Chapter XI “THE MULTIPLIER”

1. The Magic of It

We now come to the strange concept of “the multiplier,” about which some Keynesians make more fuss than about anything else in the Keynesian system. Indeed, a whole literature has developed around this concept alone.

Let us try to see what Keynes means by the term.

In given circumstances a definite ratio, to be called the Multiplier, can be established between income and investment and, subject to certain simplifications, between the total employment and the employment directly employed on investment.... This further step is an integral part of our theory of employment, since it establishes a precise relationship, given the propensity to consume, between aggregate employment and income and the rate of investment (p. 113).

Keynes gives credit to R. F. Kahn for first introducing the concept of the multiplier into economy theory in 1931. But Kahn’s was an “employment multiplier” whereas Keynes’s is an “investment multiplier” (p. 115).

Now the average propensity to consume, the reader will recall, is “the functional relationship... between... a given level of income in terms of wage-units, and... the expenditure on consumption out of that level of income” (p. 90). So, “if C_w is the amount of consumption and Y_w is income (both measured in wage-units) Δ C_w has the same sign as ΔY_w but is smaller in amount, i.e. is positive and less than unity” (p. 96).

What this means, in simple and numerical terms, is that if out of three units of income, two are spent on consumption, the “propensity to consume” will be ⅔.

Now in Chapter 10, and on page 115, Keynes advances to the concept of “the marginal propensity to consume.” He defines this, however, by precisely the same mathematical expression and notation as he has previously used to express what he now calls “the average propensity to consume,” viz. (p. 115). The marginal propensity to consume is the relation of the increase in consumption to the increase in “real income” when the income of the community increases.

The reader might not be inclined to imagine, at first glance, that either the average propensity to consume or the marginal propensity to consume was a matter of much importance so far as the business cycle or the extent of employment was concerned. Keynes simply tells us that out of a given amount of income, or of increase of income, some, but not all of it, will be spent on consumption, and some, but not all of it, will be saved.

Now economists have long pointed out that the greater the percentage of the national income that is saved and invested, the more rapid, other things being equal, will be the growth in production and the more rapidly, therefore, will the real level of income in the community rise. But just how any significant discovery concerning fluctuations in business and employment could follow from the truism that people will spend something and save something out of their incomes it is difficult to see.

Yet Keynes does think he gets a magical result from this truism. The marginal propensity to consume “is of considerable importance, because it tells us how the next increment of output will have to be [sic! my italics] divided between consumption and investment” (p. 115). And from this Keynes derives the magic “investment Multiplier,” k. “It tells us that, when there is an increment of aggregate investment, income will increase by an amount which is k times the increment of investment” (p. 115).

Let us try to find in plainer language what it is that Keynes is saying here. He explains on the next page: “It follows, therefore, that, if the consumption psychology of the community is such that they will choose to consume, e.g. nine-tenths of an increment of income, then the multiplier k is 10; and the total employment caused by (e.g.) increased public works will be ten times the primary employment provided by the public works themselves” (pp. 116-117).

What Keynes is saying, among other things, is that the more a community spends of its income, and the less it saves, the faster will its real income grow! Nor do the implications of its own logic frighten him. If a community spends none of its additional income (from, say, the increased public works), but saves all of it, then the public works will give only the additional employment that they themselves provide, and that will be the end of it. But if a community spends all of the additional income provided by the public works, then the multiplier is infinity.¹ This would mean that a small expenditure on public works would increase income without limit, provided only that the community was not poisoned by the presence of savers.

Keynes does not hesitate to accept this deduction, but he accepts it in a peculiar form. “If, on the other hand, they [the community] seek to consume the whole of any increment of income, there will be no point of stability and prices will rise without limit” (my italics, p. 117). But just how did prices get into it? The “propensity to consume,” and “the multiplier,” we have been assured up to this point, are expressed in terms of “wage-units,” which, Keynes assures us, means “real” terms and not money terms. Why didn’t we hear anything about the effect on prices until we got to an infinite multiplier? This leads us to still another peculiarity of Keynesian economics (which we shall examine at a later point), which is the assumption that increased activity and employment have no significant effect on prices and wages until “full employment” is reached—and then everything happens at once. Only then does “true inflation” set in.

