Saturday, March 2, 2013

Theory of Employment, Money, Interest, and the Capitalist Process: The Misesian Case Against Keynes II

After this reconstruction of the classical, and especially the Austrian theory of employment, money, interest, and the capitalist process, I will now turn to Keynes and his “new” theory. Before the backdrop of our explanation of the old one it shall be easy to recognize Keynes’s “new” General Theory of Employment, Interest, and Money as fundamentally flawed and the Keynesian revolution as one of the twentieth century’s foremost intellectual scandals.

Keynes sets out with a false theory of employment. Contrary to the classical view, he claims that there can be involuntary unemployment on the free market; and, further, that a market can reach a stable equilibrium with persistent involuntary unemployment. And in claiming such market failures to be possible he contends to have uncovered the ultimate economic rationale for interfering in the operations of markets by extra-market forces.
Since the free market is defined in terms of homesteaded or produced private property and the voluntariness of all interactions between private property owners, it should be clear that what Keynes claims to show is roughly equivalent to a squaring of the circle.
Keynes begins with the false statement that the classical theory assumed “that there is no such thing as involuntary unemployment in the strict sense.” 24 In fact, it assumed no such thing. Classical theory assumed that involuntary unemployment is logically-praxeologically impossible so long as a free market is in operation. That involuntary unemployment, indeed any amount of it, can exist in the presence of an extra-market institution, minimum wage laws, etc., has never been seriously doubted.
After this falsehood, Keynes then proceeds to give his definition of involuntary unemployment:

Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods [i.e., consumer goods] relative to the money wage, both the aggregate supply of labor willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment. 25

Translated into plain English, what Keynes is saying in his typical obfuscating way is that men are involuntarily unemployed if an increase in prices relative to wage rates leads to more employment. 26 Yet such a change in relative prices is logically equivalent to a fall in real wage rates; and a fall in real wages can be brought about on the unhampered market by wage earners at any time they so desire, simply by accepting lower nominal wage rates with commodity prices remaining where they are. If laborers decide not to do this, there is nothing involuntary in all this. Given their reservation demand for labor, they choose to supply that amount of labor which is actually supplied. Nor would the classification of this as voluntary unemployment-employment change a bit, if at another point in time with lower real wage rates the amount of employment were to increase. By virtue of logic, such an outcome can only be brought about if in the meantime laborers have increased their relative evaluation of a given wage rate versus their labor reservation demand (otherwise, if no such change had occurred, employment would decrease instead of increasing). The fact, however, that one can change one’s mind from one point in time to the next hardly implies that one’s earlier choice was involuntary, as Keynes would have it. Of course, one can define one’s terms any way one wishes, and in a truly Orwellian fashion one may even choose to call voluntary involuntary and involuntary voluntary. Yet through this method anything under the sun can be “proven,” while in fact nothing of substance whatsoever is shown. Keynes’s way of demonstrating the possibility of involuntary unemployment is a verbal nonsense proof which leaves entirely unaffected the fact that no such thing as involuntary employment, in the usual sense of this term, can ever exist on the unhampered market.
As if this were not enough, Keynes tops it off by claiming that involuntary unemployment is conceivable even in the never-never land of equilibrium. Indeed, he criticizes his earlier Treatise on Money by saying, “I had not then understood that, in certain conditions, the system could be in equilibrium with less than full employment.” 27 Yet equilibrium is defined as a situation in which changes in values, technology, and resources no longer occur where all actions are completely adjusted to a final constellation of data; and where all factors of production then, including labor, are employed to the fullest extent possible (given these unchanging data) and are repeatedly and endlessly employed in the same constant production pattern. Hence, as H. Hazlitt has remarked, the discovery of an unemployment equilibrium by Keynes, in his General Theory, is like the discovery of a triangular circle—a contradiction in terms.

