Was Keynes Incomplete?

Keynes, Government Spending, And You

One of the most notable economists of our age was John Maynard Keynes. There is a nice summary of his work here:


along with some of the discussion about how his generally pro-market bias has been diluted into a more social interventionist argument by subsequent reinterpretations and revisions.

There is even an entire site devoted just to him:


In this discussion, I’ll be referring to Keynesian Economics as commonly applied (i.e. with revisions) and not strictly as originally published. In particular, I’d like to focus on one of his major assertions: That in times of economic downturn, the government ought to borrow money and spend it to boost economic activity.

But first, a note on my biases: I was trained in economics with an emphasis on Keynesian methods. The primary text in my first 2 major introductory classes was simply named Economics by Paul Samuelson and leaned heavily to a Keynesian point of view.

It’s taken a while to get past that.

The Implied But Missing Bits

I don’t know if it was simply understood to be implied, or equally simply, left out. But I think there is a ‘missing bit’ in Keynes; at least as taught to most folks (and our politicians, if they have any economics education at all, have gotten the simple short form of “borrow and spend in a downturn” followed with a very large “period”).

What I think is missing: The key phrase is ‘to boost economic activity’. If a government borrows $100 and spends it to advertise how important government help is to the recovery, has it really boosted “economic activity”? The notion is that all expenditures are equal, but they are not. I would assert that $100 spent on investment is far more ‘valuable’ to economic activity than $100 spent on bread subsidy.

Yes, bread subsidy is good for the folks eating the bread, and good for the baker, but at the end of the day, most of the bread would have been made and eaten anyway. And also at the end of the day, the bulk of the value HAS been eaten. If the same $100 went to buying a bread maker, much more bread would be made over time and at lower costs. The effect would not be a fleeting increase in bread sales, but a long term increase in total bread available to all people. And increase in national wealth.

In a nutshell, that is the model of what I see wrong with the simple Keynesian “borrow and spend” prescription for government spending in times of downturn. It emphasizes consumption spending more than investment spending. If we all get a government check to go dig a hole in our front yard on even days and fill it in on odd days, all that happens is we wear out a lot of shovels and diminish our national wealth. “Shovel Ready” is a very poor way to select projects to fund.

There is an interesting article on the impact of such government spending here:


Private Enterprise Invests, Government Consumes

On CNBC they had a brief round table with Larry Kudlow mentioning a study that had found that for each $1 of government ‘stimulus’ you got 70 cents of gain. Basically, you lose 30% of your wealth in the process. I did not manage to write down the details in time, but I think that he said it was an IMF study on the efficiency of government spending on economic stimulation.

Any company that gets less than $1 per $1 spent ceases to exist pretty darned soon. Not so for governments.

But that is, IMHO, the reason for the persistent failure of ‘stimulus’ plans and at it’s root, the reason that The Socialism Shiny Thing always fails. (Eventually… Economies can take a generation to collapse, so it can be 50 years for a socialist government to “run out of other people’s money to spend” (to borrow a phrase from Maggy Thacher.)) The folks in government generally do not think about net wealth creation nor investment in economic capacity growth. They think instead in terms of bread and jobs. And jobs digging holes to fill them in are not wealth creating, nor is eating loaves of subsidized bread…

To the extent that some socialist or communist governments have emphasized investment over consumption, they have had very good economic growth and success (in an economic productivity sense). So the Stalin era of the Soviet Union had massive increases in economic output (and at horrific humanitarian costs as millions died…) and the present emphasis on economic growth in Communist China (with their odd blend of communist government with capitalist markets) has also had success. Yet, eventually, the people will demand their governments give them the goods. And that is when socialism falters.

Oddly, that seems to be the same thing that is driving the European Union onto the rocks and is causing the US to falter. That ‘voting for themselves the largess of the public purse’. So we have a massive “stimulus” bill that didn’t stimulate economic growth because it was not investment oriented, it was political payoff and bread & circuses focused. And we have Greek and Spanish stagnation as folks demand more bread and less bread makers.


So at the the end of this, I’d speculate that what Keynes ought to have made more clear was that the government ought to borrow and spend on investments that increase national wealth and productive capacity more than on bread and circuses.

That private enterprise is more capable of making good investment choices has been pretty well proven over time. IMHO, it is that divergence between political driven decision making and private enterprise driven decision making that is the foundation for the failure of The Socialism Shiny Thing over time; and the failure of capitalism using “Keynesian Stimulus” in market failures.

And that would explain such things as the present success in China (and why it’s a long term money maker, though the timing is important for trading in and out) and it would explain why I’m not seeing much worth investment in the USA under the present regime. By looking at the relative ratio of ‘public consumption’ expenditure vs ‘economic investment’ expenditure, you could know in advance what countries will grow and which will stagnate or collapse. Thus the BRIC (Brazil Russia India China) growth vs the European contraction and the USA stagnation.


About E.M.Smith

A technical managerial sort interested in things from Stonehenge to computer science. My present "hot buttons' are the mythology of Climate Change and ancient metrology; but things change...
This entry was posted in Economics - Trading - and Money and tagged . Bookmark the permalink.

33 Responses to Was Keynes Incomplete?

  1. CoRev says:

    EM, now that was a great article. As I read it I found myself agreeing and thinking in terms of expanding on some of your points. I agree mostly, but would clarify that the type of Govt spending is critical for impacting the economy, and thereby creating wealth and creating jobs.

    If you are correct (and according to the IMF article you referenced) it would appear that Romer’s multipliers are just wrong.

    The Bush stimulus plan was more successful because it emphasized short term business investment, tax cuts and included tax rebates. All impacted GDP early on in the recession. By stimulating early they reduced the pain and suffering.

