Investopedia Unabshadly Comes Out in Favor of Keynesian Economics

Investopedia is a really good website to go to for the conventional economic view.  Being that, it is less than favorable to John Maynard Keynes and Keynesian economics in many of it’s articles.  In many cases they state things he  supposedly got wrong or go as far as putting words in his mouth like, “the government can spend your money better than you”(note: he never suggested anything like that).  It’s for that reason I had a good laugh when I read their article on Mercantilism which states(emphasis mine):

This approach assumes the wealth of a nation depends primarily on the possession of precious metals such as gold and silver. This type of system cannot be maintained forever, because the global economy would become stagnant if every country wanted to export and no one wanted to import. After a period of time, many people began to revolt against the idea of mercantilism and stressed the need for free trade. The continued pressure resulted in the implementation of laissez faire economics in the nineteenth century.

The emphasis part is exactly right.  It is impossible for every country to increase exports because those export must go to a country as an import.  If every country tries to do export and bans imports, then overall trade is reduced as nations stop importing.  The hilarious part is that this is one of the fundamental precepts of Keynesian economics.  This is almost exactly the Paradox of thrift.   It is impossible for every person to save money because that money they save must come from someone who is spending.  Your consumption is my Income.

The best part of this is how matter-of-fact it makes the point.  It offers no qualifications on the statement because mercantilism is so universally condemned.  It never occurred to me until recently that it’s universally condemned for the opposite reason that market fundamentalists condemn Keynesian economics.

It’s nice to see investopedia accept such an important keynesian concept.  Now, maybe a Keynesian wrote that article and would explain the apparent contradiction between the overall site and this particular article(probably not, but maybe).  Even so, I bet I could show that article to any market fundamentalist and they would not see anything wrong with that statement simply because it is used to promote “laissez faire”.

Dumbest. Anti-Keynesian economics. Article. Ever!

Whoever claimed that there are 3 kinds of lies: Lies, Damn Lies, and statistics really got it.  I ran across a silly blog post over at seeking alpha.  It was old, but it was so stupid it was worth bringing up.  The writer was trying to make an argument against classic keynesian economics.  His principal argument was the government spending causes unemployment.  Since most keynesians advocate fiscal policy to maintain aggregate demand, that would be quite a blow if he could prove it.

Unfortunately for the writer, his entire premise was based on a chart he made that showed the unemployment rate and government spending as a percentage of total GDP, graphed over time.  The result was a  direct correlation between unemployment and increased government spending – as a percentage of GDP.  Both went up and down at roughly the same time.  Game-set-match.  The statistics prove it!  /snark.

A few objections come to mind.  A statistician would jump in and say that “correlation doesn’t prove causation“.  That is to mean, just because they happen at the same time doesn’t mean that one necessarily causes the other.  However, pointing out that logical fallacy isn’t even the strongest argument against this guy’s point.

The second thing to disprove this non-sense was mentioned in the articles comments.  I’ll call it the “aspirin” factor.

The above article is a brilliant piece of false logic. I’m sure there is an equally close relationship between headaches and aspirin consumption. Which proves that aspirin does not ameliorate head aches. In fact, if you want to be totally and completely illogical, you might deduce that aspirin actually CAUSES headaches.

In the past, governments have often responded to recessions with stimulus spending.  What that means is that the unemployment caused the spending, not the other way around.  Thanks to many “automatic stabalizers” like unemployment and such, some of this spending increases now happens without even political intervention, but it’s still in response to the unemployment, not the other way around.

So we’ve had the “lies” and “damn lies” part.  Now time for the “statistics”.  For the graphs, the person completely rigged the results by not using total spending and instead he used “spending as percentage of GDP”.  Why is that important?  Well, to get the number, you take total spending and divide it by total GDP.  What that means is that if dollar spending stays the same, but GDP gets smaller, that spending number would rise even though the total dollar amount stayed the same.  Well guess what happens during a recession?  By definition, the GDP gets smaller.   Therefore, even if total dollar spending stayed flat, it would appear that government spending increased along with the oncoming recession.  The data tells a lie that you would only believe when looking at a picture graph of the data.

So there you have it.  All in one article, lies, damn lies, and statistics.

Unemployment Vs. Economic Efficiency

Nothing makes an argument more frustrating than when 2 people are using the same words to argue over 2 different things.  When discussing strategies to get out of the recession, market fundamentalists (usually conservatives) argue to let the markets work.  Others, usually liberals who sorta-kinda understand Keynesian economics, argue that we need more stimulus to jump-start the economy.  Then the market fundamentalists respond with “markets are more efficient than government” it is always better.  Then they give some example of the government, in fact, screwing something up.  Then the liberal Keynesian says, free markets got us into this mess, and then gives an example of a corporation, in fact, either screwing something up or doing something evil.  This goes back and forth and is never resolved because they are talking about two different things.

