Keynesian Malarkey

At a meeting of various policymakers and their establishment approved advisors arranged by the IMF (a superfluous organization if ever there was one), a speech delivered by Larry Summers made some waves. Here is a viedo of the speech:

 


 

Larry Summers delivers a speech brimming with Keynesian nostrums

 


 

Well, we've always said that the only time the economy is reasonably safe is when this man is asleep. Summers spends a good five minutes singing the praises of various other central economic planners and/or their teachers as well as fulsomely praising the bailout of 2008 that saved the New York banking cartel's behind at the cost of everyone else in society. He is once again asserting, without offering a shred of proof, that (paraphrasing) “Ben (helicopter pilot Bernanke) saved us from a repeat of the Great Depression”.

 

Frankly, we are sick of this nonsense. No-one can conclusively prove otherwise of course, since we cannot go back and 'test' what would have happened had the bailouts not occurred. But sound economic theory as well as common sense tell us that saving the worst stewards of capital by printing wagon-loads of money and wasting tax-payer funds is only going to end up keeping alive a bunch of zombies that will henceforth prove to be a huge drag on the economy. This much we can indeed observe by now: the 'recovery' has turned out to be a big disappointment. This is not in spite of all these bailout efforts and all the money printing that has occurred since then, but because of them.

Had a laissez faire attitude been adopted in 2008,  we would no doubt have suffered a much deeper crisis initially. Over the course of two or three years, economic data would probably have looked quite horrendous as the huge amounts of malinvested capital left over after a series of Fed-induced bubbles would have been liquidated (or where possible transferred to better uses).

However, thereafter, a sound foundation for a sustainable recovery would have been established. The ownership of a great many assets would have moved from the hands of the state-supported zombies to the more capable hands of those who had been prudent during the bubble. It is inter alia this change in economic power that the establishment wanted to avert.

 

'Secular Stagnation'

Then Summer launches into the meat of his speech – first noting that unemployment is higher than we would like (duh) and asserting that 'GDP has fallen further behind potential as we would have defined it'.

Of course, 'potential GDP' and 'output gaps' are just Keynesian chimeras. What is this even supposed to mean? In reality, a lot of capital has been wasted and  become unusable, especially highly specific capital. It is not standing around waiting to be employed as a contributor to 'potential' GDP. The many machines that made granite tops for kitchens? They're never going to be used again!

There comes a brief hopeful moment when Summers notes that the 'classical and Keynesian models' are evidently not very useful in describing the economic situation (now he tells us!) and that 'older ideas' may be applicable.

Incidentally he also lets it slip that the 'stabilization policy' with its goal of 'having less and less volatility' was probably a bad idea (we have written about this before).

What older ideas though? Ideas about 'secular stagnation'. He then talks about the 'odd features' of the last credit boom – in spite of a huge credit bubble actuated by too loose monetary policy that created plenty of phantom wealth by pushing up asset prices, Larry finds it odd that 'capacity utilization' was not under pressure, unemployment didn't go down a whole lot and 'inflation' was quiescent' (meaning CPI didn't rise much). Apparently he is not aware that this isn't the first time in history such a concatenation of data could be observed (think 'roaring 20s').

Summers of course concludes that 'even a big bubble wasn't able to create any excess in 'aggregate demand'. What about the demand for land and houses? That wasn't excessive?

There can of course never be a 'shortfall in demand'. There can be a lack of means of paying for one's demand, but it is a good bet that most people's 'demand' is in vast excess of what they can actually afford.

For instance, the team at Acting Man has a demand for a few big private islands with airports and various amenities, a nice fat Gulfstream jet plane to flit around between them, and so forth. Unfortunately we must inform the sellers of islands such as the Greek government and the builders of airplanes that at present, we cannot yet exercise that demand. We are probably a victim of 'secular stagnation'.

 

Interest Rate Nonsense

Around five minutes in, it becomes truly absurd. “Suppose that the short term natural real interest rate that was consistent with full employment had fallen to negative 2% or negative 3%”, Summers avers. Then “you 'wouldn't see any excess demand or get back to full employment in spite of all this stimulus.”

Allow us to point out here that 'natural interest rates' simply can never become negative, as that would imply the existence of negative time preferences. It is however impossible for time preference to become negative. As Ludwig von Mises points out, time preference is a fundamental category of human action:

 

“Time preference is a categorical requisite of human action. No mode of action can be thought of in which satisfaction within a nearer period of the future is not—other things equal—preferred to that in a later period.”

[…]

Other things being equal, satisfaction in a nearer period of the future is preferred to satisfaction in a more distant period: there is disutility in waiting.