It is true, however, that the implications of their logic do frighten Keynes and the Keynesians just a little bit. Their multiplier is too good to be true. Moreover, when their schemes are tried, and their multiplier does not miraculously do its multiplying, they badly need an alibi. This is supplied by the doctrine of “leakages.”

Among the most important of these leakages are the following: (1) a part of the increment of income is used to pay off debts; (2) a part is saved in the form of idle bank deposits; (3) a part is invested in securities purchased from others, who in turn fail to spend the proceeds; (4) a part is spent on imports, which does not help home employment; (5) a part of the purchases is supplied from excess stocks of consumers’ goods, which may not be replaced. By reason of leakages of this sort, the employment process peters out after awhile.²

2. Not Fixed or Predictable

1 have said that a whole literature has developed around this concept of “the multiplier.” ³ There are many different concepts, in fact: the “logical” theory of the multiplier, which assumes no time lag; the “period-analysis” concept, which assumes time lags; the “comparative-statics” analysis, and so on. Immense ingenuity has gone into the mathematical development of these theories. But if the reader wishes to economize his time before he plows through the monographs of the multiplier addicts he will ask a few simple questions: What reason is there to suppose that there is any such thing as “the multiplier”? Or that it is determined by the “propensity to consume”? Or that the whole concept is not just a worthless toy, the kind of thing made depressingly familiar by monetary cranks?

There are, in fact, so many things wrong with the “multiplier” concept that it is hard to know where to begin in dealing with them.

Let us try to look at one probable origin of the concept. If a community’s income, by definition, is equal to what it consumes plus what it invests, and if that community spends nine-tenths of its income on consumption and invests one-tenth, then its income must be ten times as great as its investment. If it spends nineteen-twentieths on consumption and invests one-twentieth, then its income must be twenty times as great as its investment. If it spends ninety-nine-hundredths of its income on consumption and invests the remaining one-hundredth, then its income must be a hundred times its investment. And so ad infinitum. These things are true simply because they are different ways of saying the same thing. The ordinary man in the street would understand this. But suppose you have a subtle man, trained in mathematics. He will then see that, given the fraction of the community’s income that goes into investment, the income itself can mathematically be called a “function” of that fraction. If investment is one-tenth of income, income will be ten times investment, etc. Then, by some wild leap, this “functional” and purely formal or terminological relationship is confused with a causal relationship. Next, the causal relationship is stood on its head and the amazing conclusion emerges that the greater the proportion of income spent, and the smaller the fraction that represents investment, the more this investment must “multiply” itself to create the total income!

I admit that all this sounds pretty fantastic; but I am at a loss otherwise how to explain how Keynes came to think that such an amazing causal mathematical relationship should exist. Let us, however, look at other observations and notions that might give rise to the hypothesis that there is such a thing as a multiplier.

When, after a depression, a business recovery sets in, then increased expenditure in any direction, whether for investment or consumption, seems to multiply itself many times over. Wesley C. Mitchell, in a book first published in 1913, described this process:

The conspicuous agent in rousing business from its partial lethargy has often been some propitious event.... But... these propitious events did no more than accelerate a process of business recuperation already begun.... Among the ultimate effects of a period of hard times, then, are: a reduction in the prime and supplementary costs of manufacturing commodities, and in the stocks of goods held by wholesale and retail merchants, a liquidation of business debts, low rates of interest, a banking position that favors an increase in loans, and an increasing demand among investors for corporate securities....

Once started, a revival of activity spreads rapidly over a large part, if not all, of the field of business. For, even when the first impulse toward expansion is sharply confined to a single industry or a single locality, its effects in the restricted field stimulate activity elsewhere.

In part this diffusion of activity proceeds along the lines of interconnection among business enterprises.... One line leads back from the industries first stimulated to the industries that provide raw materials and supplementary supplies. Another line leads forward to the chain of enterprises that handle the increased output of commodities....

The diffusion of activity is not confined to these definite lines of interconnection among business enterprises. It proceeds also by engendering an optimistic bias in the calculations of all persons concerned with the active direction of business enterprises and with providing loans....

