By Francis Lee for the Saker Blog

A person sitting under an umbrella Description automatically generated with low confidence

Francis Lee -Taking a beer outside of the Donbass Arena – Donetsk 2010

Readers should bear in mind that I wrote the following below in 2008-09 when the global economy was in its recovery stage; a stage of convalescence after the fever of the 2007/08 boom-bust economic phenomenon.

Suffice it to say that the much vaunted ‘recovery’ was to run its course but eventually ran into phase 2 of an all-together more comprehensive debacle which started in approx. 2019-2020 and which is now in a full-blown economic downturn of global proportions. There is no way that the deflationary collapse which has now started is avoidable. This is because it has been deliberately orchestrated by the global powers-that-be: starting with phase 1 the Covid – possibly a largely manufactured crisis, but now the lockdowns with the subsequent devastation on the SME’s (small and medium enterprises, some 50% of the economy) this constituting a war on global growth and the hollow promise to ‘Build back better’ the cliché enunciated by almost every political leader in the Western world and also mouthed by the IMF, WEF, BIS, Central Banks and of course not forgetting the indispensable role played by a housetrained media. A cosy little utopia is now promised to all of us by the likes of Klaus Schwab with his reassurance that in the promised land ‘’you will own nothing but be happy.’’ But of course!

The critique of Keynes and Keynesianism from the outliers of political economy: The Austrian school and the Marxists.

If you are in favour of capitalism, then you must accept it warts and all.

British political economy’s evolution was based upon the lineage of Smith-Ricardo-Marshall and J.M.Keynes; Marx being left out, for political reasons although he belonged to the classical British tradition. Up until the 1970s Keynes contributions formed the bedrock of all economics in both academia and the political and financial establishment. Although challenged in the 1970s by supposedly free-market doctrines espoused by inter alia, the late Milton Friedman and his co-thinkers it seems that Keynes’ theories still hold sway, at least in the Anglo-American world.

Briefly stated Keynes argued that during an economic downturn – for which he had no convincing explanation – aggregate demand would fall and that this would result in increasing unemployment, falling output and a general idling of the factors of production. Since consumption was regarded as the driver of production, if followed any fall in consumption would result in the economy operating within the production possibility frontier with actual output falling short of potential output. This he described as an output gap, in this instance a deflationary gap. See figure 1 below.

UserFiles/Deflationary Gap

Aggregate demand has fallen from E to A causing a contraction in national income from Yf to Y. To close the deflationary gap, it is argued that the government can raise the expenditure – government action being necessary since the private sector was neither consuming or investing – by investing in public works or tax reduction (fiscal policy) or lowering interest rates (monetary policy). This would raise aggregate demand from A to E and therefore restore full employment. This was the theory – a theory set down in his magnum opus The General Theory of Employment, Interest and Money first published in 1936.

Thus, it was argued that the trade cycle could be tamed, although never completely abolished by using macroeconomic instruments and policies as advocated by Keynes. To be fair, however, Keynes, though advocating government deficits in times of economic downturns, also advocated tightening up of monetary policy and tax increases in periods of high growth.

There was a reaction against Keynes when his policies seemed to be failing in the turbulent inflationary years 1971-1981, this counter-revolution was led by one Milton Friedman with an updated version of the Quantity Theory of Money, i.e., that increases in the money supply would give rise to inflation. (The weakness in this theory was that the velocity of monetary circulation was left out of the theory.) It was argued that therefore government intervention into the economy, particularly deficit financing should be eschewed. For a time, this new doctrine was all the rage. It would be wrong, however, to see this apparent shift of opinion as representing any kind of ideological watershed. For in reality the neo-liberal ‘revolution’ of the 1980s did not amount to a complete rejection of the Keynesian consensus that had dominated policy during the post-World War II era. Markets were indeed liberalised and globalised, giving the corporate sector (and finance in particular) much greater freedom to seek out profit-making opportunities. But what did not change was the official presumption that governments need to intervene in markets so as to support economic growth and financial markets. Indeed, it is ironic that the ‘supply-side’ strategy – based on cutting direct taxes – which was the core of Reaganomics applied in the US in the 1980s, was essentially a form of Keynesian-style deficit financing designed to stimulate growth, although few noticed this at the time. What was undeniable is that it signally failed to bring about the sustained revival of growth anticipated by its advocates, although it did result in a doubling of US public debt and helped precipitate a financial and property market bubble and bust by 1990.