Having thrown out logic in his treatment of employment and unemployment, Keynes, in his discussion of money, then throws out economic reasoning by advancing the claim that money and monetary changes (can) have a systematic effect on employment income, and interest.
Given the fact that “money” appears in the title of the General Theory, Keynes’s positive theory of money is amazingly brief and undeveloped. Brevity, of course, can be a virtue. In the case of Keynes, it offers the opportunity to pinpoint rather easily his elementary mistakes. For Keynes, “the importance of money essentially flows from its being a link between the present and the future.” 29 “Money in its significant attributes is, above all, a subtle device for linking the present and the future.” 30 That this is false follows from the fact that in the never-never land of equilibrium no money would exist, 31 yet even under equilibrium conditions there would still be a present and a future, and both would still be linked. Rather than functioning as a link to the future, money serves as a medium of exchange; a role that is inextricably tied to the uncertainty of the future. 32 Action, which invariably begins in the present and is aimed at some future goal, more or less distant in time from the point of beginning, constitutes the real link between the present and the future. And it is time preference as a universal category of action that gives this link between the present and the future its specific shape. Money, contrary to interest, no more relates the present to the future than do other economic phenomena, such as nonmonetary goods. Their present value, too, reflects anticipations regarding the future, no more and no less so than does money.
From this first misconception regarding the nature of money, all other misconceptions flow automatically. Being defined as a subtle link between present and future, the demand for money (its supply being given), which Keynes, in line with his general inclination of misinterpreting logical-praxeological categories as psychological ones, terms “liquidity preference” or “propensity to hoard,” 33 is said to be functionally related to the rate of interest (and vice versa). 34 “Interest,” writes Keynes, “is the reward of not-hoarding,” 35 “the reward for parting with liquidity,” 36 which makes liquidity preference in turn the unwillingness to invest in interest-bearing assets. That this is false becomes obvious as soon as one asks the question “What, then, about prices?” The quantity of beer, for instance, that can be bought for a definite sum of money is obviously no less a reward for parting with liquidity than is the interest rate, which would make the demand for money then the unwillingness to buy beer as much as it is an unwillingness to invest. 37 Formulated in general terms, the demand for money is the unwillingness to buy or rent nonmoney, including interest-bearing assets (land, labor, and/or capital goods, or future goods) and non-interest-bearing assets (consumer or present goods). To recognize this is to recognize that the demand for money has nothing to do with investment or with consumption; nor has it anything to do with the ratio of investment-to-consumption expenditures, or the spread between input and output prices (the discount of higher order or future goods versus lower order or present goods). Increases or decreases in the demand for money, other things being equal, lower or raise the overall level of money prices, but real consumption and investment, as well as the real consumption-investment proportion remain unaffected; and such being the case, employment and social income remain unchanged as well. The demand for money determines the spending/cash balance proportion. The investment/consumption proportion, pace Keynes, is an entirely different and unrelated matter. It is solely determined by time-preference. 38
The same conclusion is reached if changes in the supply of money (liquidity preference being given) are considered. Keynes claims that an increase in the supply of money, other things being equal, can have a positive effect on employment. He writes, “so long as there is unemployment, employment will change in the same proportion as the quantity of money.” 39 Yet this is not only a highly curious pronouncement because it assumes the existence of unemployed resources instead of explaining why such a thing should possibly occur—for, obviously, a resource can be unemployed only because it is either not recognized as scarce at all and thus has no value whatsoever, or because its owner voluntarily prices it out of the market and its unemployment then is no problem that would call for a solution. 40
Even if one were to waive this criticism, the statement would still be fallacious. For if other things were indeed equal, then the additional supply of money would simply lead to increased overall prices and simultaneous and proportional increased wage rates, and nothing would change at all. If, contrary to this, employment should increase, this is only possible if wage rates do not rise along with, and to the same extent as, other prices. However, other things then can no longer be said to be equal, because real wage rates would be lowered, and employment can only rise while real wages fall if the relative evaluation of employment versus self-employment (i.e., unemployment) is assumed to have changed. Yet if this is assumed, no increase in the money supply would have been required. The same result (increased employment) could also have been brought about by laborers accepting lower nominal wage rates.
With logic and economic theory thrown out of the window, in his discussion of the interest phenomenon Keynes abandons reason and common sense entirely.
According to Keynes, since money has a systematic impact on employment, income, and interest, interest, in turn—quite consistently, for that matter—must be conceived of as a purely monetary phenomenon. 41 I need not explain the elementary fallacy of this view. Suffice it to say here again that money would disappear in equilibrium, but interest would not, which demonstrates that interest must be considered a real, not a monetary phenomenon.
Moreover, Keynes, in talking about “functional relationships” and “mutual determination” of variables instead of causal, unidirectional relations, becomes entangled in inescapable contradictions as regards his theory of interest. 42 As has been explained above, on the one hand Keynes thinks of liquidity preference (and the supply of money) as determining the interest rate, such that an increased demand for money, for instance, would raise the interest rate (and an increased supply of money would lower it) and that this then will reduce investment “whilst a decline in the rate of interest may be expected, ceteris paribus, to increase the volume of investment.” 43 On the other hand, characterizing the interest rate as “the reward for parting with liquidity,” he contends that the demand for money is determined by the interest rate, such that a fall in the interest rate, for instance, would increase one’s demand for cash (and also, one should add, one’s propensity to consume) and hence lead to reduced investment. Obviously, however, a lower interest rate can hardly both increase and decrease investment at the same time. Something must be wrong here.
Keynes, however, combines falsehood and contradiction into one of the most fantastic conspiracy theories ever heard of.
Since interest, according to Keynes, is a purely monetary phenomenon, it is only natural to assume that it can be manipulated at will through monetary policy (provided, of course, one is not restricted in this by the existence of a 100-percent-reserve commodity money standard such as the gold standard). 44 “There is,” writes Keynes, “no special virtue in the pre-existing rate of interest.” 45 In fact, if the supply of money is sufficiently increased, the interest rate supposedly can be brought down to zero. Keynes recognizes that this would imply a superabundance of capital goods, and one would think that this realization should have given him cause to reconsider. Not so! On the contrary, in all seriousness he tells us