Most men find their spirits raised by being in optimistic company. Therefore, when the first beneficiaries of a trade revival develop a cheerful frame of mind about the business outlook, they become centers of infection, and start an epidemic of optimism....

As it spreads, the epidemic of optimism helps to produce conditions that both justify and intensify it....⁴

Those who have a long-term acquaintance with the worlds of business and finance will recognize this as an excellent realistic description of what actually happens in a period of recovery. But it is clear that this is not a purely mechanical process, determined by some fixed “fundamental psychological law” from which we cannot escape, or by some rigid and pre-determined “multiplier.”

It is true that some consumers begin to spend more because they have more from somebody else (which they may have received in wages, say, from re-employment after idleness). This spending of newly acquired money does of course tend to accelerate a recovery. But in any case, in the days before “compensatory” governmental spending, the recovery was usually initiated (and certainly in large part continued) by people who had finally ceased to be pessimistic about the business future, and had become convinced that prices were “scraping rock bottom” and might even be due for an upturn.

Some of these people who initiate the upturn are entrepreneurs who have decided to re-stock on raw materials and re-employ some workers. They either borrow from the banks for this purpose, or simply reactivate balances that they have long allowed to remain comparatively idle. Some of the people who initiate the upturn are consumers—and not necessarily solely those who have just got new or increased incomes, but also those who have decided that their jobs are after all safe, or that they will not get a car or a house any cheaper by waiting any longer, and may even have to pay more if they wait. Optimism begets new income, which by being spent begets still more income, and so on.

Optimism, income, consumption, and investment all interact, all mutually increase each other. But there is never any precise, predictable, mathematical relationship; there is never any fixed, or purely mechanical relationship among these elements.

“Income,” “consumption,” and “investment” may be measurable quantities (at least in monetary, though not in “real” terms); but the state of business sentiment, the individual and composite expectations of Messrs. A, B, C... N, is not a measurable quantity, and can never be put into a meaningful mathematical equation. If optimism is already present, a small “new” expenditure may touch off, or seem to touch off, a wave of expenditure and re-employment. But if the outlook of the community is still basically pessimistic, if some prices or wages or interest rates are still generally regarded, for example, as being unrealistically or unworkably high, the “new” expenditure may be completely wasted so far as any stimulating effect is concerned. In this whole process the concept of a fixed or predictable or predeterminable “multiplier” is never of any use.⁵

3. “Saving” and “Investment” Again

Keynes consistently fails to provide convincing deductive reasons for any of his leading propositions, or “laws.” Nor does he compensate for this by offering any statistical proof of them, or even providing any prima facie statistical presumption in their favor. Instead, he gives us something like this: “It should not be difficult to compile a chart of the marginal propensity to consume at each stage of a trade cycle from the statistics (if they were available) of aggregate income and aggregate investment at successive dates. At present, however, our statistics are not accurate enough.” (My italics, p. 127.)

One would suppose that he would wait until the statistics were compiled before telling us what we would find. It appears that some figures had been compiled, however, by Simon Kuznets; and though they are “very precarious,” Keynes is surprised by what they show. “If single years are taken in isolation, the results look rather wild. But if they are grouped in pairs, the multiplier seems to have been less than 3 and probably fairly stable in the neighborhood of 2.5” (p. 128).

One would suppose that Keynes would show the reader how these figures were obtained, what years they covered, etc., but he does nothing of the kind. On the contrary, he says that the marginal propensity to consume shown by these figures—60 to 70 per cent—though “quite plausible for the boom” are “surprisingly, and, in my judgment, improbably low for the slump.” In other words, if the statistics do not fit in with Keynes’s preconceptions, it is the statistics, not the preconceptions, that are to be suspected or thrown out. If the facts do not substantiate the a priori theory, so much the worse for the facts. Time and again Keynes tries to carry his point by sheer ex cathedra pronouncement. His evident success in carrying it off can only be attributed to the docility of academic opinion.