But arguably the most pernicious aspect of this global liberalisation and deregulation of markets was that it reinforced rather than reversed the culture of corporate dependence on state support, which was the legacy of the post-war Keynesian era, when policy makers everywhere were driven by the idea that market intervention and support of the private sector by the state (of which the Marshall Plan of the 1940s is the classic example) was justified in order to sustain growth and employment. Although by the 1980s this view had been ostensibly abandoned – along with the restriction of cross-border capital transfers and regulation of such matters as employment and environmental standards – few were inclined to demand a corresponding withdrawal of state subsidies and protection for the private sector, least of all those corporate interests which benefited from this public largesse, and which largely set the political agenda. Hardly anyone appeared to recognise that by retaining such interventionist practices while adopting a more laissez-faire ideology, governments were creating a climate of ‘moral hazard’ – encouraging big corporations to take undue risks in full confidence that they could count on the state to help artificially boost their profitability or bail them out in the event of destabilising failure.

No, the really damaging critique of Keynes came from the so-called Austrian school, whose theories were espoused by Von Mises and Von Hayek – the latter being Keynes archenemy who taught for a number of years at the London School of Economics. (Strangely enough both were good friends.) The Austrian school believe that attempts to control capitalism through state intervention will fail and will in fact be positively counter-productive. This is because such interventions distort the price mechanism leading to misallocation of resources, inflation, and asset price bubbles. Price formation is (or should be) a function of demand and supply and prices cannot be determined in advance. Any attempt to determine prices in the absence of the demand/supply intersection is little more than guesswork and can, and often does lead to malinvestments and misallocations of resources. A good example of this would be the credit/property boom which was enabled by the accommodative actions of the central banks and Treasuries around the world, but particularly by the Bank of England and the US Federal Reserve Board, who substituted themselves for market forces and decided that interest rates should be set artificially low. Interest rates were kept low and both heads of the two respective central banks as well as Treasury officials, Gordon Brown, and Edward ‘light touch regulation’ Balls in the UK, and the Fed boss Alan Greenspan in the US. Artificially low interest rates meant private investment decisions by businesses and individual mortgage borrowers were made on the basis of guesses by central bank officials. Thus, if the interest rate is lowered to zero, or near zero, investment looks a viable option. This means that investors will pile in and drive up the price of – in this case housing – which means that the price signals are telling future investors to get into this market as there are gains to be made. And so, it goes on. This is called a bubble or asset price inflation. The price signals were wrong since the base rate was not arrived at by supply/demand market forces but by bureaucratic fiat. There thus occurred a massive overinvestment in housing with the resultant misallocation of resources into house building. Moreover, many individual investors and consumers had gone deeply into debt believing that house prices would not fall and that their speculations could bring them untold riches. The temporal anatomy of a bubble as shown below

Thus, the natural cyclical tendencies immanent in the capitalist system were thus given an additional push by government monetary policy. Why? The answer is disarmingly simple: booms and bubbles (at least during the up phase) are popular with the masses and are therefore good politics. Who can ever forget ‘the-end-of-boom-and-bust’ triumphalism of the period? Furthermore, booms and busts are intrinsic to the system. One cannot exist without the other. During the boom phase of the cycle investors and consumers tend to become overconfident and make foolish investment and purchasing decisions. Prices start to rise due to the continual demand for factor inputs, growth becomes more and more febrile, banks make foolish loans (Northern Rock comes to mind), and then, when rises in income can no longer support rises in asset prices, the whole thing collapses. This is what happened in 2007; the bust part of the cycle begins. All the bad investments and overspending now come to light. Companies go bust, unemployment mounts, debts are written down simply because debtors cannot pay, and all the misallocations of resources can clearly be seen with half-finished empty houses standing as the self-evident physical symbols of the manic bubble period which preceded them. Here Andrew Gamble explains:

