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The BBC is
running a three-part series
on notable economists, starting
with Keynes. There were a
number of errors made,
but I shall ignore those
and address two Keynesian fallacies. The first was that Keynes correctly anticipated the economic and political consequences of the Versailles Treaty,
which inflicted punitive reparations on Germany: this was true. It was bizarrely extrapolated to the current
situation, concluding that
Germany must reduce its prosperity and economic power
to a level closer to that of the other Eurozone countries in the interests
of economic balance.
The second point was that Keynes described unexpected changes in
economic behaviour as
"animal spirits". Mervyn King, Governor
of the Bank of England no less,
said on the programme that
it was the best explanation for the banking crisis five years ago. To describe such an event in those terms is
not an explanation and exposes a yawning gap in King’s knowledge.
"Animal spirits" amount to the failure of Keynesians to explain a basic phenomenon of human action. The
origin of the phrase, if the programme is to be believed,
comes from Keynes’s unsuccessful attempts to predict stock market prices. We have all been there: we invent a fool-proof
trading system only to see it fail
in practice. "Animal spirits" is a
substitute for understanding that
it is impossible to predict tomorrow’s prices with certainty,
whether they be of financial assets or of goods.
Prices change for one of two reasons. Either there is a change
in the value of the goods being
exchanged for money, or there
is a change in the value
of the money used. The banking
crisis to which King referred was about a sudden change in the value of
money.
Before the crisis,
banks were willing to lend, and consumers were willing to borrow to buy. The prerequisite was continually expanding credit, a process that was bound to end sometime. And when it did, the consequence
of a change in the availability
of money was an increase
in its value to the consumer, and the result was a fall in prices. "Animal
spirits" is an attempt
to summarise this effect without understanding it.
Left alone, prices would have adjusted to new lower levels. Government action was focused on stopping this happening, by introducing schemes such as car scrappage, or
cash-for-clunkers, to encourage demand.
At the same time central banks flooded the banking system with money to
stop its value rising. Prices were therefore
prevented from adjusting to the bursting of
the credit bubble. This Keynesian solution has another fallacy at its
heart, clearly stated by the experts, including
King, on the programme. They believe
that production has to be
subsidised in order to keep unemployment down. If
people remain employed, they will spend,
and that gets the economy back on track. This analysis is incorrect: as we have seen, the problem is prices,
not production.
The order
of events does not start with production, it starts with
consumption. If prices
are too high, because of a change in the value of money, then they must fall if consumers are to be tempted. The fall in prices exposes over-valued productive capacity. It is an adjustment that must occur, and no amount of subsidy and
money-printing to address "animal
spirits" can change that.
And the sooner it happens, the sooner an economy gets back on track.
The next
programme is on Hayek, which
should be less contentious
Originally published
on www.goldmoney.com
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