    This stimulus has included tax rebates, direct payments to state and local Govts and shovel ready project investments. We felt the rebate impacts with almost an immediate GDP spike, and little continuing economic impacts. Most of the state and local funding went to pay for existing salaries, which continued the current status. Shovel ready project investments have taken over a year (as was predicted) to actually get implemented. This stimulus has done little to impact the economy and has extended the pain and suffering, only “saved” some state and local jobs, and delayed the investment phase by focusing on “shovel ready” projects that were funded via state and local Govt actions.

    So what we can see from the past two recessions are two Keynesian approaches to Govt spending used to stimulate the economy. One was clearly more successful than the other. In this case, success is measured by how deep and long has been the pain and suffering. Oh, and how much the debt has increased.

    Just my thoughts. YMMV.

  2. Don Matias says:

    Dear Mr. Smith:

    “… the government ought to borrow money and spend it to boost economic activity.”

    In modern and highly developed nations like the U.S.A. there aren’t so many projects that will “BOOST economic activity”. These nations do not suffer from a lack of roads, airports, seaports, electricity generation and distribution, communication networks &c. &c. Therefore government spending cannot >>boost<< the economic activity.

    I like to compare these deficit spending programs to installing an electric gate opener in your garage; it's certainly nice to have and slightly improves the garage but it will certainly not catapult the house and the lives of its inhabitants into an absolutely new and by far superior category.

    JAPAN did spend much deficit = borrowed money on its infrastructure – the effects weren't too encouraging, weren't they?

  3. Ken McMurtrie says:

    A great article.
    It seems to me that stimulus spending in downturns is constructive, even if debt sourced.
    To further qualify the type of expenditure my thoughts are:
    Even “shovel ready” handouts are useful if people out of work feed this money back into the business sector and pay their bills and mortgages.
    Similarly if government expenditure keeps their staff employed, the money should feed back into the system and keep other businesses running.
    However, by far the most long term effective expenditure, as you point out, is to create new jobs and inftastructure assets, adding wealth to the country.
    The most important thing of all, my pet peeve, is that such stimulus spending should never be allowed to fund the rich and powerful (including the rogue bankers) and absolutely never find its way overseas.
    A basic problem with a country’s economy is negative balance of payments and resulting loss of their own jobs and capabilities.

  4. Soronel Haetir says:

    Unfortunately an even more basic element of Keynes gets completely overlooked by our dear leaders. After the recession you’re supposed to pay off the deficit. You’re even supposed to save for the next downturn. Instead increased revenues are seen as cause to spend still more.

    Changing how the borrowed money gets spent would reduce the pain a little, somewhat like treating a hangnail but ignoring the cancer.

  5. Ken McMurtrie says:

    Borrowing money in itself is not necessarily damaging. It needs to be assessed in relation to repayment ability and asset value added.
    Even printing money that achieves a positive outcome might be acceptable if it didn’t cause inflation and devaluation, or caused only limited problems.
    In both these respects, I fail to comprehend the value of the $US not crashing under the present circumstances, I guess there is a lot of support because it represents so much in international assets. Nevertheless, in theory, it should be practically valueless.
    Or, does the current US borrowing and printing of money show that you can get away with it?
    Or, is it only a matter of time before the “S” hits the Fan?
    Or, maybe they can start another war?
    We live in interesting times.

  6. E.M.Smith says:

    The US Dollar is being supported by a variety of things, but mostly the drop in velocity of money. Inflation is a result of the V multiplied by Q (quantity). We’re pumping out Q like crazy via printing, spending, whatever. But V has hit the skids hard…. so no net inflation.

    Basically, the government stirring the pot in so many industries and so many law changes has businesses and just plain folks sitting on their cash and not spending. At the same time, reserve requirements are raised on banks, so they have to hoard more cash too. Basically, V is in the toilet, so Q can balloon without an inflationary collapse.

    At least until V picks up again as people start to spend…

    @Soronel Haetir: Exactly right! Kaynes said to spend what you don’t have in a downturn, but to pull money from the system and save it during economic spurts (so as to prevent bubbles like the housing bubble and the internet stock bubble and…) as that dampens inflation. Politicians always like to forget the second half of that equation…

    @Don Matias: While you are right, there is more to economic activity than infrastructure. We could have government spending on training machinists or making ‘grow your own garden’ kits and it would still increase national wealth rather than decrease it. Though IMHO, the best approach would be, as noted by CoRev, direct the money via tax cuts to businesses and they will allocate the capitol to wealth building and employment far more efficiently than the government ever could.

    To your point though: Yeah, not a lot of improvement from the typical govt infrastructure work.

    What got me thinking about this was watching a stimulus slush fund funded project in my front yard… The city has crews doing street work. We had some minor cracks in the pavement. I’d have just sealed them with tar and done a quick resurface (probably rolled gravel and oil). What they did instead was cut out slabs of road and leave 6 inch deep holes, then come back and fill them in with asphalt rock mix. All of it leaving square and rectangular lumps of patches instead of depressed cracking. Yup, digging holes and filling them in. I sure hope the put a sealer coat on the road (thought the placarded time is up…) because as it stands now, it just looks like swapping small random cracks for large rectangular slabs with cracks around the edge at the ‘join’…

    But the good news is that the economy of Mexico will now improve… (the crews appear to be be largely Mexican and the names on the trucks doing the work are Hispanic contractors – they get preferential treatment as ‘minority owned businesses’ in the contract bids…) So we’ll be assuring that money continues to flow to dependent families back in Mexico. (Most ‘undocumented workers’ in the USA send buckets of money home…)

    I wonder if our congress critters realize that we buy most goods from China so stimulating expenditures on ‘stuff’ will go to China while we import ‘shovel ready labor’ from Mexico for those jobs “Americans just won’t do”… so a lot of the labor ‘stimulus’ is headed via wire transfer to Mexico…