For the Austrians the business cycle had a necessary and important function within capitalism. The crisis phase of the cycle was crucial if capitalism was to renew itself and purge itself of the false values and the misallocation of productive resources which had grown up during the boom phase. The crisis was a moment of truth, when suddenly the plans, the claims and the expectations which had been formed during the upswing were put to the test. Many of them would be found wanting, and those responsible for them would have to face the consequences. The process was not just to keep capitalism efficient; it was also necessary to keep capitalism moral. Only if agents bore full responsibility for their actions would the values of prudence, reliability and sound judgement and trust, on which capitalism relied, be upheld. The crisis purged capitalism in a double sense: both practically and morally. To many of its defenders the two were equally important. It was what gave capitalism its moral legitimacy and its practical dynamism. (The Spectre at the Feast – Andrew Gamble)

Recovery would not be achieved by bailouts, Keynesian deficit spending, or by rescuing companies which were simply inefficient or did not supply consumers or investors with their preferences as demonstrated by the market price mechanism. Such policies would simply create ‘moral hazard’ a tendency for investors and consumers to carry on as usual with losses being underwritten by the state; in this situation there was no intention or incentive for improving their business efficiency. These bailed-out entities were the economy’s living dead, kept alive on state support – zombie banks as in Europe and Japan and zombie auto companies like Fiat, Kia, and GM, or insurance companies like AIG, all of which should have been allowed to fail. With their failure more competitive efficient companies would arise in their place. So, it was argued.

Recovery could only get underway when, as during classical depressions, prices fell, which meant that if wages and interest rates fell more slowly – if at all – then disposable income would start to increase. This being the case consumers would start to spend again. Similarly bankrupted and distressed firms would be bought out at fire–damage prices by the more efficient firms with more up to date equipment. Growth now resumes given the destruction of existing capital values. The process of accumulation can restart.

The anti-deflation policies which have been adopted (i.e., Keynesian demand management) is largely a policy of price-fixing, a policy of preventing the market from exposing capital misallocations and then liquidating them. The root causes of the crisis remain in place and the underlying problems un-addressed … The economy cannot realistically be expected to rectify itself if the market is not allowed to liquidate capital misallocations. The state has erected a protective fence around the most dislocated sectors of the economy (house prices for example) trying to keep market forces outside. As long as it lasts no true recovery is possible. (Paper Money Collapse – Detlev Schlichter).

Summing up, capitalism is intrinsically cyclical. The Growth periods tend to run out of control resulting in bad investments and resource misallocation. This process is fed by easy credit and excess liquidity. Asset price inflation rises to a level which can no longer be sustained by rises in income or further borrowing. The boom turns into a bubble and the bubble bursts. Then the whole process swings into reverse – the bust has arrived. However, the bust rectifies the situation by liquidating all the mal-investments and making way for a reconfiguration of the system on a more sustainable and efficient basis. Capitalism restructures itself through these types of crises.

Although the Austrian (and indeed Marxist) analysis of the bust is, I would argue broadly speaking correct, but the policy prescriptions of the Hayekians seem frankly alarming. The scope and interdependence of the system is such that the notion of simply letting the bust take its course would lead to quite massive economic, political, and social dislocations on a global scale – a catastrophe which would dwarf the depression of the 1930s. In a strictly logical sense, the reasoning of the Austrian school is correct, but their policy prescriptions are simply too terrible to contemplate.

The Libertarians are actively promoting policies sure to bring about immediate economic hell, in the faith that punishment and suffering are the prerequisites to an economic afterlife in a better world. While in the end their philosophy of economic karma may ultimately prove correct, before accepting the remedy through collapse, other approaches should be put to the test. Economic reincarnation could take a lot longer than the Libertarians anticipate. The Renaissance did follow the fall of Rome – but only after 10 centuries. (The New Depression p.105 – Richard Duncan). So, what about the alternatives.

