Thursday, September 30, 2010

The Keynesian Bloodletting

As predicted over and over on this blog, the remedies being applied to virtually every area affected by the economic crisis are not curing anything. Quite the contrary — what's being done is aggravating the situation even more than previously. It's analogous to the state of medicine in the 18th century, in which Hippocrates's theory of the "four humors" that must be kept in balance, i.e., black bile or "melankholia," yellow bile or "cholera," phlegm or "phlegma," and blood or "sanguis." These were believed to have an effect not only on the physical body, but the mind as well, hence some of our modern terms for a person's temperament: melancholy, choleric, phlegmatic, and sanguine.

These four humors, black bile, yellow bile, phlegm, and blood, corresponded to the four elements of Greek physics, earth, fire, water, and air, respectively. The theory was that when the humors are out of balance, they must be put back in balance by increasing the one that was diminished, or taking out some of any excess. Hence, a physician's stock in trade consisted of drugs and techniques either to get the excess or poisoned humors flowing out of the body, or induce the body to produce more of a healthy humor.

There is actually a good deal of common sense in the theory. Many diseases respond to treatment of a symptom. Cholera, for instance, is not a fatal disease — but the symptoms, chronic diarrhea and vomiting as the body struggles to eject the harmful organism, will dehydrate the body and cause death; in a sense, the body kills itself. There is a cholera vaccine that is mildly effective in preventing the disease, but the prescribed treatment is usually oral or intravenous rehydration — i.e., replace fluid as fast as possible, and keep doing it.

Unfortunately, over the centuries the theory got a little over-simplified. While bloodletting can be an effective treatment in some (very rare) cases, it became virtually the only one used for every imaginable ailment. Of course, there were sometimes complaints about the ineffectiveness of other humor-balancing therapies, such as when incompetent physicians prescribed drugs that made you sick, and emetics that didn't, but, by and large, the most popular treatment was to whip out the knives and drain a little (or a lot) of blood out of the patient, or attach leeches and let them do the dirty work.

Now we get to the point of all this fascinating medical history. In Keynesian economics, the way out of a depression or recession is for the State to create money backed by future tax revenues (not that a Keynesian, Monetarist, or Austrian would put it that way), stimulating demand, and creating jobs.

In the Keynesian reality the amount of debt assumed by the State doesn't matter. All the State does in the Magic Kingdom of Keynesland is redistribute purchasing power, not create new purchasing power by tying new money to the present value of existing and future marketable goods and services.

Unfortunately, the financial system doesn't operate in the Magic Kingdom, but in the real world. Debts must be paid — and paid when due. The State cannot continue to redistribute existing wealth forever and put off the day of reckoning on to future generations; the bloodletting can't go on without a transfusion in the form of new production of marketable goods and services. The alternative is economic death.

The politicians and policymakers seem to realize this at some basic level. As an article in today's Wall Street Journal makes clear, the situation in Éire, Spain, and Portugal is getting out of hand; the fixes a short time ago didn't fix anything. All they did was make the situation worse. ("European Austerity Fuels Tensions," WSJ, 09/30/10, A8.) What is needed is cost cutting and austerity to get things back on course.

Cost-cutting, however, should — at least in a well-managed company or country — be a last resort, not the first. No company or government should ever be spending money it doesn't have to spend, certainly not in an insane effort to foster prosperity by going into non-productive debt. The first recourse of any company or government in trouble is not to cut costs, but to increase revenue, that is, grow economically.

The problem is that, within the Keynesian system, manipulation of monetary and fiscal policy (i.e., going into debt in different ways and taxing a depleted tax base) is the only source of financing for the growth that generates the tax base that provides the money for government to spend. In simple terms, in Keynesian economics you don't dare stop spending, even if you could. If you don't have government debt, you don't have a money supply. But it's debt that's causing the problem. Like the loss of fluid that characterizes cholera, the Keynesian defense mechanism is killing the body politic it is supposed to be preserving.

What's obvious, of course, is that the Keynesian prescription must be wrong — as is the whole Keynesian theory of how the body politic works. No organism, biological, social, or political, can live on itself forever without producing anything, nor can any organism survive in its own waste products. The State cannot redistribute existing wealth forever, anymore than an animal can live off its stored fat without eventually feeding; the State cannot survive being drowned in its own debt, anymore than animals can breathe the carbon dioxide they exhale.

The Just Third Way would solve this problem. First, we need to redefine money and credit so that they bear some resemblance to reality. Forget "M1" and "M2." Money is anything, repeat, anything that can be used in settlement of a debt. Next, restore Say's Law of Markets and the real bills doctrine by reforming the financial system and tying all new money to the present value of existing and future marketable goods and services. At the same time, institute an aggressive program of expanded capital ownership, and reform the tax system.

All of these steps are explained in Moulton's The Formation of Capital and CESJ's Capital Homesteading for Every Citizen. Consider obtaining copies today — and opening the door to a prime mover who has the political savvy to listen to and understand the Just Third Way.



nail-in-the-wall said...

Before I repost --- Trying to get permission for this great cartoon.

Economic Bloodletting

May use it anyway under 'fair use'.

Guy c.

Michael D. Greaney said...

Not to worry. I'm taking the easy way out and inserting the link in today's News from the Network. That way you avoid any question of copyright violation v. fair use.

nail-in-the-wall said...

Posted (HERE) and (HERE) and (HERE).

Happy New (fiscal) Year !

With still no United States budget.

Tell Congress to just stay home.