"Keynesian Economics is a Sort of Pyramid Scheme"

Great article:

Question: What got America out of the Great Depression, The New Deal or WWII?

Truly, it was neither.

Each gave some appearances of a recovery, but it wasn’t until our men returned home from WWII, capital was given some time to reset and wealth production resumed, that America saw an actual recovery. However, the effects of the New Deal continue with us to this day.

Neither WWII nor The New Deal created prosperity. WWII was arguably necessary, depending on your study of history, but we will save that for another debate. The New Deal however, was a massive waste of money that began America on it’s perpetual debt binge.

WWII

Some say WWII got us out of the Great Depression because it created jobs and reduced unemployment. They also say it was because it created demand for tanks, ammunition, guns and so on. Yes, this is all true. However, regarding unemployment in the US. When most of your men are overseas fighting a war, what do you expect to happen to unemployment? Further, where did all of this money to pay for the troops, necessary equipment and armament come from? It was borrowed or came directly out of the real production of the economy through taxes!

War is sometimes a necessary expense, but to argue that it somehow produces prosperity is a complete fallacy. To illustrate this, let’s use an example given by Thomas Woods from his book “Meltdown”. If War Time Prosperity is true, then Japan and the US should agree to duke it out in the Pacific Ocean. Only, to avoid the loss of human life, let’s build the most sophisticated, advanced and expensive remote controlled navies the world has every known. Let’s agree to meet in the middle of the Pacific and watch the remote controlled fireworks begin. Win or Lose…we both lose economically.

Consider all of the time, resources and energy involved (capital), all of which are paid for using “money”. After the end of this battle, all of that capital invested in the destroyed navies will be at the bottom of the Pacific Ocean. If War Time Prosperity were true, Japan and America would be economic superpowers overnight and our recession would be over!

What is unseen here is all of the wealth that could have been produced with the same capital now resting at the bottom of the ocean. How many cars, tools, TV’s, computers, could be made with that capital?

WWII did not make America prosperous. War is an expense, sometimes a necessary expense, but the economic destruction that it causes because of the destruction of wealth that occurs is devastating. However, we pay for our wars with debt, which means we are making posterity pay for our engagements, which Thomas Jefferson proclaimed was immoral, which is why he argued for a “War Time Tax” to make sure our wars were paid by the present generation and not posterity.

THE NEW DEAL

The New Deal was simply a modern day “Stimulus Package”. It was birthed from the ideas of John Maynard Keynes who suggested that a central government could induce economic prosperity by “priming the pump”. He suggested that if the government simply spends money, that will create demand for products and services and it will jump start the economy. He famously boiled his theory down to this simple example. You can pay a man to dig a hole and another person to fill it. The fact that nothing productive is taking place doesn’t matter, the spending alone will stimulate the economy. He argued that debt spending was the best way to go, because taxes can damage an economic recovery by taking real capital out of the economy, thus defeating the purpose.

In some ways Keynes was right, but that is a complicated argument to make and filled with caveats that in the end, actually debunk his theory. One particular caveat is “time” itself. When Keynes introduced his theories there were other prominent economists who would offer one damning criticism in the form of a question (F.A. Hayek). What about the long run? Keynes famously replied, in the long run, we are all dead. As if this is some sort of joke. John Maynard Keynes knew that what he was theorizing was not sustainable, but he obviously felt that the long term negative effects were so far off in the future that they were irrelevant. The problem for us today is that you and I have reached the long run. We are paying for his misguided economic theories. Our economy is not based on the only sustainable path to prosperity, which is wealth creation, but instead, it is a marriage of capitalism and a massive amount of subsidization and central planning which is administered by the Federal Government and Federal Reserve which are ultimately funded by the US taxpayer, now and in the future.

Subsidies Include:
Direct Farm Subsidies
Welfare for the poor
Corporate Welfare
Loan subsidies and guarantees – (homes [FNMA, FMAC HUD], education, business loans)
Direct government spending, “stimulus”
Tax “Credits” – Cash for Clunkers, Home Buyer Tax Credits
etc.

Central Planning:
Interest Rates (FED)
Money Supply (FED)

What we saw during the New Deal Era was a fake recovery, much like we are seeing now. It wasn’t until capital was allowed to reset, in spite of the New Deal, that real investment and subsequent production of real wealth returned. The problem is that we have been left with this legacy of economic manipulation that is ultimately making us poorer. When government intervenes and acts outside of its Constitutionally limited role, it takes wealth, whether from the present through taxes or the future through debt and diverts it as a central planning agent. This diversion of capital causes bubbles and busts, like the one we saw with the current housing crisis.

Furthermore, many point to increases in GDP under the New Deal and other economic indicators to say that it worked, much like we are seeing today. The misleading thing about GDP is that it is only a good indicator if it is soley a result of free market activity. As soon as intervention is introduced, there is no way to compare GDP or use it or any other economic indicator as a measure of real economic productivity. Under the New Deal specifically, there were prices floors which were implemented. This temporarily caused an increase in GDP for more inelastic goods such as food. Also, when much of the spending is coming from the government in the first place, the GDP is inflated beyond its true level.

Keynesian economics is a sort of pyramid scheme. It can work or give the appearance of working until either a.) the government can no longer borrow (see Greece) or b.) capital has been so miss-allocated that a massive economic collapse occurs as a result. Yet, we continue down the same road building new bubbles and subsequent busts, each successive bust is worse than the one before it.

The most common misconception dealing with wealth is that money = wealth. This is not true. Wealth can be measured in money, but that does not mean that the unit of measurement is wealth itself. If money equals wealth, countries could simply print wealth and their citizens would just sit around all day drinking beer. One problem, where is that beer going to come from? Therefore the only way to true and sustainable prosperity is through wealth creation (production). We know this by this simple example: Which country is more wealthy? The one who is producing bread, shoes, clothes, tools, cars, etc. Or the one who produces “bank notes”?

What good is money if there is no bread to buy? The one temporary exception to this is an economy based upon debt, like ours. 70% of the US economy is based upon consumer spending. That is why following 9/11 President Bush told everyone to go shopping. Why didn’t he tell us to go produce wealth? Because that is not how our economy has been constructed. America has been producing some wealth, but not nearly enough to justify its rate of consumption. We could be as wealthy, if not more wealthy than we currently appear. But we have allowed the Federal government to squander and destroy our wealth and that of future generations through the justification of Keynesian economics.

Government spending does not create prosperity. Government is an expense to any nation, it is a necessary expense when it is confined to its legitimate role of simply protecting natural rights from legitimate foreign and domestic enemies, but when it ventures beyond this role and takes on the powers of economic manipulation, it destroys wealth which is the basis of prosperity. Instead of making us richer, it actually makes us poorer for it.

This series is based on the book “Economics in One Lesson” by Henry Hazlitt.