that a properly run community equipped with modern technical resources, of which the population is not increasing rapidly, ought to be able to bring down the marginal efficiency of capital in equilibrium approximately to zero within a single generation. 46

It is “comparatively easy to make capital goods so abundant that the marginal efficiency of capital is zero (and) this may be the most sensible way of gradually getting rid of many of the objectional features of capitalism.” 47 “There are no intrinsic reasons for the scarcity of capital.” 48 Rather, it is “possible for communal saving through the agency of the State to be maintained at a level where it ceases to be scarce.” 49
Don’t worry that this would imply that no maintenance or replacement of capital would be needed any longer (for, if this were the case, capital goods would still be scarce and hence command a price), and capital goods instead would have to be “free goods” in the same sense in which air is usually “free.” Don’t worry that if capital goods were no longer scarce, then consumer goods could no longer be scarce either (for, if they were, the means employed to produce them would have to be scarce, too). And don’t worry that in this Garden of Eden, which Keynes promises to establish within one generation (why so long?!), there would no longer be any use for money. For, as he informs us, “I am myself impressed by the great social advantages of increasing the stock of capital until it ceases to be scarce.” 50 Who would dare disagree with this! 51
Yet more is to come. Because, as Keynes sees it, there are some obstacles on the path toward paradise. For one thing, the gold standard stands in the way, because it makes the expansion of credit impossible (or difficult at least, in that a credit expansion would lead to an outflow of gold and a subsequent economic contraction). Hence Keynes’s repeated polemics against this institution. 52 Furthermore, there is the just explained problem of his own making: that a lower interest rate supposedly increases and decreases investment simultaneously. And it is to get out of this logical mess that Keynes comes up with a conspiracy theory: For, while the interest rate must be reduced to zero so as to eliminate scarcity, as we were just told, the lower the interest rate the lower also the reward for parting with liquidity. The lower the interest rate, that is to say, the lower the incentive for capitalists to invest, because their profits will be reduced accordingly. Thus, they will try to undermine, and conspire against, any attempt to resurrect the Garden of Eden.
Driven by “animal spirits,” 53 “gambling instincts,” 54 and “addicted to the money-making passion,” 55 they will conspire so “that capital has to be kept scarce enough.” 56 “The acuteness and peculiarity of our contemporary problem arises, therefore,” writes Keynes,