If you’re arguing for more stimulus or increased aggregate demand and end up arguing over how much governments and markets do or don’t suck, you’ve lost the argument or – at best – will stalemate.  The reason is that in most cases markets are more efficient than government trying to do it.  Be it selling shoes or setting apartment rent prices.  The liberal position is not to suggest otherwise.  The problem is that it has nothing to do with your argument for demand management.  An economy that is deficient of aggregate demand can not fix itself because it has nothing to do with an individual product or industry.

To understand why these are two different things, let’s take a look at a proto-typical private market.  Let’s say that you run a company that sells dish soap and one day people  buy less dish soap.  Pretty soon you’ll notice you’re selling less dish soap and will start making less of it.  You’ll now need fewer employees and equipment to make that dish soap.  You can either move those employees and equipment to make other things(like paper plates) or you can lay off your employees and sell the equipment.  In a good economy those employees and equipment would eventually go to a company making other things.  That is economic efficiency that government should stay out of.

What happens when people start buying less of everything?  Those employees that were laid off would have no where to go because all companies are making less things because they are selling fewer things.  That’s what happens during a recession.  Now you have high unemployment and nowhere for those employees to go.  It is the difference between micro and macro economics.  If one is thinking “micro” they will think that the economy will simply sort things out – “let the markets work”.  However, when one looks at the big picture you’ll see that private markets can’t sort it out because it has nothing to do with the efficiency that markets are good at.

Additionally, if one takes a micro approach to a recession and sees that workers are being laid off, they might (rightfully, in a “micro” approach) suggest that the workers need to take a pay cut to stay employed.  Take our dish soap example.  If consumers are buying only less dish soap, then workers could take a pay cut to keep everyone employed.  If workers demand less money, then it might be better for the company owner to hire people instead of buying and maintaining expensive machines and computers to do the same work.  If however, the problem is that consumers are buying less of everything, pay cuts for all workers will only make the problem worse.  If all workers in an economy take a pay cut, those workers will then turn around and buy less of everything because they now have less money.  That must then be followed by another pay cut which would then lead to another general drop in people buying stuff which would lead to another pay cut… etc…

To suggest that an economy needs increased demand does not require one to reject free enterprise.  The private market cannot deal with a drop in aggregate demand because no single company or person can control overall demand.  John Maynard Keynes was the first to show this systemic problem.  His recommendation was for the government to be that outside force that adds demand to the economy by doing social investment.  The idea was that government would give more people money to work, and then they would spend that money which would then cause people beyond the government to get jobs.  Doing this restored demand and had the bonus of providing public works that society could benefit from like parks and libraries.  Since his time, economists have come up with further refinements to his original recommendation.

For market fundamentalists of course, this is all heresy.  Instead, the market fundamentalists continue blaming the government for everything.  To any other reasoned person, you see a deep systemic problem that requires outside intervention to balance.  These two concepts don’t have to conflict.  You can advocate for private markets and government intervention to restore aggregate demand.  Only dogmatic market fundamentalists can’t see the difference between that and eliminating free enterprise.

The Useless Quantity Theory of Money

“If the government creates money all it’ll do is cause inflation and we’ll all suffer.” This is one of the deadliest lies we’ve been told for the last 40 years. For centuries, philosophers and economists thought that any increase in money would always increase prices. John Maynard Keynes pretty much set the record straight on that about 80 some years ago. But the idea has been resurrected in the last few decades and is now mainstream again. It’s this rationale that conservatives use to justify destroying social programs, budget cuts, and the basis for the current debt “ceiling” discussions in Washington. What makes the idea so insidious is that it makes sense on the surface. With most things, the more of something there is, the less it’s worth. But unlike most things, money has no intrinsic value. That makes it fundamentally different. Below I will show you the modern re-emergence of this theory and why it is bullshit.

Money has no value until it is spent. What that means is that only at the time of purchase does it have an effect on inflation. For instance whether a single dollar bill is spent 4 times, or 4 dollar bills are spent once, the effect is the same. To give an example of what I mean, let’s look at two scenarios:

One day, a cold man buys a coat from a coat shop for a dollar. Now let’s say the owner immediately gives that dollar to one of his employees as their salary for the day. The employee then turns around and buys a coat as well. The shop owner then takes that dollar and buys lunch at a cafe. The owner of the cafe then takes that dollar to the shop and buys a coat. Finally, the shop owner takes the dollar to the owner of a billboard and buys advertising. The billboard owner then takes that dollar and buys a coat with it. On the way home the shop owner buys a book with his dollar from the bookstore.