    (Sidebar: My mother was an immigrant. I was 12 or so before she became a naturalized citizen. I am not ‘anti-immigrant’. My ‘first second language’ was Spanish. I started to learn it at age 4 when I met the mexican kid from down the street. We stayed very good friends through high school – but lost touch after that. There were often ‘undocumented workers’ visiting his house. A place where I spent as much time as I did at home, and he at mine too. It was always a little unclear if his dad was legal or not… but the INS ‘green truck’ was cause for folks to scramble some times. I’ve been eating Mexican food most of my life, often at his house, and watching Spanish TV. I’m not anti Mexican. I’m just recognizing the facts and the truth on the ground. I also find it terribly offensive when folks say “Jobs Americans just won’t do” as I’ve done them. From picking peaches and walnuts and washing dishes on up. My mother was waiting tables most of my childhood. American’s will do whatever needs doing. For a fair wage. It’s just so terribly denigrating to the folks doing those jobs AND it’s insulting to Mexicans – to imply they are only wanted for scut work. But I do think we ought to invite new immigrants in through the front door rather than asking them to become criminals to gain entry.)

    So an added issue from globalization is that much of the Keynesian stimulus will no longer be staying inside our borders but instead will immediately head off shore. From talking with the guys working on my street, it was pretty clear some of them had not been here all that long. Their accents were pretty thick… and just try to find a shovel not stamped “made in China”… you can do it, but it’s pretty hard.

    At the end of it all, I’m not seeing where digging holes in my street and filling them in again (with asphalt) has stimulated the economy all that much. If the money had been left in my pocket instead of taxing it away; it would have been spent anyway. Though most likely on ‘dinner and a movie’ or the car. And I’m also pretty sure a simple sealer would have been fine on the cracks in the road. And if money were left in the pocket of local businesses, they just might have decided to expand and hire more folks… instead of hunkering down and hoarding their cash as they wait in fear to find out what the government will do to them next.

    So IMHO the added velocity of money from the stimulus, minus the Out Of The USA leakage, is less than the loss of velocity of money from businesses hunkering down. What the pork giveth, the tax beating taketh away… and we get not much of a change…

  7. CoRev says:

    EM Smith said: “And if money were left in the pocket of local businesses, they just might have decided to expand and hire more folks… instead of hunkering down and hoarding their cash as they wait in fear to find out what the government will do to them next.” Isn’t that the truth of it!

    How could any long term business decision be made in this anti-capitalist administration. Hunker down and wait it out seems to be the prevailing mood.

    Now, as to the Fed Govt saving, a rainy day slush fund, that is not possible. There just isn’t any place to put those excess funds. Clinton’s approach was to pay off the long term, high interest debt. That would work for a while, and when the debt goes away, where? Bush’s approach was to give it back, Y’ano the “tax cuts for the rich!” Both are valid approaches.

    BTW, if you are paying down the Fed debt, you are most times removing pension funds from the safest set of investments and forcing them into some less safe.

  8. Malaga View says:

    …for each $1 of government ‘stimulus’ you got 70 cents of gain. Basically, you lose 30% of your wealth in the process.

    And then you lose another $1 (plus interest) from the real economy so the government can pay off the debt of $1.

    Isn’t this really what economics has become all about for the west: killing the goose that lays the golden egg… it is a slow death falling down a spiral staircase… now we are waiting for the final straw that breaks the camel’s back… if it hasn’t been broken already!!!

    PS: I did economics as part of my degree in the 70s… and it was obvious then that they didn’t know what they were talking about… they kept on changing the rules to fit the latest reality. They were really just making it all up as they went along… and they used peer pressure to enforce their new theories and dogmas…. if you can’t convince them then confuse them… nothing really changes… except we are further down that spiral staircase.

  9. Malaga View says:

    Bread and circuses
    “Bread and circuses” (or bread and games) (from Latin: panem et circenses) is a metaphor for handouts and petty amusements that politicians use to gain popular support, instead of gaining it through sound public policy. The phrase is invoked not only to criticize politicians, but also to criticize their populations for giving up their civic duty.

    In modern usage, the phrase has become an adjective to deride a populace that no longer values civic virtues and the public life. To many across the political spectrum, left and right, it connotes the triviality and frivolity that defined the Roman Empire prior to its decline and that may contribute to the decline of modern society.


  10. reid simpson says:

    Another problem with government stimulus spending, even in the capital sectors, is that their motivation is all wrong (i.e., buy votes, political paybacks, good ol’ boys, etc.).

  11. BarryW says:

    The failure is in part because of a lack of feedback (consequences) to those making the decisions. This is where there is a divergence between capitalism and corporatism. The latter lacks an effective feedback mechanism to reward or punish actions from the top on down. Government suffers from the same problem. Smaller business works because there is a relatively quick feedback. You don’t sell your product you fail. GM can’t sell their product, they get bailed out. CEO’s go off with their millions and whine to their golf buddies about how unfair it is if they get canned. Same problem exists in all centrally planned systems. Red China has allowed feedback mechanisms to work to a degree so they appear successful. Japan has stagnated because they haven’t allowed feedback mechanisms to operate. The western governments have figured out that votes can be bought by expropriating money(taxes) and redistributing it back to the masses. No mechanism to stop or regulate it.

  12. Ken McMurtrie says:

    Whilst on the money subject, will some please explain why the government seems to think that a balance sheet is improved by lending money to a bankrupt system?
    If liabilities (debts) substantially exceed assets (money and fixed assets) the company is technically bankrupt and should cease trading and the directors restricted from trading, I thought.
    Applying a bailout loan increases assets and liabilities equally, although may change the ratio a little. The company is still bankrupt, yes?