out of the possibility that the average rate of interest which will allow a reasonable average level of employment [and of social income] is one so unacceptable to wealth owners that it cannot be readily established merely by manipulating the quantity of money. 57

In fact,

the most stable, and least easily shifted, element in our contemporary economy has been hitherto, and may prove to be in the future, the minimum rate of interest acceptable to the generality of wealth owners. 58

Fortunately, we are informed, there is a way out of this predicament; through “the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital.” 59 And surely they deserve such a fate. For “the business world” is ruled by an “uncontrollable and disobedient psychology,” 60 and private investment markets are

under the influence of purchasers largely ignorant of what they are buying and of speculators who are more concerned with forecasting the next shift of market sentiment than with a reasonable estimate of the future yield of capital assets. 61

As a matter of fact, don’t we all know that “there is no clear evidence from experience that the investment policy which is socially advantageous coincides with that which is most profitable;” 62 indeed, that the decisions of private investors depend largely on “the nerves and hysteria and even the digestions and reactions to the weather,” 63 rather than on rational calculation?! Thus, concludes Keynes, “the duty of ordering the current volume of investment cannot safely be left in private hands.” 64 Instead, to turn the present misery into a land of milk and honey, “a somewhat comprehensive socialization of investment will prove the only means.” 65

The State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage [must take] an ever greater responsibility for directly organizing investment. 66

