Tuesday, June 6, 2017

Half Right is Still Half Wrong

Recently someone sent us the link to an article by Steven Kates published in 2010 on “The Failure of Keynesian Economics.”  As everyone who reads this blog knows — or should know — we’re not ones to let mere antiquity determine whether or not something is true; we don’t hold with those who worship the past any more than with those who reject it out of hand.
"I don't have to make sense.  I am John Maynard Lord Keynes."
No, if we’re going to reject something or disagree with it, it will (we hope) be because we disagree with what is said, not who said it or when it was said.  The “problem” with Kates’s article thus is not with the fact that he said it, nor when he said it.  It isn’t even with what he said.  We don’t really disagree with anything he said.
What we disagree with is what he didn’t say — which is always a very large receptacle of wrigglers to unseal.  Kates correctly noted where his analysis differs from that of Keynes and why . . . but not where he agrees with Keynes.  This would not only have strengthened his argument against Keynesian economics, but led him to a possible solution.
"You know . . . even I can see that doesn't make any sense."
True, Kates clearly believed he was giving a solution to the tyrannical rule of Keynesian economics.  That is, instead of increasing taxes to fund increased public expenditures to stimulate the economy, decrease taxes to fund increased private expenditures to stimulate the economy.
The problem-behind-the-problem with Keynesian economics, however, is not so much what the Keynesians are doing.  Instead, it is what the Keynesians (and others, such as Kates) think they are doing.
The issue Kates addressed is the difference between tax cuts to stimulate the private sector, and tax increases to stimulate the public sector.  He correctly pointed out that while Keynesians think they are the same in their effects, they are, in fact, radically different.
But here’s where the problem-behind-the-problem comes in.  Being trapped in the past savings paradigm, the Keynesians and others think they are doing one thing when they are actually doing something quite different.  And that spells disaster no matter how you look at it.
"The money is worthless. I'm guarding the container."
What the Keynesians think they’re doing.  Even Keynesians will admit that their monetary policy is not “tax and spend” . . . at least, not directly.  It’s “print and spend.”  This presumably replaces the direct taxation of income, with the indirect taxation through inflation of purchasing power.
Print and spend is actually worse than tax and spend, because there is no limit to the amount of money you can print as there is to the amount of income you can tax.  Keynesian theory is that by printing money, all you’re doing is chopping up the wealth of the economy into smaller and smaller pieces.
Redeeming all those promises is not a problem because in an emergency, the government can simply increase direct taxes and drain excess purchasing power out of the economy.  This is how Georg Friedrich Knapp said the State can control the economy: back the entire money supply exclusively with government debt.  If more purchasing power is needed, issue more debt.  If less is needed, tax away the excess.
It is impossible to go bankrupt, because the money is 100% backed by the total wealth of society.  You only have to be careful not to increase the amount of government debt too much faster than wealth is created, because imposing a 100% tax is unrealistic politically.  You should therefore limit increases in debt to a reasonable proportion of new wealth that has been created, except when you can get away with more.
The Black Hole of Government Debt
What the Keynesians are really doing.  Unfortunately for Keynesian monetary theorists, they don’t understand money.  They think that what they are doing when backing new money with government debt is cutting up the existing wealth of society into smaller pieces.  What they are actually doing is issuing claims against both existing wealth and as-yet uncreated wealth.
And that’s the problem behind the problem.  Government debt that is anything other than borrowing existing savings is backed not by the power to tax existing wealth, but the power to tax future wealth . . . that may or may not materialize.  As long as people believe the government will eventually be able to tax enough to redeem its promises, things won’t get too bad.
The moment people lose faith in the government, however, all bets are off.  The money becomes worthless, and either hyperinflation kicks in, other currencies come into use and the government becomes worthless, or both.
And financing government spending by creating money instead of taxing or borrowing existing money is one of the best ways to ensure that future wealth is not created.
What can you buy with worthless money?
True, taxing away or borrowing savings dries up consumer demand to a limited extent.  A government can only borrow what already exists, however, and can only sustain high taxation for a limited period.  There seems to be a limit of 20% of GDP on the amount of taxes that can be collected.  And most financing for new capital formation comes out of future savings, anyway, even if the economists and politicians think otherwise.
It is inflation that really kills consumer demand.  As the value of the currency is eroded, people pay more and get less.  This in turn lowers the demand for new capital, and thus new jobs.  Nor does increasing transfer payments (funded by new debt instead of taxes) make things better, as it only masks the problem for a while, making the underlying problem worse at the same time it claims to be solving it.
Half the problem is exactly what Kates said it is: the government is spending too much.  The answer is not, however, to cut taxes.  It’s stop the government from creating money, and restrict all new money creation to the private sector — and even then, all new money must be backed by wealth, either existing inventories or new capital (which, when it comes down to it, means future inventories).
In other words, the money supply must — not should, must — be backed by existing assets or reasonably expected (and specific) future assets.  It should not be backed by vague hopes of taxes that the government might be able to collect if everything works right and everybody is exceptionally lucky.

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