Closet Keynesians Emerge

One of the best tests for determining whether a financial columnist or a professional economist is a Keynesian is to examine his views on personal spending. If he favors an increase of personal spending as a means to stimulate the economy, he is a Keynesian. He may not call himself a Keynesian, but he is a Keynesian.

John Maynard Keynes believed that an economy could become a self-reinforcing economic depression because the general public saved too much money. He believed that the key to economic growth is not productivity, but rather spending. He did not believe that the price system is a reliable system of resource allocation. For example, he did not believe that the interest rate is a price that allocates investments and savings. He believed that it is possible that many people in the economy can save money by hoarding currency — not depositing it in a bank, where it is immediately lent. This, he said, undermined the interest rate’s role in equating savings and investments.

First, this observation is irrelevant in a world in which almost all currency is either deposited in a bank account or sent abroad, where it functions as a currency for black markets.

Second, hoarding currency pressures sellers to reduce prices. This acts as an incentive for people to buy more goods and services with their currency. The supposed excess of supply then disappears. Holding currency is a means of thrift. This thrift produces a positive result: lower prices and therefore greater purchasing power for the currency. This process was disparaged by Keynes as a liquidity trap. It was no trap. It was a benefit for holders of currency.

Keynes and his disciples had a solution to the liquidity trap: increased government spending and monetary inflation. This debases the currency, forcing hoarders to spend. The process by which this was accomplished, worldwide, was World War II. In the name of the war effort, every nation authorized its central bank to inflate.

This is what they are all doing again, in our Keynesian world, in which hardly anyone in the West hoards currency. Central banks are inflating. Governments are running huge deficits.


The Keynesian assumes that in a recession, the world is no longer suffering from scarcity. He believes that there are no remaining opportunities for profit in serving future consumers. The Keynesian believes that the central government must intervene and spend money in order to stimulate the economy. Expected private demand for future goods is insufficient to persuade entrepreneurs to invest money to meet this demand. The expected return on capital is zero. The Keynesian economist believes that the government gets money from lenders, and that by spending this money, the government can increase demand by consumers. This increased demand stimulates the economy. There will be economic growth, and therefore the government will reap a positive rate of return on its investments. This is what politicians are promising. “The government will be repaid.” It is a fantasy, but even if it comes true, this will benefit the government, not taxpayers.

Keynes was quite clear on one point: it does not matter what the government invests in. It does not matter if the government spends every dime on building pyramids. Or the government can bury paper money in jars, and hide these jars around the community. This way, individuals will have an incentive to go out and dig up jars of money, and therefore this will stimulate the economy. You might think I am exaggerating here, but this is specifically what Keynes taught in his supposedly magnum opus, The General Theory of Employment, Interest, and Money (1936).

If someone believes anything as silly as the Keynesian economic system, he is likely to believe that consumer spending, in and of itself, will create such demand that the economy will be reversed from its recessionary condition. He believes that if he can just persuade enough people to go out and spend money, no matter what they spend it on, the economy will revive.

The problem is, the only way that people can go out and spend money is to spend money that would have been used for saving and investment in producer goods. Or else the individual can borrow money to buy consumer goods, therefore redirecting save the money from an investment to consumption. One of the reasons consumers are so successful in reallocating money from investment to consumption is that they are willing to pay preposterously high rates of interest in order to continue spending. An entrepreneur is not likely to pay 18% or 24% per annum in order to invest in some project. A consumer is quite likely to do this, and millions of consumers do this every week. They pay outrageous rates of interest in order to buy goods that are worth half of what they paid retail if they try to sell these goods in the used goods market a month later. They are so present-oriented that they do not care much about the future. They want immediate consumption.

You might think that relying on consumers to bail out the economy is to place one’s hope in people with extremely poor economic judgment. These people are present-oriented. They are burdened with what Ludwig von Mises called high time preference.

The Keynesian believes that the key to long-term economic prosperity is spending, and if this requires deficit spending, so be it. It does not matter to the Keynesian whether a consumer with poor economic judgment goes out and spends his money, or whether a government bureaucrat with even worse economic judgment goes out and spends the government’s money on poorly conceived economic projects. The Keynesian is convinced that both of these individuals, despite their poor economic judgment, are capable of producing economic prosperity simply by spending money on what ever they find amusing.

Former Senator Fred Thompson has produced a low-budget guerrilla video parodying Keynesian economics.

Someone without an extensive understanding of the actual writings of Keynesian economists might find Thompson’s performance absurd. He would conclude that no one in his right mind would believe such nonsense. This conclusion is incorrect. Academic economists believe it, and so do the majority of people elected to Congress. They are going to prove just how much they believe in this theory over the next year. They have done so since September 7, and they are going to accelerate the amount of deficit spending in order to get the economy rolling again. This is straight Keynesian theory.

