The
Keynesian case presented
Joseph
Stiglitz, who is described by the Sunday Telegraph as
“one of the world’s leading economists” has updated his
book, Freefall. Stiglitz provides last Sunday’s
Telegraph with an exclusive extract, headed,
The euro may not survive. For those who don’t know
Stiglitz, he is a card-carrying Keynesian and a Nobel
Prize winner; for those of us that do he is nearly as
misguided as Paul Krugman, another Nobel Prize winner.
Early in his extract, he regrets that when the G20
brought the developed countries together, “there was a
moment when the whole world was Keynesian, and the
misguided idea that the unfettered and unregulated
markets were stable and efficient had been discredited”.
This sets the scene for us, being a firm statement that
he does not believe in a free market. Furthermore this
extract is so full of common Keynesian fallacies that he
provides a useful text for criticism of daft Keynesian
ideas without going to the needless expense of buying
his book. And it is so muddled that I shall restrict my
critique to just a few of his key misconceptions.
1.
He states that “Critics claim that Keynesian
economics only put off the day of reckoning”, and he
argues that to the contrary, unless we go back to basic
principles of Keynesian economics, the world is doomed
to a protracted downturn. Mr Stiglitz is confusing
cause and effect. A primary cause of all our troubles is
the expansion of credit, firstly fuelling the dot-com
bubble and secondly the residential property bubble. Mr
Greenspan rescued us from the former by pitch-forking us
into the latter. A further cause is the growth of
non-productive government at the expense of the
productive private sector; a result of past
interventions that are never unwound. The crisis has
been created by the very policies he believes in, and he
somehow thinks that even greater doses of
credit-creation and budget deficits will get us out of
it. The world is doomed to a downturn because attempts
by governments to undermine free markets eventually
fail, not because of insufficient stimulus. The problem
with basic Keynesian theories is that they rely on
tricking the market with unsound money, and successive
waves of intervention have left us with a legacy of debt
and devalued savings, or put more simply, we are bust.
2.
He states that “The low interest rates on
long-term bonds and inflation-indexed bonds suggest that
the ‘market’ itself is not too worried about inflation,
even over a longer period”. This is incorrect.
Bond yields reflect the fact that the Fed and the Bank
of England are pricing bond markets through QE
purchases, wrongly persuading fund managers that
government bonds are a safe-haven. You cannot draw
conclusions from a rigged market.
3.
He believes that governments can still do more to
help the private sector grow – “if the old banks
won’t lend, create some new banks that will”. He
fails to understand that banks are operating in an
economic environment that is totally different from
before the credit-crunch. The private sector is burdened
with an insupportable debt mountain and it is a bad bet.
Banks’ primary duty is to their shareholders, and they
will seek the best returns available, commensurate with
risk. And guess what – their best returns come from
lending money to governments and to dynamic businesses
in developing economies. If governments were to create
new banks with a different approach, bankers would have
to be retrained to have the sense knocked out of them.
4.
“Had Greece and Spain been allowed to decrease
the value of their currency, their economies would have
been strengthened by increasing exports”. This is a
common assumption that goes all the way back to Keynes’
Tract on Monetary Reform, and is wholly
fallacious. If it was true, Germany’s and Japan’s trade
surpluses would have diminished as their currencies
rose, and the continual devaluations of sterling and the
US dollar would have diminished their trade deficits as
well. Experience shows that devaluation does not reduce
trade deficits, as Stiglitz wrongly states. Trade
imbalances are simply the result of government
interventions: debtor nations run unbalanced budgets,
intervene in the currency markets, inflate the money
supply and permit banks to create excessive levels of
credit. Without these inputs, the private sector always
balances its trade and capital flows; with them it does
not have to.
5.
Our final example addresses the future for the
euro: “There is one solution: the exit of Germany
from the eurozone or the division of the eurozone into
two sub-regions.” This recommendation overlooks the
fact that there is no exit mechanism and for the
treatment of affected debt. What creditor is going to
agree to redenominate his loans in drachmas, pesetas or
lira? It also overlooks the fact that members of
Stiglitz’s new sub-region would be simply unable to
raise money in the capital markets without paying
considerably higher interest rates than they do today.
Leaving the euro would accelerate their bankruptcy and
create the economic and banking crisis Stiglitz says he
is trying to avoid.
These misconceptions in Stiglitz’s book extract are but
a small sample of his Keynesian errors. Unfortunately,
they have been repeated so often that they are now
unquestioned. People like Stiglitz have become an
integral part of the establishment and their insistence
on interventions and regulation to counter perceptions
of private sector short-comings is finally wearing the
private sector down. That is why the global economy
risks collapse, and not as he supposes, from
insufficient Keynesian stimulus.
Like Paul Krugman, Stiglitz has achieved the highest
honours the establishment can bestow in the form of a
Nobel Prize. Yet the wise man reads his writings in the
knowledge that they are infallibly wrong and therefore
excellent guidance for what is right.
4 October 2010