In the second scenario. Let’s change the order. The cold man, the cafe owner, the employee, and the billboard owner all come in to the coat shop in the morning and buy a coat for a dollar. At the end of the day, the shop owner takes those 4$ and pays his employee’s salary of 1$, buys dinner at the cafe, buys his billboard ad, and gets his book. That’s 8$ worth of activity from 4 single dollar bills.

In both scenarios, the end result is the same. 4 people have coats, the shop owner has payed his one employee, gotten a meal, has advertising, and bought a book. That’s 8$ worth of activity from a single dollar bill in the first scenario, and 8$ worth of activity from 4 single dollar bills in the second scenario. How is that possible? Doesn’t more money always mean higher prices? In short, No. The rate that money is spent also has an impact on prices. As far as prices and demand is concerned, a single dollar being spent 10 times has the same effect as 10$ being spent once.

This is something that economists have know for a long time. They even have a fancy, glazed-eye inducing formula to represent it. Money Price Formula They eventually boil the formula down to this. MV=PQ. In their own convoluted way, what economists are trying to say is that, All existing Money(M) multiplied by the average number of times it is spent(V) is equal(=) to the amount of goods in the economy(Q) * the average price of those goods(P).

For example, if in a small town there are only 10 physical dollars(M) and each dollar is spent 3 times(V) then that means there was 30$ worth of activity. So if there were only 3 things bought(Q) in that village(say a toaster, a coat, and a lighter), then their average price would have to be 10$(P). If there were 6 things bought, then the average price would have to be 5$. M times V must always equal P times Q. M * V = P * Q. This equation is non-controversial among all economists. It is logical and self-evident.

This finally brings me to the lie we’ve been told for decades. Some guy, decades ago, took that equation MV = PQ and said something to the effect, “well, if you ‘assume’ that the velocity of money is constant and that the economy cannot(or will not) increase the amount of goods, then any increase in the money supply will only serve to increase prices”. Algebraically, it makes perfect sense. If you assume that ‘V’ and ‘Q’ are constant, then making M bigger would HAVE to make P larger. Thus was born the Quantity Theory of Money. You probably see the problem with this already. ‘V’ and ‘Q’ are most certainly not constant! (Funnily enough, that same guy still managed towin a Nobel prize in economics.)

‘V’ or the velocity of money is not constant. That’s why during the start of a recession the federal government can run huge budget deficits and still see ‘P’ or prices go down. When people feel insecure about the economy, households save money in case of a layoff, and businesses don’t risk new investments. The rate money is spent goes down and in the case of 2008, completely eclipsed the increase in the money supply created by budget deficits.

The other assumption that ‘Q’ is constant is also bullshit. An increase in money or spending rate can make the number of goods in the economy(Q) go up instead of prices. Think of a car factory being inundated with requests for more parts. Instead of increasing prices they could add a third shift. As long as there are enough unemployed workers to hire for the third shift, the increase of MV will affect quantity(Q) and not prices(P). Q would increase instead of P as long as the ability to increase supply exists. If there aren’t enough workers (or some other constraint), then the factory would have to raise prices. This situation would exist when there is almost no one who is unemployed to be hired for the third shift. You might be asking “why wouldn’t the factory just increase prices and reap all those profits?” The answer is that if the factory just increased prices they would be susceptible to some other factory adding a third shift and keeping their prices low – or as economists like to put it, “firms increase quantity before prices to maintain their marketshare”.

Now you should be able to see the absurdity about worrying about rising prices when unemployment is so high. High unemployment means that ‘Q’ isn’t at it’s highest. Therefore increasing ‘M’ via federal budget deficits will have very negligible effects on ‘P’. Instead new jobs will be created and we can enjoy the increased goods without increased prices. Only when the economy is maxed out will budget deficits start increasing prices. It is at that point that we can start worrying about budget deficits and debt “ceilings”. Worrying about them before that happens is stupid.

I’ve tried to show in the most logical way I am capable, of why we shouldn’t fear increasing the amount of money at times like this. Now that you’ve seen the basis for the “Quantity Theory of Money” and the assumptions that it relies on, I hope you can see why it’s bullshit. While it may be “technically” true if it’s assumptions are true, the assumptions are rarely, if ever true.