Money and Government: The Past and Future of Economics
Robert Skidelsky
Yale University Press, 2018
xiv + 402 pages
The title of Murray Rothbard’s Power and Market provides a useful entry to understanding Robert Skidelsky’s long and learned book. Rothbard drew a contrast between peaceful cooperation through the free market and State coercion. Which do you support, he asks: power or market? Skidelsky, a historian and economist who has written admiring biographies of Keynes and the British fascist Oswald Mosley, is for the most part clear in his answer: power should prevail over the market.
Thus, although he notes that mercantilism rests on economic fallacies, he still thinks this system has much to be said for it. “Rising prices were associated with prosperity; falling prices with dearth. This correlation led a group of seventeenth-century thinkers called mercantilists to identify money with wealth. The more money a kingdom had, the wealthier it was; the less, the poorer.” This view is mistaken: mercantilism was based on the “fallacy that exporting is better than importing and that the object of economic policy should therefore be to secure a favourable balance of trade ... of course, all countries cannot achieve a trade surplus simultaneously, so the pursuit of these policies involved continuing trade wars between the leading European powers.”
But what is wrong with trade wars? “The mercantilists believed that state activity and spending could galvanize the growth of national wealth. War was an investment decision by the state: the state needed sufficient revenue to conquer foreign markets.” Why rely on peaceful exchange when you can take what you want by force?
In addition, war has another benefit: it reduces inequality. “Recently, discussion of distribution has centred on the fact, and meaning, of the sharp rise in inequality since the 1970s, particularly in the United States and Britain. The most notable contributions here are Thomas Piketty’s Capital in the Twenty-First Century (2013) ... and Walter Scheidel’s The Great Leveler (2017). ... Both attribute the great compression of wealth and incomes in the middle years of the last century to the effects of the two world wars and Great Depression.”
Skidelsky is not content to urge the merits of power over market. He wishes to challenge advocates of the free market on their own ground. They take as their standard the welfare of consumers and on that basis argue for voluntary exchange. The fundamental argument of his book is that, in doing so, they fail to realize the disruptive effect of money. In a barter economy, Say’s Law, which Skidelsky wrongly states as “the infamous ... Law that supply creates its own demand” holds true. As W.H. Hutt pointed out in his major study A Rehabilitation of Say’s Law, the law is better stated as “all power to demand is derived from production and supply.” Another way to state the law is “the supply of a good on the market is demand for other goods.” There can be no overproduction that covers all of the economy.
Once money enters the scene, the situation alters. Instead of spending their money on consumption or investment goods, people can hoard money. “Speculators, too, have always known that in disturbed times they can profit from being liquid. Increased propensity to hoard, what Keynes called the ‘speculative demand for money’, thus arises from increased uncertainty. It slows down the economy by slowing down the spending of money on currently produced goods and diverting it into financial operations. Thus money earned in producing goods may be unavailable for spending on those goods, causing unemployment.”
As Skidelsky tells the tale, neoclassical economists who favored the free market attempted to solve this problem through the quantity theory of money. By varying the quantity of money, the monetary authorities could keep the value of money stable. In that way, the fears of speculators would be calmed and hoarding averted or countermanded. Milton Friedman’s monetarism is the best known example of this view, but Knut Wicksell, and even Keynes before the General Theory, supported it. As Keynes came to realize, though Friedman did not, monetarism does not work. The central monetary authority is unable to control the money supply in the way this theory supposes.
Although Skidelsky mentions Austrian economics several times, he never confronts the Austrian criticism of his entire line of reasoning. In the Austrian view, he has gotten wrong both the alleged problem posed by hoarding and the alleged “cure” that the proponents of the free market suggest for it.
As Murray Rothbard has pointed out in Man, Economy, and State, allocation of resources between consumption and investment depends on the rate of time preference. The demand to hold money creates no special problem for this allocation. In assuming otherwise, Keynes and his followers wrongly took the loan rate of interest to be primary, when in fact it is subordinate to the primary determinant of the rate of interest, the aforementioned rate of time preference.