Keynes and his followers

Well, I think we need to clear up one or two things about Lord Keynes before we start. Keynes was emphatically not a socialist, if anything he was actively hostile to socialism. He opined that: The class struggle will find me on the side of the educated bourgeoisie. (1925). We might legitimately enquire who, apart from Keynes himself, might the ‘educated bourgeoisie’ be exactly! Further, The Labour party is a class party, and the class is not my class (Am I A Liberal – in Essays in Persuasion p.297). Again, How can I adopt a creed – Socialism – which, preferring the mud to the fish, exalts the boorish proletariat above the bourgeois and intelligentsia who, with whatever faults, are the quality in life and surely carry the seeds of all human advancement. (A Short View of Russia – Ibid.) It seems necessary to state this since of the widespread belief on the left the Lord Keynes was indeed some sort of (closet)-socialist. This could not be further from the truth: Keynes main aim in life was to save capitalism from itself.

Keynes’ magnum opus, The General Theory of Employment Interest and Money first published in 1936, represented the culmination of his earlier writings in which he elaborated what he believed to be the problem situation which had arisen in the world economy during the 1930s, and what he believed to be the solutions. Keynesianism is not really a theory of the trade cycle, nor is it a general theory (more of which later) it is more a theory of bust and possible ways out of economic depressions. The bust period in a capitalist economy generally follows a period of excess credit and hence debt-fuelled growth. This was the case during the roaring 20s with runaway credit (debt) fuelling growth until – pop went the weasel! Credit duly contracted as the defaults multiplied, and so the Roaring 20s transmuted into the depressed 30s.

In 1930 the US money supply comprised currency held by the public (9%) and deposits held at commercial banks (91%). Banks used these deposits to fund their loans. When the credit that fuelled the Roaring 20s could not be repaid, the banks began to fail. When a borrower defaults it not only destroys credit, but it also destroys the deposits which funded the credit. Between 1930 and 1933, 9,000 US banks failed. The corresponding destruction of deposits caused the country’s money supply to contract by a third from $46 billion in 1928 to $31 billion in 1933. As the money supply shrank the happy economic dynamic that expanding credit had made possible, went into reverse, and the global economy spiralled into catastrophe. (The New Depression – Richard Duncan pp.121)

Post-crash, the problem was not excess demand but insufficient demand. This became known as debt-deflation. This is where Keynes and his co-thinkers entered the scene. With consumers and investors not spending, aggregate demand in deflationary conditions is flat, or even falling. Therefore, the solution could only be increased spending by the government. This to be carried out by a mixture of monetary policy (lowering interest rates and Open Market Operations, now referred to as Quantitative Easing – QE) and/or fiscal policy (taxation and public spending). This is of course something of an oversimplification of Keynes’ theories which were somewhat more radical than most of his enthusiasts found to their taste, but it broadly captures the gist of what he said. The increase in aggregate demand would feed through to the rest of the economy and so induce an increase in output which would be eventually self-sustaining. Governments would find it necessary therefore to run budget deficits during this period. Q.E.D.

This approach was taken up by the Roosevelt administration when it came to office in 1933. At that time unemployment in the US stood at the alarming figure of 25%. A raft of policy measures including the Works Programme Administration (WPA), National Recovery Act (NRA), Tennessee Valley Authority (TVA) Civilian Conservation Corps, were implemented. Unemployment fell to 14% by 1936, but then rose again during a new recession in 1937/38 to 20%. So, the track record of Keynes policies seems patchy to say the least.

In our own time we have seen almost a repeat of the 1930s debacle. The long boom of 1980-2007 was floated on a sea of debt. Of course, it could never last, and it didn’t. This ‘recovery’ was based upon low to zero interest rates, massive expansion of the money supply, large-scale corporate, state, and personal debt levels, and a general zombification of the economy. The present crisis is, however, much larger, and more global than that of the 1930s. We have borne witness to two whole credit/property induced booms came to a shuddering halt. when the sub-prime borrowers in the US defaulted.