  13. P.G. Sharrow says:

    Being a farmer and small businessman for near 50 years I don’t know much about economics. But I do know that having bureaucrats demanding greater and greater control of my activities is a real turnoff to my creating wealth for them to steal. That is why I “retired” from the wealth creation scene.
    China looks good at the present. Many command economies go through that and then collapse. When they start from the low base all they need to do is copy what works. But they have no second act and try to keep doing the same things. Fast up and fast down, China is going over the top right now.
    All bureaucrats any place in the world act the same and strangle the economy that they are shepherding by preventing change and progress. The longer that the bureaucrats can be kept weak the longer the civilization will last.

  14. Mooloo says:

    In modern and highly developed nations like the U.S.A. there aren’t so many projects that will “BOOST economic activity”. These nations do not suffer from a lack of roads, airports, seaports, electricity generation and distribution, communication networks &c.

    By most estimates the US is profoundly in need of a better road and rail system. Bridges are a particularly weak point for the roads, and the rail system is very poor compared to Europe.

    It can’t do much about power generation and distribution, because to take a oversight of those would be “socialist” and therefore political death to those who propose it.

    JAPAN did spend much deficit = borrowed money on its infrastructure

    Japan notoriously built “infrastructure” that was just digging holes, in the shape of roads to nowhere and excessively big bridges.

    Australia and New Zealand are investing in things like home insulation and broadband connections. They will not pay off directly, but will increase economic activity in the long run.

    Then again, both countries actually paid off debt during the good period and so are weathering the storm fairly well. I looked on in bewilderment as Bush and Blair were allowed to run up huge deficits at the same time. What were you guys thinking?

  15. CoRev says:

    Mooloo said: “I looked on in bewilderment as Bush and Blair were allowed to run up huge deficits at the same time. What were you guys thinking?” Dunno bout Blair, but Bush set out to offset the budget surplus, which were set to take excess revenue out of the economy forever. Few actually think that is/was a good thing.

    As far as Bush’s deficits, just as the first round of tax cuts were getting close to being passed to solve the excess revenue situation, the US was entering a recession and was attacked. So a deeper and extended tax cut was called for to stimulate the economy, and the US went on the offensive.

    Had the economy barreled along at the 2006 rate for 24 more months the Bush budget would have been, or close to be, balanced or in slight surplus. That would have duplicated the Clinton era performance while fighting a war, recovering from an attack and recovering from a recession.

    That’s what was going on in the US, but you would not know that because of our liberal pro-Dem press.

  16. Mooloo says:

    Had the economy barreled along at the 2006 rate for 24 more months the Bush budget would have been, or close to be, balanced or in slight surplus.

    Which shows how low the aim was! In good times a surplus should be taken for granted. That’s what good times are.

    NZ and Australia used large surpluses to pay off debt. Britain and the US spent all their extra money as soon as they got it.

    A person who behaved like Bush – not paying off debt when the going was good, just leaving it to be a disaster when bad times came – would be regarded as a foolish spendthrift. Why is he immune to this logic? (The Brits, at least, are waking up to Brown’s silly behaviour.)

  17. Dave McK says:

    Hi Chiefio. I see you’re on a topic I once was a serious student of.
    My take on Keynes:
    His earliest works were strict Adam Smith – and he had only one definition of inflation- the same one as everybody else- the printing of currency, full stop.

    However, like others before him, finding there is virtually no employment for an economist who rehashes the well understood fundamentals and that the potential employers are government seeking justifications, he was able to innovate a meme that was just what Attila ordered.

    Because it is the natural course of things that the cost and therefore price of all manufactured items decreases, as economies of scale are realized and as equipment is amortized, Keynes proposed that the government could actually inflate at a rate consistent with some computed average price drop – and the prices wouldn’t drop but the government could take the difference and call it ‘price stabilization’.
    The same people who loved Al Gore and Obama, basically, awarded him a Nobel prize for a nice bit of math to show how to do it- unless I’ve got this twisted, which is possible.

    This didn’t change the fundamental facts of economics:
    By debasing the currency – that is removing an explicit basis for it- the nature of wealth was dramatically changed.
    Wealth, as pursued by most of us, serves the purpose of accumulating for that rainy day or emergency or something bigger that needs saving up for. Formerly, wealth was a store of value. Once it became inflatable, it acquired an expiration date and a user fee. It no longer serves the original purpose and substitutes must be found for that.

    What it did change was the language used in economics courses and in the public forum.
    In a similar way, the language has been debased by artificial and deliberate inflation of verbiage- and I mean counterfeit.
    The terms ‘price inflation’ and ‘wage inflation’ and that damned velocity meme are ways to devalue the one single concept of inflation, which is counterfeiting, plain and simple.

    As long as he provided moral justifications to the thieves he had a top job. But Nixon still enacted price controls, didn’t he? Everybody knew better, including Keynes, but you can’t sell what the lone buyer isn’t buying.

    But this is important.
    there is no ‘my reality, your reality, personal reality’ – there is reality.
    there is no ‘wage inflation’, ‘price inflation’, velocityequation.of.inflation – there is counterfeit currency.

  18. Dave McK says:

    I think it’s important to understand that these guys make it up- it’s not for real – it’s only for you to believe – but don’t do it. Politics is the art of the plausible – not the realizable. This is their profession. Don’t fall for it every possible way or you might as well call them ‘husband’. You get what you pay for – you should understand what you are actually paying for. And stop doing it.

  19. CoRev says:

    MooLoo, I take it you are not from the US of A. Our current Fed debt stems from the our civil War 1861 and since. Don’t know where you reside, but there is an obvious difference in governance. We can not carry over surpluses. They get spent, annually or they pay down the current debt. Our current debt is mostly held by pensioner and pension funds, world wide.

    So paying down the US Fed debt is not just a simple exercise in payment. It hurts real people, by adding more risk to their long term savings.

    There’s so much more, but this is not a Civics class room.