Keynes did not believe that individuals would respond favorably to encouragement that they spend more money during a recession or a depression. This is why he believed that the national government must intervene and run a deficit in order to stimulate the economy. He believed, correctly, that politicians and bureaucrats have much less restraint on spending other people’s money than individuals have with respect to their own money. This is why Keynes appealed to politicians to increase deficits in order to increase spending.


All around us, there are individuals who once proclaimed something remotely resembling economic sanity who are now proclaiming modified Keynesian doctrine. They are “spend now” Keynesians — not the real thing. One of the most flagrant examples of a turnaround in this regard is a video editorial by Ben Stein on the CBS news program, Sunday Morning. He said:

We are in a recession. People are being laid off right and left. Homes are being foreclosed in huge numbers. Detroit is teetering on the brink of disaster. There is a wild, palpable fear running amok in the nation. . . .

People are planning not to spend. They’re not spending. This is not a good idea.

For those of us who still have our jobs, who still have a few nickels to rub together, we should be buying like mad.

Stein then cited the source of his seemingly revolutionary idea: John Maynard Keynes.

Look, we’re faced with John Maynard Keynes called “the paradox of thrift.” If everyone is cheap and thrifty and doesn’t spend, the economy slumps and everyone is poorer, not richer.

This really isn’t rocket science. It’s part of what caused the Great Depression.

No, this was not what caused the Great Depression. Federal Reserve expansionary monetary policy in the 1924—29 period caused it. This was intensified by nations’ passing tariffs in 1930 that reduced world trade and shrank the division of labor. On this point, see Ben Stein’s high school teacher in Ferris Bueller’s Day Off. The script writer had it right. Stein does not.

So, for those of us who can still pay our mortgages, let’s tip the doorman double, get cashmere sweaters and flat screen TV’s for our kids, and trips to Palm Springs for our wives.

If we as a group (those of us who are still employed and have some money put aside) buy a lot this season, we could just kick-start this economy into a higher gear.

Stein distinguishes himself from the common-variety Keynesians, who in fact are the real thing.

That would be a lot faster than the public works projects that Mr. Obama is talking about. We, our own little selves, could keep big retail chains in business and provide a lot of employment for sales clerks, just for starters. . . .

If we can afford it, now is not the time to zip up the wallet. Now is the time to get out there and buy something and keep our fellow Americans employed and our beloved animals fed. If we wait for the bureaucrats to do it, it will take too darned long. If we do it ourselves, it will get done.

There was a time when Stein was a great defender of personal thrift. I clearly remember an article he wrote, probably 20 years ago, about how much he saved every month. He was forced to do this, he said, because he derived his income from selling articles and appearing as a character actor in movies. He had no way of predicting what his income would be in the future, so he said he was almost maniacal about saving money each month, just in case his income would fall in subsequent months. He published this personal testimony as an article in the tabloid, The American Spectator.

Stein was also a great proponent of investing in no-load stock mutual funds. For years, he insisted that the best thing that a person could do to save for the future was to buy a no-load mutual stock funds in a stock market indexes. He continued to recommend this through the year 2007. In another recent video editorial, he admitted that this advice had been wrong, and that anyone who followed it had lost a great deal of money. His only consolation was that professional investors had also lost a lot of money, and they had been paid far more money than he ever was.

His most recent editorial, on going out and spending money, is a consistent extension of his errors in the past. He never understood that the United States stock market is a gigantic Ponzi scheme. He did not understand that the increase in stock prices from 1982 to the year 2000 was based on a false premise, namely, that increased American productivity was sufficient to enable companies to repay investors handsomely in the future.

He ignored the obvious: dividends were generally low for the entire period. An individual could barely pay the supposedly low fees of their no-load mutual funds with the dividends he received. Profits were low for the entire period, leading to a very high price/earnings ratio of 40 in 2000 — 200 for the NASDAQ. It should have been obvious from this that the system was a Ponzi scheme. It relied on a greater fool buying your stocks at a higher price in the future. Those who got in early would profit; those who got in late would lose their shirts.

From March of 2000, this Ponzi scheme began to self-destruct. The stock indexes peaked in 2000, and if you discount for price inflation, all of the indexes are lower today than they were in March of 2000. That was the month in which I told my subscribers to get out of the stock market and stay out. It was obvious to me that the peak had taken place. It was clear to me that a 200 to 1 price earnings ratio for the NASDAQ could not be sustained. It was going to crash. It did: by 80%.

But the perma-bulls would not change their song and dance. They kept telling the lemmings to buy and hold an index fund of the United States stocks. This was suicidal advice in 2000, and it was even more suicidal advice in 2007. But the lemmings liked the story, so Keynesians kept preaching it, along with the Supply-Siders and Chicago School economists. Ponzi schemes eventually break down. This is why the stock market is down today.