The same was to also happen in Ireland the UK and Spain who had also built their policies around house-price inflation. Mortgage-backed derivatives – i.e., those financial products which were based upon these repackaged dubious mortgages – were parcelled up and sold as new financial products to brain-dead investors around the world, after being given the triple AAA seal of approval by the ratings agencies. These derivatives were only producing a stream of income so long has the mortgagees continued to pay their instalments – when they defaulted the derivatives became worthless, the banks (who among others such as pension funds who had been purchasing these debt instruments) then found their newly acquired ‘assets’ had turned into liabilities, overnight. Many banks were effectively insolvent, and the great bank panic of 2008 spread around the world. Governments found it necessary to bail-out these institutions in order to avoid a global meltdown. So, the banks simply transferred their junk ‘assets’ onto the sovereign nations’ balance sheets. Needless to say, this was only the opening of the great recession of 2007 which is ongoing. The crisis has now apparently moved from the US – whose fundamental problems remain unresolved however – to Europe where the problem seems more acute.

Since the nadir of 2008/09 there has been a stabilisation rather than what we might meaningfully call a recovery in the global economy. Growth is flat or falling in Europe, although there are very marked regional disparities, and very weak (and as I write, beginning to actually stall) in the USA, again with regional disparities. Interestingly, perhaps with all the clamour regarding austerity in the eurozone, no mention is made in the 40 or so US states – some effectively insolvent – which are overseeing swingeing austerity programmes, California and Wisconsin come to mind. Concomitant with this there are high levels of unemployment on both sides of the pond. Official figures for US unemployment, as found in the Bureau of Labor Statistics, are completely fraudulent since whole swathes of de facto unemployed have been disappeared off the register simply by definition. The same disappearing trick was used with the core inflation figures. See chart below. On the left is the chart which gives three levels of unemployment according to how the word is defined. In fact, there are six definitions U1-U6. The Bureau of Labor Statistics uses U3 but the figure for U6 is double. And if the same definition was applied as used to be the case, then unemployment would be almost 4 times the official account. The same jiggery-pokery is used when defining inflation. Each redefinition gives a lower figure.

mhtml:file://C:\Users\Public\Pictures\shadow%20govt%20statis.mht! mhtml:file://C:\Users\Public\Pictures\shadow%20govt%20statis.mht!

It was the late Lord Gilmour who once said of his government’s unemployment reduction: Now we have reduced the unemployment figures, perhaps we can make a start on reducing unemployment. I am afraid the pollution of statistics is the same for inflation, GDP growth and various other economic statistics. These statistics are not some measurements of objective facts, but simply political constructions. (In this connection see Crash Course, Fuzzy Numbers and John Williams Shadow Government Statistics).

The general Keynesian response to the present situation has been a hue and cry for stimulus at all costs. Keynesian counter-cyclical policies consist of 1. Monetary policy. This comes under the remit of the central bank and consists of control of interest rates and money supply. 2. Fiscal policy, which is the remit of the Treasury consisting of taxation and public expenditure. This has not been adopted in the eurozone, been partially adopted in the UK and adopted in the US. In the eurozone the policy of deflation – very much the German approach – was adopted. This has put the weaker economies in the peripheral zone through the wringer of a grinding depression. No stimulus policies have been undertaken, since it is argued this would pile more debt onto unprecedented levels already extant. Results have to say the least, not been exactly encouraging, particularly in the southern periphery. This situation has received press coverage ad infinitum much of it justified, but much incredibly biased and ignorant, but hey, this is the white noise democracy in action. Given that the eurozone crisis has received saturation coverage we will move on to the UK. Here we have a bizarre mismatch of policies: a loose monetary policy with the Bank of England lowering the base rate to 0.5% and engaging in money printing – otherwise known as Quantitative Easing – and a tight fiscal policy with the Treasury cutting back on public spending. The result? The worst of both worlds, inflation, and stagnation – good old 1970s stagflation. No end in sight to the slump in sight.

The poster child for the Keynesians is United States which has thrown everything but the kitchen sink at the problem in both fiscal and monetary terms. This has produced some low growth and a slight fall in unemployment, albeit from a very high level, and recently reversed, but each additional stimulus has had less of an impact than the one preceding it. A sort of diminishing returns has set in, whereby more and more of the ‘fix’ is needed to get any sort of result.

‘’ … in the 1970s the increase in GDP was about 60 cents for every dollar of increased debt. By the early 2000s this had decreased to close to 20% of GDP growth for every new dollar of debt.’’