  20. Jason Calley says:

    Hey Dave McK,

    If I were more articulate, I think I would have posted what you just said. YES! To make the game a little more apparent, we need to remember that politicians — including those politicians who are given the authority to manipulate the economy and the distribution of wealth — will ALWAYS make their decisions based on political considerations and valuations, not on what is best for the masses.

    I am amazed that no post on this topic has yet mentioned (for good or ill) the Austrian School of economics and Ludwig von Mises.

  21. E.M.Smith says:

    What were you guys thinking?

    Here, let me fix your punctuation:

    What? Were you guys thinking? …

    And the answer is clearly “no”…

    @P.G. Sharrow:

    Never met a farmer yet who didn’t have a better grasp of actual economics than everyone and anyone from a city… Especially “microeconomics” and input optimization in risk scenarios…

    A person who behaved like Bush – not paying off debt when the going was good, just leaving it to be a disaster when bad times came – would be regarded as a foolish spendthrift. Why is he immune to this logic?

    It’s not “A Bush Thing”… We’ve let politicians from both sides get away with that error for as long as I can remember. I think Reagan was the only exception post Kennedy. (And even Reagan spent like crazy. Not complaining, he basically brought down the Soviet Union by outspending them on guns…) Basically, IMHO, the average guy in the USA has NO idea what so ever how to manage money and the average politician has less (the politician has been told that Keynes said it’s OK to just print and spend…)

    @Dave McK: While I generally agree with the sentiment that debasement of the currency is the major effect of Keynes as applied today, I must take exception with the assault on the velocity of money concept. It is a very valid concept. It applies even if you use only gold as your currency. (There were various forms of economic collapse even on the gold standard, and these were often tied to changes of the velocity of money. It’s just a lot harder to manage it with gold as you can’t just whip up a few thousand tons with a pen…)

    One of the major arguments for paper currency was that when the velocity of money slowed down with gold, there was deflation (and that’s been shown to happen many times in history). If you think inflation is bad, you ought to try deflation…. Just ask what you would do if your mortgage was held constant and your paycheck was smaller each year… Yes, that happened as wages shrank. So by using a paper currency, the government could ‘better manage’ that deflation threat. (And it HAS worked very well for that…) The problem is that it makes it just too darned easy to abuse the currency (as also has been shown to happen many times in history…) and make inflation a constant process.

    So I find myself more or less in agreement with the conclusion (we need a currency tied to a fundamental of value that can not be printed at will, be it gold, silver, iron, an hour of labor, whatever) but for slightly different reasons.

    BTW, the ‘velocity of money’ meme is one of the most basic concepts of economics that can easily be demonstrated. If you have 10 beers made per month and 10 dollars, then the price of the beers will depend entirely on the velocity of the money. If it changes hands one time per month, the price would be $1 / beer ( 10 dollars / 10 beers). If twice the velocity, $2 / beer ( (2 x 10) dollars / 10 beers). And if everyone stuffs their gold dollars in the mattress, and only spends them over 2 months, then beer would sell for 50 Cents per each ( (10 / 2 ) dollars / 10 beers ).

    The only ways out of that process is for the beer makers to cut back on beers made ( a major consequence of deflation, that shutting down of production ) or for a heck of a lot of inventory to remain unsold each month ( another consequence of deflation and economic slowdowns). But if the market is to clear, the price must shift as the money velocity changes. (And it DOES change. It is a measured quantity and pretty easy to measure.)

    So I’d suggest not tossing rocks at the velocity of money concept, it’s pretty well proven. Even with gold. But rather point out that the ‘cure’ of a paper currency is worse that the ‘disease’ of business cycles. Besides, the government COULD still use Keynesian methods with a gold backed currency, they would just need to have gold flow out of Fort Knox during times of economic recession and BACK IN during times of surplus…

    Basically: It’s not the velocity of money concept that is evil, it’s just a description of what happens. Rather it’s the abuse of the money supply that is evil (and politicians are structurally unable to keep their hands off the currency printing press… )

    So paying down the US Fed debt is not just a simple exercise in payment. It hurts real people, by adding more risk to their long term savings.

    There’s so much more, but this is not a Civics class room.

    But I always liked Civics ;-)

    FWIW, if the US Treasury was not sucking up all those $Trillions they would flow into corporate bonds instead. Many of them are as secure as US Paper. The idea that the nation needs to be in perpetual debt so bond spreads on low risk bonds will be better for pensioners is, er, um, a bit of a stretch.

    @Jason Calley: I’ll consider doing such a post. I mostly look at the impact of Keynes as that’s what’s driving our political machinery these days. It has predictive power in markets… while the others are more interesting academically, the real market impact is lower in most of the world (due to a small number of politicians following that guidance…)

  22. Dave McK says:

    “It’s not the velocity of money concept that is evil, it’s just a description of what happens.”

    This is true.
    It is also true the PNAS made a list. If every single thing on their list be true, it doesn’t change the nature of the beast and what it was made to be used for.

    In application it is called ‘the churn’. Churning is a negative sum game.

    Lol @ deflation – it’s like taking the lead out of gas when you could have put none in.

    As a premise for scenarios – if it requires spending what I haven’t got and then owing for it- I’m not going to be able to subscribe. It’s bad economics. That’s really the first lesson everybody needs to learn. When the ‘science’ is all about rationalizing a violation of the first fundamental principle, it’s nonscience, eh? In fact, it’s anti-science.

  23. CoRev says:

    EM Smith said: “The idea that the nation needs to be in perpetual debt so bond spreads on low risk bonds will be better for pensioners is, er, um, a bit of a stretch.. But that’s really not what I said. I was just describing the reality of Fed debt. The last time we had none was before the Civil War.

    Doesn’t really matter. We are neither right or wrong, just differing view points or viewing angles. Loved the thread.

    G’day to Ya!