This fact is already implied in the statement stressed at the beginning of this chapter, that man distinguishes the time before satisfaction is attained and the time for the duration of which there is satisfaction. If any role at all is played by the time element in human life, there cannot be any question of equal valuation of nearer and remoter periods of the same length. Such an equal valuation would mean that people do not care whether success is attained sooner or later. It would be tantamount to the complete elimination of the time element from the process of valuation.”

 

(emphasis added)

Gross market interest rates contain other elements beside time preference (such as risk premiums, price premiums and a profit component), and there are rare occasions when we see certain financial instruments (i.e., bonds) trade at prices that produce a negative interest rate return. However, all these situations can be fully explained without resorting to throwing out a fundamental category of action such as time preference.

As regards 'full employment': if we want to have full employment, there is one sure way of achieving it. Return to an unhampered market economy. As long as labor remains a scarce economic good, only catallactic (i.e., voluntary) unemployment can appear in a truly free market economy. Unemployment cannot be fought by instituting 'negative short term interest rates'.

Summers then goes on to say “imagine a situation where natural interest rates have fallen below zero, then conventional macro-economic thinking leaves us with a serious problem”. But that is like saying “imagine that water were to flow uphill instead of downhill. Wow, wouldn't that be a big problem”. There's no reason to imagine such hypothetical situations except perhaps as an intellectual game. They have no bearing on reality.

 

Summer Admits He Is Crazy

Summers then launches into the idea that any attempts to prevent future bubbles or crises may be 'counterproductive', because they would 'suppress aggregate demand' and fail to 'restore equilibrium'. He then thankfully admits that he 'may be mad and have all of this wrong' –  we by and large agree.

Note that there is actually no such thing as 'equilibrium'. That exists only in the very 'models' which he admitted at the outset are useless. The market process is a process of continual changeit tends toward equilibrium, but can never reach it. It is also sheer madness to wish for an 'equilibrium state' – even if it could be attained (which is impossible anyway). Such a  state  would mean the end of all economic progress.

Summers concludes by saying “in the years ahead we may have to think about how to manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor holding our economy back below its potential”.

First of all, the premise is wrong. Who is 'we'? Obviously the assortment of planners and their advisors at the conference. Summers isn't thinking about the plans of you and me, he is thinking about how to best interfere with them. The economy does not need to be 'managed' by anyone. The best thing that could happen to the economy would be if it were left completely alone.

What the planners should really be thinking about is how to gracefully slink away into the dustbin of history where they belong. Time for your retirement, boys and girls!

Summers is of course correct that the 'zero nominal interest rate is a chronic systemic inhibitor' holding the economy back, but not in the way he sees it. He believes that pretending that the cost of capital should be zero means the interest rate  is too high!

 

Addendum:

One sure indicator that we have been presented with a load of baloney by Summers is that Paul Krugman absolutely loved it. We will look at Krugman's interpretation of the speech in an upcoming article, as it is actually quite interesting.

 


 

larry_summers

Larry Summers – the world is undoubtedly safer when he does this.

(Photo credit: Chip Somodevilla / Getty Images)

 


 

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4 Responses to “Meet Larry Summers, Social Engineer”

  • zerobs:

    there cannot be any question of equal valuation of nearer and remoter periods of the same length. Such an equal valuation would mean that people do not care whether success is attained sooner or later.

    Perhaps Larry Summers would prefer to die now rather than later.

  • Solon:

    Well, we’ve always said that the only time the economy is reasonably safe is when this man is asleep.

    That is one awesome line.

    They (Summers’ “we”) are going to drive this economy off the cliff and into a deep deep gorge, at the bottom of which we may find ourselves trading by barter once again… a century or more of economic progress consumed in the ball of flames exploding from the economy’s crash. After the fire, we will be left to scrabble out a hard painful subsistence out of the ashes and embers that remain.

    We need to be very careful that politicians don’t lead us down the path to war in order to obscure the coming leap off the cliff. Soon, it will be the only alternative left to the State and its Statists.

    • No6:

      I think the US has already gone over the cliff, just no one in the vehicle is as yet any worse off. They will feel the pull of gravity soon enough.

      • Solon:

        I don’t think so. I think the option of finding a glide path still remains (gold bond, followed by opening the Mint to gold and implementing hard money). And, as Japan shows, States can defy gravity for a long time while they print themselves pretty new parachutes. Not forever, but a long time. Theoretically, the rate of interest can be halved indefinitely. I think though that on a practical level, it can be halved until the degree of short term volatility approaches the front-running profits available. Ie, it’s no fun to play anymore. At which point, Wall Street heads for the exit marked “Gold” and the Fed will be forced to make an actual decision: self-annhilation or hyperdeflation.

        But confidence and sentiment are strange and nebulous things. You could very well be right… this might end tomorrow, especially given the right exogenous event(s).

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