The August 17, 1998 issue of Fortune features a paean to John Maynard Keynes by Paul Krugman entitled “Why Aren’t We All Keynesians Yet?”
Here is my response:
Paul Krugman’s column of August 17, 1998, “Why Aren’t We All Keynesians Yet?” is silly and discouraging. Under the general heading “No Free Lunch,” Krugman celebrates the 20th century’s largest promoter of Free Lunch Economics, J.M. Keynes. It was Keynes, after all, who claimed that credit expansion “performed the miracle...of turning a stone into bread.” Mr. Krugman’s piece features an error in almost every paragraph and cries out for an informed response.
Krugman’s litany of praise begins with a mischaracterization of Keynes’s Economic Consequences of the Peace, a book forecasting the economic consequences of the Versailles Treaty. French Economist Etienne Mantoux demonstrated in 1944 that Keynes was wrong in his details as well as his central thesis.
Keynes predicted that, as a result of the Treaty, iron and steel production in Europe would decline; it rose. He predicted that German pre-war coal output could not be sustained; it was. He predicted that Germany could not export coal; it did. He predicted that the German merchant marine would be insufficient for Germany’s trade; by 1924 it was the envy of the world. He predicted that Germany’s amount of savings could not recover to its pre-war level; it did. In other words, Keynes was wholly wrong about the strictly economic consequences of the Versailles Treaty.
It turns out Keynes was not much better in forecasting the political consequences of the Treaty either. Keynes predicted that the Treaty would lead to “anarchy and famine.” Krugman’s hindsight is such that, since Hitler rose to power, Keynes was a prophet. In fact, Europe, and Germany in particular, saw neither anarchy nor famine. Mantoux reveals that Hitler’s popularity in Germany rose as the treaty reparations demanded of Germany were repeatedly reduced.
Regarding Keynes’s theorizing about German economic conditions, Krugman fails to point out that Keynes himself recognized that his own policies were more National Socialist than free market. In the Preface to the 1936 German language edition of his General Theory Keynes told his German readers that his theories were much more suited to a totalitarian state, like the one the Nazis had in place, than to a free market.
The stability of the world economy after World War II, to the extent that it was stable, was maintained despite the Bretton Woods agreement, not because of it. Such stability proved to be superficial as the inflation of the late sixties and early seventies demonstrated. Richard Nixon’s closing the gold window in 1971 was a direct consequence of the inflationary incentives put in place under the Bretton Woods agreement.
Additionally, Krugman’s claims regarding Keynes’ General Theory are repeatedly in error. Krugman states that he “tried going through the pre-Keynesian business-cycle literature” and found it to be “a vast wasteland.” If he did, he did not try hard enough. In 1912, Austrian economist Ludwig von Mises’s The Theory of Money and Credit, was published. Among other things, Mises did explain, more coherently and correctly than Keynes did, why depressions occur and what should be done about about them.
Keynes cited “insufficient aggregate demand” stemming from unstable business investment as the cause of depression. He offered no explanation for why an economy should suddenly experience insufficient aggregate demand. Mises, on the other hand, explained that the business cycle is due to credit expansion stimulated by the central banking authority. Such expansion lowers the interest rate below the market rate, encouraging investment that will not be met by future demand. Such investments are bound to fail. The only way back to economic prosperity is to allow market forces to liquidate unwise investments. Further credit injections will only start the process over again.
Keynes wrote a generally favorable review of Mises’s book but criticized it for being unoriginal. He later admitted that he could not understand German well enough to understand original ideas. Such was the integrity of Mr. Keynes.
Mises followed his first great work with two monographs and an article in 1923, 1928, and 1931, respectively, that more fully described the cause and nature of, and the remedy for, economic crises. In 1931 his student F.A. Hayek published his Prices and Production outlining and developing Mises’s theory. Hayek then followed in 1941 with The Pure Theory of Capital. Hayek’s contributions to Krugman’s “vast waste-land” were rewarded with a Nobel Prize in economics in 1974.
Finally, Krugman gets it wrong about Keynes’s supposedly first “coherent explanation of the hyper-inflations” underway in Europe in the 1920’s. Mises’s The Theory of Money and Credit had already provided a general explanation for the stages of hyper-inflation experienced by Germany in the 1920s. In 1923, Mises applied his general theory to the case of Germany in a book on monetary stability submitted to the printer more than eight months before the final breakdown of the German Mark. And Mises was able to explain Germany’s monetary breakdown without referring to anything like the chimera “too much aggregate demand.”
The reason that Keynes is not and should not become a cultural icon is that Keynes was wrong. The problems that Japan is facing now are not due to consumers and investors suddenly “spending too little.” They are the necessary outcome of massive, state-sponsored credit expansion coming home to roost. For a better understanding of today’s economic crises, we should look back not to Keynes, but to Mises.