  24. Dave McK says:

    For a parochial perspective:

    The Congress had no other resource for funds than the creation of paper money; and notwithstanding the $100,000,000 which had already been issued had so depreciated that $742 in Continental bills were valued at only $100 in specie, they authorized, in their desperation, the issue of $50,000,000 more.

    so, time for another law:

    “That if any person shall hereafter be so lost to all virtue and regard for his country as to refuse to receive said bills in payment, or obstruct and discourage the currency or circulation thereof, and shall be duly convicted by the committee of the city, county, or district, or in case of appeal from their decision, by the Assembly, Convention, Council, or Committee of Safety of the Colony where he shall reside, such person shall be decreed, published, such treated as an enemy of his country, and precluded from all trade or intercourse with the inhabitants of these colonies.”

    Bunch of freaks just as mendacious as what you see on deck today, no?

    This story is very old. I remember reading about some single digit century oriental economist advising the monarch that debasing the currency (by plating – cladding the coins has been around for a long time. Diocletian killed the Roman ‘Owl’ with it back in 312) was causing all the specie of intrinsic value to be exported – an earlier observation of Gresham’s law from centuries past.

    In any case, there is only one reason for a monopoly on counterfeiting and never has been but one. The peripheral mythology gets an occasional new meme to replace a threadbare one. It becomes catechism and is there for open discussion and debate- but talk is even easier to coin than money, eh. That’s what it’s there for.

    It matters – but the question of value always requires a defined context, eh- so it matters to whom and for what?
    It is obviously not intolerable for the victims – or else they wouldn’t be tolerating it, would they?

    You know Marin; you know the rules. Whoever has the money already won. Game is over. It’s all about the handholding. Now we find out how much that vicitm card is actually worth with inflation…lol. Mmm, the taste of sympathy.

  25. E.M.Smith says:

    The thing you are talking about is “legal tender” laws. If you look on our present bills it says it is legal tender. That is backed up by a law saying so… (Still doesn’t get the jerks to take a $100 bill at the donut shop, though…)

    There is a pretty good literature about legal tender laws, too, including a quote from Greenspan (that I’ve had in prior postings) basically saying that you need a legal tender law as long as you use paper currency.

    It’s just one of those odd quirks of human behaviour that I can’t fully understand. I *know* that paper is worthless, but I use it… I was much happier in the days of silver dollars (and still have a batch…) and gold coins. But now I’m a dinosaur. Oh Well.

  26. E.M.Smith says:

    EM Smith said: “The idea that the nation needs to be in perpetual debt so bond spreads on low risk bonds will be better for pensioners is, er, um, a bit of a stretch.. ”

    But that’s really not what I said. I was just describing the reality of Fed debt. The last time we had none was before the Civil War.

    Doesn’t really matter. We are neither right or wrong, just differing view points or viewing angles. Loved the thread.

    OK, as a statement of practical impact, you are right. It would mean that retirement fund managers would have to look to corporates or foreign sovereign debt instruments. A tiny increase in risk, but also more gain.

    I’d still be happy with zero national debt.

  27. Dave McK says:

    Friedman flipped, Greenspan flipped – you should read those guys before they became ‘celebrated economists’. Pi radians.
    Smith and Von Mises would have passed their papers with no red marks.
    You should read Greenspan in Rand’s non-fiction. What he originally believed, he quickly chucked for a guru position.

    From economists they became confidence men. The Consumer Confidence Index is a very explicit recognition of this fact. The boys in the fed don’t have any delusions about the fact that they are operating a fraud. It’s their job to keep it going. The religion is named Monetarism.

    But if somebody gives me something for that holy token, it’s good for what it gets. If I were a hustler I’d seek a lot of dollar debt right now, converting it to something that actually does store value, to be able to pay it back with cheap stimulus inflated paper later.

  28. Jim Latta says:

    E.M.Smith. I like your blog and based on the comments posted, you seem to have attracted a quality audience. After a lifetime I’ve come to realize how much my government school education, through an MBA, was infused with pro-government propaganda. Pro-government propaganda is in our history books, economics texts, newspapers, magazines, television; practically everywhere. You may have repeated some of it when you wrote that Ronald Regan helped bring down the Soviet Union by out-spending them on guns.

    I think Ronald Regan was one of the best presidents in US history, but the fact is that socialism will always eventually collapse on its own. That the Soviet Union was able to last 70 years is a testament to the fantastic natural resources within the USSR and the stoic Eastern European people who were able to survived on practically nothing. My company sent engineers into the USSR countries for years before the collapse and their descriptions of the situation were horrible; shortages of everything, nothing worked and economies in shambles.

    We are now witnessing the collapse of the Greek economy. Their current governmental system only lasted 35 years. They have a unicameral legislature, in which the Socialist, New Left and Communist parties hold a combined total of 65% of the seats. Their prime minister is selected by the ruling (Socialist) party, so they don’t have the checks and balances we have in the US, allowing their government to highball their economy straight down the road to a socialist collapse.

    During the 20th Century it was clearly proven in many counties around the world that socialism doesn’t work in the long run. We even had wonderful controlled experiments in Germany and Korea, on different continents with peoples of vastly different cultures. We split these countries in two, making one part socialist and the other part capitalist. After about 35 years the capitalist part enjoyed a high and rising standard of living, while the socialist part was sinking into oblivion. Satellite today photos show much of Asia ablaze with lights, while North Korea is pitch black.