(The Great Financial Crisis p.49Foster and Magdoff)

The Federal Reserve had already initiated 2 rounds of QE injecting literally trillions of $s into the economy. In addition, it lowered interest rates to 0.25% – zero to all intents and purposes. The Fed’s purchase of paper assets was facilitated with the printing of paper monies. These paper assets consisted of US Treasury bonds and junk securities from government sponsored enterprises such as Freddie Mac and Fanny Mae, the two government agencies whose remit as to issue mortgages to prospective US homebuyers. This meant that the assets purchased by the Fed were nothing more than debt, un-redeemable debt at that. This is a weird situation where the US central bank was buying US bonds issued by the Treasury department so that the US Federal government could pay its current bills. And where did the Fed get its money from? Out of thin air apparently, it simply printed the stuff! When the stage is reached where governments have to pay their current expenditures by printing money then the alarm bells should start ringing. An idea of the monies involved is described as follows:

Before the first round of QE began, the Fed held roughly $900 billion of assets. When it ended on March 31, 2010, the Fed’s balance sheet had more than doubled to $2.3 trillion. There is no precedent for fiat money creation on this scale in the US during peacetime. (Richard Duncan Ibid.)

Increasing the supply of paper money in the economy in the absence of demand for it can only produce one result – inflation, albeit after a time lag. It will be objected, however, that the US rate of inflation was at the time only 2.3%. True. But bear in mind that both food and fuel price increases are left out of the calculation in what is termed US ‘core inflation’, another egregious example of officialdom’s statistical sleight of hand. Were those price rises added in then at the very least the US inflation figures would almost certainly double. Moreover, the global effects of the Fed’s policies have been to export this inflation around the world as a mass of greenbacks flew out of the US looking for more favourable investment outlets. The global supply of these Eurodollars (i.e., US$s circulating outside of the US) had ballooned, and this led to an inflationary impact globally as food and commodity prices (notably oil) have spiked. This in turn has led to food riots and political disturbances throughout the world, particularly in the Middle East. A sort of unforeseen justice was done, however, when higher oil prices hit the price of gasoline in the US – a boomerang effect. The inflationary effect of the Fed’s money printing also meant that local currencies were put under pressure. When the $ tsunami entered a country, their own currency was subject to an upward revaluation, which meant a higher exchange rate. They therefore faced with two choices: one, do nothing and let their export markets contract since their currency was now more expensive, or two, maintain the value of their currency against the US$ by purchases of more of these dollars with their own currency. This would mean that their own money supply would expand and become inflated. Thus, US inflation had become global inflation. Yes, devaluation is a great way to start a currency war.

As far as fiscal policy goes the US has consistently run budget deficits since the 1990s when it actually recorded a small surplus. The cost of the government takeover of Fannie Mae and Freddie Mac, the cost of ongoing wars in the middle east, the cost of bailouts to various financial institutions, the cost of fiscal transfers to cash-strapped states (due to end in June) and various stimulus programmes has raised the US budget deficit to $15.5 trillion, which given that the Gross Domestic Product of the US as of May 2012 was $15.6 trillion, makes the ratio close to 100%. Even before the economic crisis, the U.S. debt grew 50% between 2000-2007, ballooning from $6-$9 trillion. Now the implications of this are indeed sobering. According to the authors Reinhart and Rogoff (This Time Is Different) when debt to GDP ratio reaches 90% this will constitute a drag on future growth. Longer terms implications of America’s chronic debt problem are manifest.

Over the next 20 years, the Social Security Trust Fund won’t have enough funds to cover the retirement benefits promised to Baby Boomers. That means higher taxes since the high U.S. debt rules out further loans from other countries. Unfortunately, it’s most likely that these benefits will be curtailed, either to retirees younger than 70, or to those who are high income and therefore aren’t as dependent on Social Security payments to fund their retirement.

Second, many of the foreign holders of U.S. debt are investing more in their own economies. Over time, diminished demand for U.S. Treasuries could increase interest rates, thus slowing the economy. Furthermore, anticipation of this lower demand puts downward pressure on the dollar. That’s because dollars, and dollar-denominated Treasury Securities, may become less desirable, so their value declines. As the dollar declines, foreign holders get paid back in currency that is worth less, which further decreases demand.

