

[David Atlee]

From my blog at http://theatleeappeal.com/

I'm sure by now, most of you have at least heard of this economic idea known as Keynesian economics. What is Keynesian economics? Where did it come from? Who is using it? Why do you say it doesn't work? These questions and others are about to be explained. No, this is not about to be a boring economics lecture. Considering the current economic state this country is in, along with the policies being implemented to "fix" it, a quick study on Keynesian economic theory will give you an educational and intellectual boost. Once you have this knowledge in your head, you will get free drinks at any bar you start a conversation in. Now that I have your attention, here we go.

Let's first take a look at the beginning of the Keynesian model. John Maynard Keynes was a British economist in the early to mid 20th century. His career began to take off after he was assigned to be an advisor for Britain's financial department during the Treaty of Versailles after World War 1. After that role, Keynes became a highly successful stock trader during the 1920s, but saw his fortune collapse in the market crash of 1929. By the mid 1930s up into the 1940s, Keynes found himself in a battle between two men who were well known for their Laissez-fair capitalism theories (the exact opposite of Keyne's beliefs): Friedrich von Hayek and Milton Friedman - champion of the supply and demand equilibrium. Liberals' economic ideals come from Keynes while conservatives pledge their economic allegiance to the theories of Hayek and Friedman.

Now that the fun stuff is behind us, we can take a look into the meat of this thing. This is the basic idea behind Keynesian economics, or commonly known as ''The Keynesian Multiplier": For every dollar the government spends, the GDP will increase 1.5 times that amount. There is more to Keynesian economics than the notion that the only way an economy can grow is through government spending. Investopedia lays out the groundwork for another Keynesian ideal:

Keynesians wanted to counteract saving by taxing savings to force people to spend more. The Keynesian model arbitrarily separated private savings and investment into two separate functions, showing the savings as a drain on the economy and thus making private investment look inferior to deficit spending. Unless someone holds his or her savings entirely in cash – and true hoarding like this is rare - it's invested either by the individual or by the bank holding the capital.

Is any of this starting to sound familiar? What do we keep hearing from Democrats in Washington? Spend! Spend! Spend! According to Obama, if he didn't spend all that money from the $785 Billion stimulus plan, we'd be worse off now than if he didn't pass it.

What are some previous examples of Keynesian-like economies that have failed in the past? We can trace the first example back to Germany via 1930s. Now, before some of you jump out of your chairs in offense, take a deep breath. This next part is strictly looking at Hitler's economic policies and nothing else. Llewellyn H. Rockwell is the chairman of the Ludwig von Mises Institute in Auburn, Al. He puts in detail for us what Hitler's economic policies were:

He suspended the gold standard, embarked on huge public works programs like Autobahns, protected industry from foreign competition, expanded credit, instituted jobs programs, bullied the private sector on prices and production decisions, vastly expanded the military, enforced capital controls, instituted family planning, penalized smoking, brought about national health care and unemployment insurance, imposed education standards, and eventually ran huge deficits. The Nazi interventionist program was essential to the regime's rejection of the market economy and its embrace of socialism in one country.

Keynes was fond of Hitler's economic interpretations because they rejected the notions of free-market capitalism and focused heavily on a government charged economy. These are the types of economics that led into the slave-type state of Germany. All of German's citizens depended on government. Do you see a similar pattern with the welfare state in America?

What about the most famous example of failed Keynesian theory? Let's look at Japan's lost decade. Japan experienced an asset bubble back in 1989 similar to what we faced here back in 2008. Land prices tanked and banks were left with bad loans as far as the eye could see. Japan began its first rounds of massive stimulus programs in the early part of the lost decade. According to the American Enterprise Institute for Public Policy Research, the stimulus's increased GDP by 1% in 1994 and 4% in 1997. However, like all government spending projects, they are only a sugar rush. The theory is fundamentally flawed because in order for the government to spend money, it must first take that money out of the private sector which results in a zero-sum game.

According to the same publication, Japan raised consumption taxes from 3 to 5% in 1997 in order to combat the massive debts from massive stimulus programs. Connecting the dots yet? Japans economy collapsed again only one year later in 1998. What do we hear from Washington right now? The idea of a VAT tax, taxes on energy in order to go green, eliminating the Bush tax cuts, raising capital gains taxes, health insurance mandates, and the list goes on. What also do we here from Washington? "Spend, spend spend!" "Republicans only care about the debt". Since when did reading history go out the window for our leaders? Democrats in Washington adore the Keynesian economic theory. Yet, history has proven time and time again that this form of economics does not work.

What does work? Laissez-fair capitalism. This is what brought America's economic boom between the late 1940s and early 1970s. Then again in the 1980s through the early 90s. This theory is centralized around the theory of market induced supply and demand. The price of a product whether it be a commodity or job is directly tied to this equilibrium. The beauty with this theory is that markets always correct themselves. Take any commodity as an example. The price of commodity X is directly tied to the supply of that product and how badly people want or need it. If there is a huge demand, the price will continue to rise until it reaches a point where buyers find the price above its worth. This is how investing works. Investors find undervalued assets that will have a high demand and buy in early. The price of that product rises, and they sell out when they believe the price nears an unsustainable level. Once the price reaches critical mass, demand drops along with price. And then the cycle continues.

This is not how the previous housing bubble burst though, to a degree. The demand for housing was hyper-inflated through government initiatives which encouraged home ownership. You had, in affect, an artificial bubble even though supply and demand played a large role. Now where are we? Supply is way ahead of demand and the asset value has crashed. Sadly, politicians do not find a need to study the past in order to make decisions that are beneficial to the state of the union. Politicians make political decisions only on the basis of re-election from their constituents. If Obama, Reid, Pelosi, and some Republicans spent only 5 minutes a day addressing the concerns of the citizens, Keynesian-like economics would not even be a thought in their economic recovery efforts.