    The US started seriously down the road to socialism around 1913 with Woodrow Wilson. I don’t think we’ll make the 100 year mark. The national debt is ballooning out of control. Forget the idiotic CBO budget projections. In 1999 they forecast a cumulative 10-year budget surplus of $2.5 trillion, which turned out to be a $3.2 trillion deficit, and the Obama budget projections are just as impossible. Social Security started paying out more than it took in last summer and the shortfall will become an avalanche. Medicare costs are out of control and will become horrific under ObamaCare. Fannie Mae and Freddie Mac are both hemorrhaging money and will require trillions more. The FDIC is broke and spending billions a week bailing out failing banks. There’s not much press coverage yet, but the Post Office has become a financial disaster with over a million high-paid employees and pensioners, and hardly any mail to carry. The State of Illinois is not paying its bills because it’s out of money and California is close behind, as are other states with socialist economies. A number of state and local pension funds are only 20 – 40% funded and municipalities are starting to declare bankruptcy. Socialism is NOT an economic system which is viable long term.

  29. E.M.Smith says:

    @Jim Latta: I’m essentially in agreement with all that you said. (And in fact have said similar things in other places – often. Thought the N/S Korea and E/W Germany pair makes a really nice existence proof that I’ll “borrow”…)

    The only difference is over Regan. And even there I don’t think we are that far apart. What Regan did, though, was to convince the leadership of the USSR that it was simply not possible for them to keep up with our level of military growth by putting the foot down on the gas pedal and building weapons like crazy. Prior to that, they could point at the number of soldiers and tanks and feel some confidence. Regan made ’em sweat and made ’em realize that even with crushing poverty from the populace, they were still losing the arms race.

    I’m not asserting that was THE cause, simply the last straw. The proximal cause that pushed them over the edge.

    FWIW, I’m quite certain they would have collapsed without Regan, but I think it would have taken a further 10 years or so.

    For the USA (as I said on some other thread here – the WSW one?) it will all come down to the November election and the question of: will the people hobble the government enough to stop this train wreck.

    I’ve also commented on the various pension, medicare, medicaid, etc. costs under the name “Demographic bomb”. When it goes off, we collapse. What we have now is just the fuse sputtering… In fact, the whole takeover of the medical system is just an attempt to push out the Medicare collapse by about 5 more years. Obama even admitted so in a TV interview I saw.

    He fully understands that the purpose is to pull in more bodies that are healthy to pay for the costs of the infirm. He specifically said it was needed to prevent the collapse of Medicare / Medicaid. (And I’ve pointed out that the standard response of failing Socialism is to try to pull in more folks to find more of other peoples money to spend.)

    So the whole ‘game’ is to get the young folks who don’t need medical services much to pay for their ‘free’ medical care, and then use the money for the old folks who need it. Having already cut payments to below cost, and with more doctors not taking medicare patients, that had a crisis. They had driven the portion paid by non-government bills to double (as hospitals and doctors tried to hide the subsidy of Medicare/Medicaid patients in private bills). That created the ‘cost crisis’ that let them herd everyone into the socialized medicine tent. Now we pay for 4 years BEFORE we get benefits… In year 5 the crisis starts.

    BTW, I treat all budget projections as a complete work of fiction. They have no clue.

    Also, FWIW, anything said by a politician about ‘cutting’ is treated as a lie. I’ve gotten tired of trying to figure out if they are talking about the derivative of growth, the second derivative, the third… or a complete fiction. I’ll believe that they are ‘cutting the budget’ when I see the headcount in Washington drop by over 15%. And even then I’m going to be asking how much was just moved to contracts and contractors…

    My expectation is that they will pay all pension and SSI obligations with 100 cents on the dollar. Via a massive inflation. It hasn’t begun yet, but it will. It’s the only way out of the box they’ve built. So folks will get their $100,000 gold plated government pension, and it will maybe just pay the rent on a modest apartment. Then they can go stand in line at the Government Clinic for health care with everyone else… but they will have medical care ‘paid for’ by the retirement package…

    It’s going to be a mess. And nobody in government has the wisdom to see it or the stomach to deal with it. They will simply sit in denial as they drive this bus into the concrete wall.

    Oh, and I’m also pretty sure that one of the reasons for the desire to get more illegal immigrants in, is to have more ‘fresh workers’ to pay taxes to support the present population when the Demographic Bomb goes off. (And I’m OK with that, I just want them to come in via legal channels – no line cutting – and with needed skills – beyond being able to lie, cheat, trespass, etc. to sneak in…)

    So the game is pretty clear: Expand the number of “marks” so the Ponzi scheme can be played out One More Round.

    But it isn’t going to work.

    I’ve set my projection for the Ah Shit collapse at 2020. I give it 10 more years. They have ‘lifetime extension’ processes for the next 5, then it will take an added 5 of lag time for the inflation to build to out of control and the Demographic Bomb to have enough size and momentum.

    If we’re lucky, November turns it around. If not, well, maybe the best thing to do will just be to ‘pile on’ and accelerate the inevitable.

    The ‘wild card’ for me is if we have a Eurozone meltdown first. If Greece, Spain, etc. default and / or collapse then a European collapse would happen first, and likely accelerate the US one by a couple of years.

    In any case, it will be ‘interesting times’.

    I just wish I had a farm in Hill Country Texas and not a “lot” in a California metroplex. I can survive anything with a remote farm and a few acres…

    Basically, if The Tea Party supported candidates win, there is hope. If they don’t, we’re cooked. Start making contingency plans.

  30. Jim Latta says:

    E.M. Smith, I agree 100% with your excellent post, but let me hit one more lick at idea that we needed massive military spending to hasten the collapse of the USSR.

    History shows that numerous countries have collapsed economically because of the costs of fighting wars or trying to maintain too big a military. I’m afraid the US will join the list. Our government is currently spending something like $1.045 trillion/year to “protect” us from foreign attackers, through the tangle of agencies shown below:

    Department of Defense – $689 billion, Iraq and Afghanistan 2010 off-budget special appropriations – $137 billion, Department of Veteran Affairs – $88 billion, Department of Homeland Security – $52 billion, National Intelligence Directorate includes 16 different intelligence gathering agencies – $48 billion, State Department – $16 billion, Nuclear Regulatory Commission maintenance of nuclear weapons – estimated $15 billion, National Cemetery Administration & American Battle Monuments Commission – few hundred million. (Some of NASA’s $19 billion budget is “military”).