The bottom line is that the large Federal debt is like driving with the emergency brake on, further slowing the U.S. economy. (Article updated March 3, 2012)

Now if at the time we add in private debt to the equation – i.e., the debts of household sector corporate sector, business sector, non-corporate businesses, State, and local government – then the debt soars to something like $50 trillion, or 363% of GDP. Then of course there is the chronic deficit on current account which adds a further dimension to the problem, but hey, let’s not labour the point. The seriousness of the situation is only matched by the complacency of the US authorities who seem to think they can go on raising the budget borrowing ceiling and that overseas investors will simply keep on buying their Treasury bonds forever. If ever there was a definition of unsustainable this, is it.

In fact, the structural problems in the US economy could well be fatal if these colossal debt levels are not reined in or simply stabilised. The US is being kept afloat by their ownership of the global reserve currency and the willingness (for now) of investors, mainly China, Japan, and the oil-rich states in the middle east to keep purchasing US Treasury paper – paper assets of dubious value and paltry yields. Overseas investors are aware of this situation and have begun to lower their exposure to the US$s and dollar denominated assets by diversifying into other assets and have also started to trade in their own currencies rather than the dollar. Straws in the wind perhaps, but indicative of future trends.

Taken by themselves Keynesian demand-side policies of stimulating the economy hardly begin to grapple with the problem. This is because deeper problems are on the supply-side not the demand-side of the economy. Namely because of the Marxist theory of the tendency of the rate of profit to fall, a supply-side phenomenon (see below). Other factors can be classified as follows. Deindustrialisation as the manufacturing base is hollowed out or emigrates to cheaper venues, ageing populations, rising energy costs and scarcity, saturation of markets, lack of leadership at the political level, finance running amok, the ability to create paper money and assets without limit, an inadequately trained workforce, skills and investment deficits, structural unemployment brought about by new technologies. Of course, I could have added in the issue of climate change but didn’t want to depress my readers unduly. Keynesianism is fixated on the demand-side. But in a world beset by the sort of supply-side problems listed above traditional demand-management policies used since the war will not be effective. It is also worth adding that both Germany and Japan, where the wartime devastation was manifest both recovered strongly without Keynesian demand management. This actually serves to validate both the Austrian and Marxist theory that upturns and booms in a capitalist economy are the result of the destruction of existing capital values. Japan and Germany roared ahead because their own industries and infrastructure was decimated, and they had to install the most modern up to date capital equipment and technologies and again start from scratch. Economies which start from a low base tend to have very high rates of growth.

I did mention earlier that Keynes’ General Theory is in fact not a general theory at all but a special theory. Such policies may have been appropriate for the post-war period with the usual cyclical movements of the trade cycle, but dare I say, this time it’s different. What we are now confronted with is a systemic global crisis of capitalism. In the present situation Keynesian policies – which are commonly understood and promulgated by his epigones – are unlikely to have the desired effect for the following reasons.

‘’Keynes’ theory that government spending could stimulate aggregate demand turns out to be one that works in limited conditions only, making it more of a special theory than a general theory which he had claimed. Stimulus programmes work better in the short run than in the long run. Stimulus works better in a liquidity crisis than and insolvency crisis, and better in a mild recession than a severe one. Stimulus also works better for economies that have entered recessions with relatively low levels of debt at the outset … None of these favourable conditions for Keynesian stimulus was present in the United States in 2009.’’ (Currency Wars – James Rickards – pp.186/187 – My emphasis)

It has been calculated that growth would have to be at the rate of 6% per annum which when inflation is factored in reduces to actual growth of 2% to make any inroads into the huge debts. This seems very, very unlikely, although this is what the US authorities will attempt to do.

