Monday, June 18, 2012

Lies, Damned Lies, and Definitions, I: The Problem

On June 11, 2012 Dr. Joseph Stiglitz, Nobel Laureate in economics, went on "Russian Television" (RTV) to plug his new book, The Price of Inequality, and announce the end of hope in America through the presumed need to increase State control of the economy in order to increase opportunities for good education, nutrition, and healthcare so as to diminish the wealth gap.

The fact that these and other things often touted as the cause of prosperity are actually the result of it was not raised. The only way to fix America's (and the world's) broken economy is for the State to take over and run things properly.

The problem is that Dr. Stiglitz is absolutely correct . . . if we accept the truth of the assumptions of the Keynesian paradigm within which he operates.

As Keynes explained, given the assumption that the only way to finance new capital formation is to cut consumption and accumulate cash (General Theory, II.6.ii), there is no way that the world can advance economically unless wealth is concentrated. As Keynes declared in 1919 in The Economic Consequences of the Peace, the book that established his reputation,

"The immense accumulations of fixed capital which, to the great benefit of mankind, were built up during the half century before the war, could never have come about in a Society where wealth was divided equitably." (2.iii.)

The problem becomes what degree of State control is required to redistribute just enough wealth through taxation and inflation to keep the economy running without depriving business of adequate investment capital to finance new capital formation and create jobs. (General Theory, VI.24.ii.)

Unfortunately for Dr. Stiglitz's analysis (and for the world that has allowed itself to be cozened by the glamour of Keynesian promises), the Keynes's assumptions and the unsoundness of the monetary and fiscal policy based on those assumptions have been disproved many times. For example, anyone bothering to look and see what Jean-Baptiste Say actually said in his statement of the "law" of economics named for him would instantly see that Keynes restated Say's Law of Markets so as to construct a "straw man" that he then proceeded to demolish.

Nor did the Keynesian penchant for redefinition of basic terms and concepts and illogic end there. Keynes's definition of saving — "the excess of income over expenditure for consumption" — simply ignores the possibility that "savings" can be (and frequently is) the excess of income over the costs of production that can be used to repay the financing of the capital that generated that same production.

Misunderstanding such a basic fact of finance virtually guarantees that the economy will not function properly, any more than filling an automobile's gas tank with hay or feeding a horse gasoline will do anything but harm. We need to understand how capital is actually financed before we can know what to do to correct today's situation.

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