    Then there’s the human cost in terms of lost opportunities for productive contributions to the private sector and the death and disabilities suffered by our military personnel and costs to the states for various programs and tax breaks for veterans, and maybe their national guard.

    I think the most effective counter to the Soviet Union was our ICBM deliverable nuclear weapons and the Mutually Assured Destruction (MAD) doctrine. No country that possesses nuclear weapons and reliable means of delivering them has ever been attacked. This is because politicians are quite willing to send their citizens off to be slaughtered in wars. But, when they know that they themselves, and their families, might be the first casualties in a war, by being vaporized in a nuclear blast, they gain a whole different perspective on the advisability of getting into a war.

    Our military spending may have helped ensure that the USSR collapsed sooner than it otherwise would have, but if we wind up significantly hastening our own collapse, through massive military spending, I’m not sure it was such a good idea.

  31. E.M.Smith says:

    Don’t particularly disagree, other than the end. The only difference I see is that we ought to have ramped down more after the cold war ended.

    The USA takes about a 10% economic penalty for being policeman to the world. That 10% loss on a compound interest basis is a hugh shortfall in growth others do not have.

    The end game is being left behind economically. But not necessarily an economic collapse. The collapse part comes out of the deficit spending to support it AND the reduction of investment in productive capacity (i.e. our deindustrialization and shipping the productive capacity to China).

    So we could maintain our level of military expenditure IF we had maintained our level of R&D and Investment (i.e. growth of productive capacity). With the first curve rising or holding flat, and the second curve dropping, well, eventually you run out of other peoples money to spend on the military. Add in a massive increase in spending on ‘social programs’ and the end game comes at you ‘right quick’…

    Basically, in about 3 years China can simply say “If you would like your $Trillion this year, you need to not sell those airplanes to Taiwan and oh, leave that base in Okinawa… ”

    Now we won’t have to do it… we could always accept that we will not be able to provide medical care for Granny on the Chinese Credit Card… And if the $Trillion is withheld we would likely not have the money to support all the bases around the world anyway.

    We’re back to the basic “guns or butter” question, but with my twist of “guns and factories vs butter and farms”. As we raise the expenditures on Guns AND butter while we cut expenditures on factories and farms, and put the difference on the Chinese Credit Card, we end up with neither guns NOR butter when the card gets shut off.

    That our ‘leaders’ don’t see that does not give me much hope.

    And yes, I understand the arguments about “stop it over there and early or we will have problems over here and bigger”. IMHO, we need the ability to deal with any problem anywhere, but the discipline not to deal with all problems everywhere.

    Put more simply: I see no reason at all for the USA to give Israel and Egypt a few $Million each to not kill each other. Take our money and our folks and bring both home. Ditto South Korea. They have a thriving economy. Why are we there? Let them buy their own guns. I’m sure they have 30,000 folks who could use a nice army job. How about Europe? Why do we have ANY base in Germany? (I can almost see the case for the medical facility as time is of the essence…) Iraq? We’ve done our part. Hand it back to the Iraq people and leave. Africa? Not my problem. Ditto South America, Japan, etc.

    Put our Navy in our own home ports (San Diego, Seattle, Hawaii, New Orleans, New York, etc.) and base our troops where they can see their families each day. Then the money stays home. Make it a rapid deployment force and we can ‘whack-a-mole’ as needed.

    And none of this “Foreign Aid” that mostly amounts to bribes and corrupting other folks governments.

    So do some of that stuff, and make our own stuff at home for our own use, and we can tell China we don’t need their credit card…

  32. Jim Latta says:

    Right-on. And what really shows the insanity of maintaining something like 750 military bases in something like 132 foreign countries is that the US government just put up warning signs around a large swath of land in southern Arizona warming US citizens to stay out because of the danger from illegal aliens, because we don’t have the capability to protect our own border.

  33. Para starting “in a nutshell…” Keynes did not, as you suggest emphasis “consumption spending more than investment spending”. Nor does any serious economist. But if you think that is what Keynes said, let’s have the chapter and verse – preferably from his “General Theory”. It says nothing about this in the first link in the above article.

    Para starting “What I think is missing”. This para is irrelevant because neither Keynes nor any other serious economist has suggested that “all expenditures are equal”. So again, let’s have chapter and verse. Plus, again, it says nothing about this in the “summary” to which the above link leads.

    REPLY: [ I guess you didn’t read what I said, so I’ll quote it again here:

    “In this discussion, I’ll be referring to Keynesian Economics as commonly applied (i.e. with revisions) and not strictly as originally published.”

    So no, I’m not going off to search all his works to find where other folks have changed them in what is taught in classes to non-economists, such as the politicians who are making decisions based on the cut down simplified model they get; nor for evidence of how politicians have misapplied it. Simply look at what they are doing and you will see a lot of money going into non-investment purposes. All those signs telling us they are spending money to make signs, for example.

    Further down:
    “I don’t know if it was simply understood to be implied, or equally simply, left out.”

    So to clarify: I’m talking about how POLITICIANS apply Keynes, based on their one intro-Econ class (if they are lucky) or what they hear from ‘advisors’ if they are not so lucky. Not what Keynes original works might say (or my have implied but did not emphasize enough to stick in folks brains). So feel free to search all of Keynes works and post a specific citation of where he DOES say investments vs consumption matters to government expenditures macro impact. I’d love to have an addition that shows the version of Keynes taught in intro-Econ is seriously broken and in his own words. That would not change the thesis of this article in any case, as evidenced by how the present crop of “stimulus’ is focused on political favors and non-productive uses rather than wealth building investments. -E.M.Smith]

Comments are closed.