I trust that none of this requires further comment. It is too obvious that these are the outpourings of someone who deserves to be called anything, except an economist.
Such a verdict finds still more support when Keynes’s theory of the capitalist process is finally considered. That Keynes is no friend of capitalism and capitalists should be obvious from the above quotations. In fact, by advocating “a socialization of investment” he comes out openly as a socialist. 67 For Keynes, capitalism means crisis.
He identifies essentially two reasons for this, the first one, to which Keynes attributes the cyclical nature of the capitalist process, has already been touched upon. Surely, so long as the course of the economy is largely determined by capitalists who, as we have heard, “are largely ignorant of what they are purchasing,” and who conspire “to keep things scarce,” it cannot be a smooth and even one. Depending mostly on people who base their decisions on their “digestion and the weather,” the capitalist process must be erratic. Moved by the “waxing and waning” of entrepreneurial optimism and pessimism, which in turn is determined by the “uncontrollable and disobedient psychology of the business world,” booms and busts are inevitable. Business cycles—so the central message of chapter 22 of Keynes’s General Theory, the “Notes on the Trade Cycle”—are psychologically determined phenomena. This is surely incorrect. A psychological explanation of the business cycle is strictly impossible, and to think of it as an explanation involves a category mistake: Business cycles are obviously real events, experienced by individuals, but experienced by them as occurring outside of them in the world of real goods and real wealth. Beliefs, sentiments, expectations, optimism, and pessimism on the other side are psychological phenomena. One can think of one psychological phenomenon as affecting or influencing another one, but it is impossible to conceive of a psychological phenomenon as having any direct impact on outcomes in the outside world of real things and goods. Only through actions can the course of real events be influenced; and any explanation of the business cycle then must necessarily be a praxeological (as opposed to a psychological) one. Keynes’s psychological business cycle theory in fact cannot explain that anything real happens at all. However, as real things are made to happen people must act, and allocate and reallocate scarce resources to valued goals. One cannot act as arbitrarily, though, as Keynes would have it, because in acting one is invariably constrained by real scarcity which cannot be affected by our psychology at all. Nor does Keynes explain with his theory why entrepreneurial mood-swings would result in any particular pattern of business fluctuations—such as the boom-bust cycle, that he supposedly wants to explain—instead of any other conceivable pattern of fluctuations.
The second reason for the instability of capitalism, and the desirability of a socialist solution, according to Keynes, is capitalism’s inherent stagnationist tendencies. His stagnation theory centers around the notion which he takes from Hobson and Mummery, and endorses, “that in the normal state of modern industrial communities, consumption limits production and not production consumption.” 68 With this as one of his axioms only nonsense can follow.
Stagnation is due to a lack of consumption. “Up to the point where full employment prevails,” he writes, “the growth of capital depends not at all on a low propensity to consume but is, on the contrary, held back by it.” 69 Combined with this underconsumptionist thesis is a “fundamental psychological law, upon which we are entitled to depend with great confidence both a priori from our knowledge of human nature and from the detailed facts of experience, that men are disposed, as a rule and on the average, to increase their consumption as their income rises, but not by as much as the increase in their income.” 70 “As a rule … a greater proportion of income [will be] saved as real income increases.” 71
On its own, this second law, which is accepted as plausible here for the sake of argument (except for adding that consumption can, of course, never fall to zero), would not seem to indicate any trouble. So what? If savings overproportionally increase with increasing incomes, so much the better for the social product. 72 But Keynes, in his characteristic logic-carefree way of thinking joins this law to the thesis that production is limited by consumption, and he has then no difficulty proving whatever he wishes.
If consumption limits production, and if nonconsumption rises with rising incomes, then it indeed seems to follow that increasing incomes imply their own undoing by increasing nonconsumption, which in turn limits production, etc. And if this is so, it also seems to follow that wealthier societies, which non-consume more, should be plagued particularly hard by this “stagnitis”; and that in any given society it should be the rich, who nonconsume more, who contribute most to economic stagnation (except for the “minor” problem that one cannot explain, according to this theory, why individuals or societies could be wealthier than others in the first place!). In any case, Keynes accepts these conclusions as true. 73 Accordingly, he presents his recommendations on how to get out of stagnation. In addition to a “comprehensive socialization of investment,” Keynes suggests measures to stimulate consumption, in particular an income redistribution from the rich (people with a low propensity to consume) to the poor (those with a high propensity to consume).

Whilst aiming at a socially controlled rate of investment with a view to a progressive decline in the marginal efficiency of capital I should support at the same time all sorts of policies for increasing the propensity to consume. For it is unlikely that full employment can be maintained, whatever we may do about investment, with the existing propensity to consume. There is room, therefore, for both policies to operate together;—to promote investment and, at the same time, to promote consumption, not merely to the level which with the existing propensity to consume would correspond to the increased investment, but to a higher level still. 74