Every system of investing that does not rely on the actual increase in productivity of the businesses being invested in to pay off all debts — whether bonds, certificates of deposit, or retirement dreams of long-term holders of the company’s stock — is a Ponzi scheme. It can be a government Ponzi scheme, such as Social Security or Medicare. It can be a Ponzi scheme by a state or local government, which promises enormous retirement benefits to state employees. It can also be a no-load mutual stock index fund. Ponzi schemes all have the same thing in common: future productivity will not repay the investors with sufficient money of constant or increasing purchasing power for the investors to achieve their goals. The investors have retirement goals which will be impossible to achieve by means of the investment strategies recommended by the experts. Investors believe the nonsense, and apparently their advisers believe it, too. Politicians get elected in terms of this nonsense. But it is nonetheless nonsense.


To tell American consumers that they can improve the productivity of the economy merely by going out and spending money is Keynesianism. It is utter nonsense. The only way to increase the productivity of the economy is through thrift. The money generated by this thrift must then be invested wisely, in terms of future conditions, so that the company or fund making the investment can reap a profit. If economy cannot do this through increased productivity, it will eventually find itself incapable of raising additional capital. Without additional capital, there can be no increase in productivity.

Economists are supposed to know this, but ever since the Great Depression and the publication of Keynes’s magnum opus, most economists have not believed this. They believe that we really can spend ourselves into prosperity, either through personal spending or through government spending. The Keynesian system is opposed to investing during recessions.

I can remember the slogan that was promoted by the government in 1958: “you auto buy now.” It was preposterous then, and it is preposterous now. The government today is lending money to Chrysler and General Motors because American consumers are not buying the output of those two companies. The government understands that it cannot afford to give every citizen enough money to go out and buy a new General Motors or Chrysler car, so it uses tax dollars to offer below-market loans to companies that would otherwise go bankrupt. This is the government’s alternative to relying on the general public to go out and spend money in a way approved by politicians.

The fact that professional economists have returned to Keynesianism — in the words of the Bible, like a dog to its vomit — should not surprise anyone. Professional economists cannot shake their faith in big government. They cannot shake their faith in deficit spending. They also cannot shake their faith in the power of government to increase productivity merely by spending money on boondoggles. They believe in government, and in government boondoggles, with the same kind of commitment that theologians in the Middle Ages believed in scholastic theology. They cannot think outside the box. The box is labeled: “Spend!”

The government is determined to thwart all attempts of individuals to save more money and therefore increase productivity. It is committed to the idea that the individual is unreliable in his commitment to deficit spending. There was even a slight uptick in the second quarter of 2008 in household savings. It rose by a little under 3% per annum. This was a reversal of recent years, when most American households did not increase savings at all. In fact, they actually borrowed a in order to maintain their spending habits.

Politicians and government economists look at this slight uptick in the rate of savings, and they are horrified. They want the government to intervene immediately, so as to counteract these economically rational decisions of American consumers to reduce their consumption and increase the rate of savings. No matter how little this increased rate of savings is, Keynesian economists and politicians are determined to offset this rate of savings by increasing government spending.

Where will the government get the money? Through taxes, through investors in government bonds, and through debt sold to the Federal Reserve system, which will create the money out of nothing. Despite the fact that Treasury bill rates actually reached zero this month, government economists and academic economists generally say that the government should run massive deficits in order to spend this money into circulation. Despite the fact that investors are getting nothing for their money, this is not enough to persuade government economists and politicians to let the economy alone. They want the government to spend even more.

Supposedly, thrift destroys wealth. “What we need is more spending.” The government is going to give us more spending. It is going to undermine investments in the private sector. It is going to move primary spending away from investing in into increased personal spending.

The result is going to be accelerating price inflation. While professional economists are wringing their hands in fear over price deflation, the Federal Reserve System has been increasing the monetary base. The government is waiting for banks to start winning the money to the general public instead of depositing the money with the Federal Reserve System. With the Federal funds rate target at zero, banks will soon start lending again.

The money supply will increase, prices will increase, and we will be back in the clutches of price inflation by the end of 2009. From that point on, price inflation is going to be the major problem in American economic life. The Keynesians will get their wish: spending without investing. There will be more money chasing a restricted supply of goods and services. The supply of goods and services will be restricted precisely because the government has intervened in the credit markets in order to stimulate consumption.

This is why the recession is going to last much longer than normal. It is going to be an inflationary recession. It is going to result in what was once called stagflation. This is what Keynesianism always produces. It is hostile to thrift; it is hostile to investing; and it is favorable to government deficits. The productivity that is needed to get us out of this recession will be restricted by policies of government spending.

The lemmings will not be convinced to spend more money until they see the prices are rising so fast that if they do not get rid of the money, they will be losers. That day is coming. It is not here today. This is why you can still buy bargains. It is still a buyer’s market.


Save now. Buy later. Buy assets that will rise in price because of increased monetary inflation.

December 31, 2008

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

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