Rothbard explained the basis of the Austrian account of the interest rate in this way: “People, therefore, allocate their money, among consumption, investment, and hoarding. The proportion between consumption and investment reflects individual time preferences. To think of the rate of interest as ‘inducing’ more or less saving or hoarding is to misunderstand the problem completely. ... One grave and fundamental Keynesian error is to persist in regarding the interest rate as a contract rate on loans, instead of the price spreads between stages of production.” In contrast to the Keynesian fear that expectations of falling consumption demand will lead to a cycle of further price falls and lowered expectations, Rothbard says, “The expectation of falling factor prices speeds up the movement toward equilibrium and hence toward the pure interest rate as determined by time preference.”
Moreover, the speculative bubbles that Keynes feared stem not from sudden and mysterious collapses of the “animal spirits” of investors but rather from injections of bank credit in fractional reserve banking, a system unsustainable without state control of the money supply. Skidelsky is well aware of this theory but has little to say about it, perhaps because he does not like its consequences for policy: “The causes of the crash of 1929 have been much disputed. Friedrich Hayek claimed that it was a result of excessive credit creation in the United States. In his account, the price stability of the mid-1920s, so much praised by the monetary reformers, was an indication of inflation, not of equilibrium, since productivity gains would have naturally produced a falling price level. ... ‘Excessive credit creation’ became the standard ‘Austrian’ explanation of the 1929 collapse. It resurfaced to explain the crash in 2008. ... On the Austrian analysis, recessions give a chance to reallocate ‘mal-invested’ productive factors to efficient uses. They should therefore be allowed to run unhindered until they have done their work. Economists whose common sense had not been completely destroyed by their theories rejected the drastic cure of destroying the existing economy in order to rebuild it in the correct proportions.” Skidelsky is sure that allowing prices to fall in a depression would ruin the economy, but as James Grant shows in his outstanding The Forgotten Depression, the US government did exactly that in coping with the downturn in 1920–1921, and the result was a speedy recovery. Skidelsky cites Grant’s book in his bibliography but ignores its relevance to his complaint against the “drastic cure.”
Further, Austrians reject the quantity theory of money. Mises in The Theory of Money and Credit said about it: “There is no justification whatever for the widespread belief that variations in the quantity of money must lead to inversely proportionate variations in the objective exchange value of money, so that, for example, a doubling of the quantity of money must lead to a halving of the purchasing
power of money.” Austrians thus oppose endeavors by the state to stabilize the value of money based on this theory. It is ironic that Skidelsky takes the failure of monetarism, a form of state intervention, to show the defects of the unhampered market economy. It is ironic that Skidelsky takes the failure of monetarism, a form of state intervention, to show the defects of the unhampered market economy.
Our account of Skidelsky’s book now takes a surprising turn. Although he opposes the free market, he is not prepared to dismiss entirely the views of the Austrians. To the contrary, he considers Hayek a great thinker and recognizes that his warnings against government intervention have merit. “Liberalism, or social democracy, unraveled with stagflation and ungovernability in the 1970s. ... Keynesian/social democratic policymakers succumbed to hubris, an intellectual corruption that convinced them they possessed the knowledge and the tools to manage and control the economy and society from the top. This was the malady against which Hayek had inveighed in his classic The Road to Serfdom (1944).”
Skidelsky recognizes that the Keynesians had no adequate answer to the “stagflation” of the 1970s. He also recognizes the force of the “public choice” analysis of government though he by no means commits himself fully to it. “Its main thrust was to emphasize the importance of the private incentives facing politicians and bureaucrats. The Keynesian-social democratic state was modelled as a private interest masquerading as guardian of the public interest. This was back to Adam Smith.” Skidelsky errs, though, when he says that “Public choice theory is simply rational expectations theory applied to government. It takes from REH [rational expectations hypothesis] the methodology of modelling public policies as the solution to individual maximization problems.” This is not correct. The basis of the theory is that politicians are self-interested actors, but this does not commit one to a particular model of how such actors behave.
Even readers who disagree with the thrust of the book will benefit from Skidelsky’s wide learning. The author sometimes makes mistakes. He says, “The French state, which emerged from the war [WWII] as the nation’s chief investor, did not have to learn its statism from Keynes; Colbert had pointed the way in the eighteenth century.” That was a neat trick for Colbert, who died in 1683. He calls the well-known businessman and New Deal financial expert Beardsley Ruml “Rummel.” But the slips are few and minor.
Just as in his earlier book How Much Is Enough? (2012), Skidelsky manifests an inordinate distaste for money and “greed.” Far better in his eyes is the pursuit of power by the State, even at the cost of wars and massive public debt. Some of us will not agree.