How is such a thing as simultaneously promoting investment and consumption in order to increase income conceivably possible? In fact, Keynes gives us his own formal definitions of the terms involved: “income = consumption + investment; saving = income - consumption; therefore, saving = investment.” 75 Under these definitions, a simultaneous increase in consumption and investment out of a given income is conceptually impossible!
Keynes is not terribly disturbed over “details” such as these. In order to get what he wants, he simply shifts, completely unnoted, the meanings of his terms. He drops the just quoted formal definitions, which would render such a result impossible, and he adopts a new meaning for the term saving. Instead of unconsumed income, saving quietly comes to mean hoarding (i.e., the act of not-spending money on either consumer or capital goods). 76 Thereby the results can be easily made to come out right. For then savings are no longer equal to investment; and saving, being defined as the act of not-spending, automatically acquires a negative connotation, while investment and consumption take on a positive one. Moreover, now one must almost naturally be worried about savings exceeding investment, or so it seems, for this would seem to imply that something is leaking out of the economy, and that income (defined as investment + consumption) must be somehow reduced. Keynes certainly worries about this possibility. He calls it “a chronic tendency throughout human history for the propensity to save to be stronger than the inducement to invest.” 77 And this chronic tendency must surely be particularly pronounced if incomes are high, for then, as we have been told, savings reach a particularly high proportion of income. But do not despair. Where something can leak out, something also can leak in. If savings is unspent money, then savings can be brought into existence, simple enough, by means of governmental money creation, so as to compensate for the outward leakage which tends to increase with increasing incomes. There is the danger, of course, that these compensatory “community savings” immediately leak out again by being added to the private sector’s cash hoardings (because, according to Keynes, the newly created savings would lower the interest rate, and this in turn would increase the capitalists’ liquidity preference so as to counteract such a tendency and to artificially “keep capital scarce”). But this can be taken care of by the “socialization of investment” as we know, and by some Gesellian stamped money schemes (“The idea behind stamped money is sound”). 78 And once saving and investing is done publicly—through the agency of the State, as Keynes would say—and all money is spent, and no keep-things-scarce motive is in the way any longer, there is indeed no longer any problem with increasing consumption and investment simultaneously. Since savings is unspent money, and newly created money and credit is just as genuine as any other because it is not “forced” on anyone, savings can be created by the stroke of a pen. 79 And since the State, contrary to the scarcity-exploiting capitalists, can make sure that these additional genuine savings are indeed being spent (instead of wandering into hoards), any increase in the supply of money and credit through governmental counterfeiting increases consumption and investment at the same time and so promotes income twice. Permanent inflation is Keynes’s cure-all. It helps overcome stagnation; and more of it overcomes the more severe stagnation crises of the more advanced societies. And once stagnation is defeated, still more inflation will abolish scarcity within one generation. 80
Yet the wonders do not cease. What is this leakage, this surplus of savings over investment, that constitutes all such dangers? Something must leak from somewhere to someplace else, and it must play some role here and some there. Keynes tries to disperse such thoughts by asking us once again not to apply logic to economics. “Contemporary thought,” he writes, “is still deeply steeped in the notion that if people do not spend their money in one way they will spend it in another.” 81 It would seem hard to imagine how this contemporary thought could possibly be wrong, but Keynes believes it false. For him there exists a third alternative. Something, an economic good one would think, simply drops out of existence, and this means trouble.

An act of individual saving means—so to speak—a decision not to have dinner to-day. But it does not necessitate a decision to have dinner or buy a pair of boots a week hence or a year hence or to consume any specified thing at any specified date. Thus it depresses the business of preparing to-day’s dinner without stimulating the business of making ready for some future act of consumption. It is not a substitution of future consumption-demand for present consumption-demand—it is a net diminution of such demand. 82

Still, the strictures of a two-valued logic do not quite crumble yet. How can there be any net diminution of something? What is not spent on consumer goods or capital goods must still be spent on something else—namely on cash. This exhausts all possibilities. Income and wealth can be and must be allocated to consumption, investment, or cash. Keynes’s diminution, the leakage, the excess of savings over investment, is income spent on, or added to, cash hoardings. But such an increase in the demand for cash has no effect on income, consumption, and investment whatever, as has already been explained. With the social money stock being given, a general increase in the demand for cash can only be brought about by bidding down the money prices of nonmoney goods. But so what? 83 Nominal income (i.e., income in terms of money) will fall; but real income and the real consumption-investment proportion will be entirely unchanged. And people along the way get what they want: an increase in the real value of their cash balances, and of the purchasing power of the money unit. There is nothing stagnating here, or draining, or leaking, and Keynes has offered no theory of stagnation at all (and with this, of course, also no theory of how to get out of stagnation). He merely has given a perfectly normal phenomenon such as falling prices (caused by an increased demand for money, or by an expanding productive economy) a bad name in calling it stagnation, or depression, or the result of a lacking effective demand, so as to find just another excuse for his own inflationary schemes. 84
Here we have Keynes in his entire greatness: the twentieth century’s most famous “economist.” Out of false theories of employment, money, and interest, he has distilled a fantastically wrong theory of capitalism and of a socialist paradise erected out of paper money.

Economics and Ethics of Private Property: Studies in Political Economy and Philosophy, The

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