The End of the Keynesian Era
January 3, 2012
(This item originally appeared in Al Jazeera on January 3, 2012.)
New York, NY - The
beginning of the Keynesian Era can be dated, perhaps, to September
1931 - the year when Britain intentionally devalued the pound,
throwing the world into turmoil and currency conflict. Today, we are
again in an extended period of economic crisis. However, I suspect
that this will turn out to be the end of the Keynesian Era - the
time when it is, in fact, Keynesianism itself which destroys us.
"Keynesianism" is really just this century's version of
Mercantilism, which dates from the beginning of the 17th century.
There's nothing particularly new or original about it. Behind the
billows of academic obfuscation, it amounts to two policies:
exaggerated government spending in the face of recession, and some
sort of "easy money" policy. Although the term "Keynesian" has
become unfashionable, virtually all academics and government
economic advisers are Keynesians today.
The primary attraction of Keynesianism, I would say, is not its
wonderful overall results, but rather, that it provides a good
excuse for politicians do to what they wanted to do anyway. Any
politician knows that a certain way to increase one's popularity is
to hand out government money. In a recession, politicians are likely
worried about their declining popularity, and thus their first
instinct is to hand out more money. The Keynesian economists often
boast that the money can be spent on total waste, such as "digging
holes and filling them back up".
The other Keynesian trick is some form of "easy money" policy, which
usually results in a decline in currency value. Currency devaluation
can, in some cases, result in what appears to be a short-term
improvement in economic conditions. However, it is said that "you
can't devalue yourself to prosperity", and it is true. The countries
that have the greatest success in the long term, also have the most
stable, highest-quality currencies.
A basic effect of currency devaluation is to reduce real wages,
since wages are paid in a devalued currency. This can increase
"competitiveness", but it is easy to see that a strategy that
reduces real wages cannot create long-term prosperity.
'Easy money' policy
The Keynesian strategy - government spending, typically on waste,
and an "easy money" policy that amounts to currency devaluation - is
basically a kick-the-can strategy. Both policies are inherently
destructive, but can create what appears to be a short-term benefit,
particularly from the standpoint of a politician. Pursuing policies
that are inherently destructive, over a long period of time, will
result in economic decline.
When the Keynesian remedy was tried during the Great Depression, it
did not work. The Depression went on for year after year. In 1939,
President Roosevelt's Treasury Secretary Henry Morgenthau concluded:
"[W]e have tried spending money. We are spending more than we have
ever spent before and it does not work… I say after eight years of
this Administration we have just as much unemployment as when we
Japan has tried a similar approach for over 20 years now, and it is
not working there either.
Today, governments have not really followed the
hole-digging-and-filling routine of mid-century Keynesianism.
However, the idea that the government will attempt to fix
private-sector problems with the expenditure of vast quantities of
public money remains. So far, this has taken the form primarily of
filling the financial holes in bank balance sheets, so that private
investors will not take a loss on their earlier poor decisions.
To do so, governments have dug huge holes in the public balance
sheets. Several countries - Greece, Spain, Italy, Portugal and
Ireland - have already reached the point where they would have
defaulted if left to the private markets. Several other countries,
including Japan and Belgium, are not far from default, and even the
US and German governments are strong only in comparison to the
alternatives. The notion of spending your way to prosperity has run
into the brick wall of default.
This has made the Keynesians even more reliant upon their second
trick, which is some form of "easy money" policy. Today, this has
reached a degree that is unprecedented in the last century. The
United States, the United Kingdom and Japan have adopted "zero
interest rate" policies, and on top of that, they have undertaken
aggressive "quantitative easing" policies. The ECB is not far
behind: although their target rate is 1.0 per cent, the one-year
German government bond trades at 0.03 per cent. Expectations are
rising for the ECB to adopt some form of "quantitative easing", or
perhaps, even dropping this euphemism and buying government bonds
simply to facilitate government funding.
The result of this hyper-aggressive Keynesianism is that the values
of currencies around the world have steadily declined over the past
10 years. The best measure of this decline is their exchange rates
with gold. It now takes around five times as many dollars to buy an
ounce of gold as it did in the 1990s. This is not, I assert, because
gold has become more valuable, but rather because the US dollar has
become less valuable, as a result of these Keynesian money
Not surprisingly, it also takes about five times as many dollars to
buy a barrel of oil, about $100 today compared to $20 in the 1990s.
If you consider the overall effects of this for a moment, it becomes
clear that the real value of wages, pensions, bonds, stocks and
other assets are declining as a result of this currency decline. You
still can't devalue yourself to prosperity.
However, the negative effects have not yet been fully felt. With
dramatically negative "real interest rates", and expectations for
even more aggressive monetary easing worldwide, the trend towards
currency decline will likely continue and in fact accelerate.
When Europe's various acronymic efforts to borrow themselves out of
debt floundered recently, a near-universal chorus rang out: just
have the ECB buy the debt. The quantities were in the hundreds of
billions, and eventually trillions of euros. Even an economic
simpleton can see this is a recipe for total currency annihilation.
Yet, the supposed financial sophisticates were nearly unanimous.