One final point with regard to Keynesian policies: They are often thought of as an alternative to austerity, when in fact they are simply austerity by other means. It is an open secret, though never admitted, that both the Fed and the Bank of England are attempting to monetize the debt levels in both countries. This entails keeping inflation one or more jumps ahead of wages, pensions, benefits, and interest rates. This inflation is engineered by the central bank which devalues the currency – supposedly to make exports more ‘competitive’ and printing money through QE. Devaluation leads to an increase in import prices which will tend to feed through the rest of the economy causing domestic inflation. The time-honoured claim made by Harold Wilson in 1967 that the proposed 17% devaluation of the £ ‘would not affect the pound in your pocket’ was simply a barefaced lie. When a country devalues its currency, it makes itself poorer (‘competitive’ is of course the preferred description). That is its whole raison d’être, and in this respect, it is no different from a policy of deflation. Thus, the disposable income of the mass of the population is effectively pushed down as prices rise, and the most acutely affected will be the poorer sections of the community or anyone who keeps their assets in cash. The more opulent, however, will be able to switch into stronger currencies, and physical assets such as precious metals, property, l’Objets d’Art which will appreciate in price. Inflation will help debtors since their debts will be effectively amortized, i.e., grow less as inflation lowers the magnitude of the debt. Of course, the principal debtor is the government. Forcing down interest rates to near zero in an inflationary environment gives savers two options. Do nothing and watch their savings melt away, or just go out and blow the lot. Similarly, investors will be forced into more risky investments as they see the paltry return to safer bolt holes such as gilts being eaten away by inflation. The whole approach, to quote Keynes, albeit in a different context: ‘’contemporary capitalism … is not intelligent … is not beautiful … is not just … is not virtuous – and it doesn’t deliver the goods (1933)

And paradoxically, because disposable income is crimped by such a policy, aggregate demand falls, and this gives another push to deflation – the law of unintended consequences.

Keynesians see the problems of past and present capitalism as purely technical. They apparently believe that capitalism can be ‘fixed’ using appropriate tools and that it would therefore be possible to have permanent semi-boom conditions. This is clearly expounded by economists such as the American Keynesian, Paul Krugman in his book Peddling Prosperity, first published in 1994. Having spent most of his life during the post-war boom, he is apparently dumbfounded that it suddenly ended in the early 1970s. He intoned that … In 1973 the magic went away. Well, ‘magic’ had nothing to do with it. Capitalism was beginning to enter a periodic systemic convulsion which is now reaching its climax.


Karl Marx and Friedrich Engels. The Tendency of the rate of profit to fall. A supply-side theory of capitalist crisis. As follows.

‘’Marx discovered that falling profitability derives from the additional capital investments that are necessary to raise productivity. Labour productivity only increases durably as a result of more and better productive capital being employed for each worker. Technically this takes the form of the mechanisation of work, although it is generically expressed as a greater amount of capital stock for each employee. Productivity enhancing investment tend to grow the productivity of the capital invested relative to the amount spent on wages. The consequence is that the accumulating cost of investing plant and equipment, added to the spending on raw materials and rises inexorably to the relative cost of labour.

Operating profit represents the net value produced by this labour, after the deduction of all input costs, including wages, capital depreciation, and other operating expenses. The profit arising from the new value created by labour in the in the production process tends to decline relative to the rising amounts of capital invested in fixed assets and materials. This means that the profit rate measured over all capital deployed – in employing people as well as in fixed assets and other inputs – will also tend to decline. This tendency of the rate of profit to fall follows as a direct consequence of the development of the social productivity of labour, since this is dependent upon increasing amounts of capital investment.’’ Creative Destruction – how to start and economic renaissance – Phillip Mullan p123/134.

Interesting that Mr Mullan is using the term ‘Creative Destruction’ which was widely understood to be used by Joseph Schumpeter not Marx.

Anyway, Marxist theory posits capitalist crises in the supply side of the economy, the production of capital rather than the demand side which is the Keynesian position.

For further reading see Capital, Volume 3, Part 3, The Tendency of the rate or profit to fall. Chapter XIII, The Law as Such.

Also, the published works of Marxist bloggers and authors David Harvey and Michael Roberts are available, if that is to your taste.


The Essential Saker IV: Messianic Narcissism's Agony by a Thousand Cuts
The Essential Saker III: Chronicling The Tragedy, Farce And Collapse of the Empire in the Era of Mr MAGA