I expect we will have our Keynesian crisis, in which several more
governments, including the United States, either default, or print
money to avoid a default. Currency values will probably continue to
decline, perhaps not so gradually as has been the case thus far.
Gold, which you could call the one currency that cannot be devalued
by a government, would seem to soar to great heights, when measured
in these plummeting bits of fiat paper. In fact, it would be
Eventually, governments will be incapable of either borrowing or
devaluing their way out of their problems. Then what?
Address the problems
If Keynesianism amounts to can-kicking, a better approach would be
to address the fundamental problems that are causing the crisis in
the first place, and to improve economic conditions in a broad
Contrary to popular imagination, a government default does not have
to be a big crisis. We are in fact quite accustomed to government
default, having much experience with it over the past few decades,
mostly with governments of emerging market countries. What happens
is: the borrowers and the lenders get together in a room, and decide
on a restructuring of the debt. Typically, principal is reduced by
about 50 per cent or so, which is what happened in the case of the
Russian default of 1998.
That's it. By itself, it is relatively minor. Just as declaring
bankruptcy can be a great relief for an individual, who is finally
free of his obligations, it can also be a relief for governments,
whose debt commitments are dramatically lightened.
A lot of the fears surrounding sovereign default are actually
related to the various stupid and economically destructive things
that governments often do in such a crisis. These might include such
things as: huge tax increases, capital controls, outright
confiscation of assets and currency turmoil. Countries can indeed be
ruined for decades as a consequence of these sorts of actions.
However, it doesn't have to be that way. What did Russia do
immediately following its default and currency collapse in 1998? In
1999, the government lowered the VAT rate from 23 per cent to 20 per
cent. That was a warmup for the biggie: in 2000, the government
passed a 13 per cent flat tax plan, implemented at the beginning of
2001. In 2002, the corporate tax rate was reduced from 35 per cent
to 24 per cent. In 2004, the VAT was reduced again, to 18 per cent.
Payroll taxes were reduced from a total of 35 per cent to 24 per
cent. In 2005, inheritance and gift taxes were eliminated. In 2008,
the tax rate on dividend income was reduced to 9 per cent from 15
per cent. In 2009, the corporate tax rate was again reduced to 20
Russia did not suffer a decade of misery after its default in 1998.
At the lows of that year, the RTSI stock market index hit a nadir of
38. By 2008, it had risen to 2487, an increase of 64 times! The
Russian government's reaction to its default - implementing a
barrage of growth-friendly policies - produced probably the most
economically productive decade of the last two centuries of Russian
Russia's GDP, measured in US dollars, was four times larger in 2008
than it was in pre-crisis 1997. This strategy is completely opposite
to the "austerity" approach of Greece and others today.
Insolvency of banks is a major part of our crisis today, and oddly,
nobody seems to know what to do about this. The solution is a form
of bankruptcy, in which the institution continues to function, but
the liabilities are restructured. In the U.S., this is known as
"Chapter 11" of the bankruptcy code. American Airlines has entered
bankruptcy, but its airplanes continue to carry travellers. General
Motors entered and exited bankruptcy, but continued to produce cars.
No public money is necessary for this. The idea that fixing the bank
problem requires a "bank bailout" and immense quantities of taxpayer
funds is wholly incorrect. Banks can regain their solvency simply by
swapping some portion of their debt liabilities for equity.
However, the government might have a role in organising this
process. In 1933, the US undertook a "bank holiday" of about two
weeks, in which insolvent institutions were reorganised.
"A currency, to be perfect, should be absolutely stable in value,"
wrote the economist David Ricardo in 1817. Even a brief glance at
the economic history of our own era shows that the most prosperous
countries are those with the most stable, reliable currencies, such
as the US, Germany, China and Hong Kong. Currency turmoil is
associated with economic stagnation and decline.
Before the Keynesian crisis is over, the US dollar, the euro, the
yen, the British pound and other once-reliable currencies will
probably be revealed as just so much-fiat junk.
For 182 years - 1789 to 1971 - the US had a stable currency policy
in the form of a gold standard system. This worked beautifully. The
country became the wealthiest and most productive in the world. The
last two decades of that period, the 1950s and 1960s, were some of
the most prosperous in US history.
However, the Keynesians have always hated the gold standard, because
it prevents them from engaging in one of their favourite pastimes,
currency jiggering. The floating currency system that emerged in
1971 is a reflection of these Keynesian ideas.
By the end of our crisis, we will probably see a worldwide rejection
of Keynesian funny money ideology. People will want to return to the
stable money principles of the gold standard era.
Today, government default, bank insolvency, and depreciating
currencies plague our economic environment. Humans seem to learn
slowly, and only with great pain and struggle. Eventually, I expect
the crisis to get so bad that all attempts to maintain the status
quo will disintegrate.
However, this would be the first step toward a much brighter future.
With Russia-like tax reforms, banks that have been restructured to
solvency without public funds, and a world gold standard system, the
post-Keynesian era should be a time of great prosperity.
Nathan Lewis is the author of Gold:
the Once and Future Money (2007), available in five languages. He
is an asset manager in New York.
The views expressed in this article
are the author's own and do not necessarily reflect Al Jazeera's