The whole multiplier concept rests on the assumption of already existing unemployment. This of course is a deliberate, even when tacit, assumption on Keynes’s part; for it is his contention that substantial unemployment is the “general” situation, and that “full employment” (even when defined to allow for “frictional” unemployment) is only a “special” situation. But this contention is never established.⁶ It rests in turn on the assumption that there can be such a thing, and even that there normally is such a thing, as “an equilibrium with unemployment.” This, as we have seen, and will see more fully later, is a contradiction in terms. For while Keynes’s “multiplier” and other concepts assume unemployment, Keynes never correctly tells us the reasons for this unemployment. Those reasons always involve some disequilibrium, some maladjustment in the interrelationships of prices, wage-rates, interest rates, or other costs.

No “multiplier” can be calculated or even discussed except in relation to these maladjustments. If some wage-rates are excessively high in relation to some prices, and no specific voluntary adjustments are made, then a small amount of government spending will be completely ineffective in restoring employment in the specific industries involved. The government spending may have to be so big (and financed in such an inflationary manner) that it raises the nation’s whole “price level” sufficiently to increase employment in the affected industries. But even so, the employment could much more easily be brought about by price-and-wage adjustment than by further government spending.

In fact, if unemployment is being caused by specific wage-rates that are too high, and the new government spending merely encourages the unions with excessive wage-rates to demand still higher wage-rates, the new spending may not result in any net increase in employment, and could even be followed by a decrease.

Another difficulty with Keynes’s “multiplier” concept is that it does not clearly and consistently distinguish between “real” income (or income measured in constant dollars) and money income. True, he expresses his “multiplier” most of the time in terms of “wage-units.” But we have already seen (p. 64) that he so defines “wage-units” as to make them in fact not a quantity of employment but a quantity of money received by workers who are employed. His “wage-units” are, in brief, not “real” units but monetary units.

And Keynes’s “multiplier” jumps without notice from “real” terms to monetary terms. This jump becomes flagrant on pages 116 and 117. There we are told that if the propensity to consume is ⁹/₁₀:

then the multiplier k is 10; and the total employment caused by (e.g.) increased public works will be ten times the primary employment provided by the public works themselves.... Only in the event of the community maintaining their consumption unchanged in spite of the increase in employment and hence in real income, will the increase of employment be restricted to the primary employment provided by the public works. [My italics.]

But this passage is immediately followed by this sentence: “If, on the other hand, they seek to consume the whole of any increment of income, there will be no point of stability and prices will rise without limit.” (My italics.)

To repeat our question (on p. 137), How did prices get into this? Just where did we jump from “real income” to prices rising without limit? This brings us to another peculiar Keynesian theory (for each fallacy depends for its support upon other fallacies). This is the theory that when there has been unemployment, and demand increases for any reason, the effect is wholly to increase employment and/or volume of goods sold—and never to increase wage-rates or prices—until the point of “full employment” is reached! Then (as by assumption there can be no more employment) “prices will rise without limit.” Neither economic theory, general experience nor available statistics support this Keynesian notion. But we shall postpone further analysis of it until a later point.

One fallacy in the “multiplier” that is alone sufficient to discredit it completely is the assumption that the entire fraction of a community’s income that is not “consumed” is hoarded; that no part of this unconsumed income is invested.

The “propensity to consume,” in brief, determines the “multiplier” only on the assumption that what is not spent on consumption is not spent on anything at all! If the propensity to consume is ⁷/₁₀, or ⁸/₁₀, or ⁹/₁₀, or anything less than¹⁰/₁₀, the economic machine will run down unless “investment” rushes in to fill the “gap” left by “saving.” This “investment” can only be supplied by a deus ex machina, and this god turns out to be the government with “loan expenditure.” All these assumptions are not only false in fact, but a contradiction of Keynes’s own formal definitions in the General Theory of “saving” and “investment.”

For Keynes himself has assured us that in Chapter 6: “Saving and Investment have been so defined that they are necessarily equal in amount, being, for the community as a whole, merely different aspects of the same thing” (p. 74). He has also told us that “the prevalence of the idea that saving and investment, taken in their straightforward sense, can differ from one another, is to be explained, I think, by an optical illusion” (p. 81). Further, he has ridiculed “the new-fangled view that there can be saving without investment or investment without ‘genuine’ saving” (p. 83).

Yet the notion of a “multiplier” depending on a “propensity to consume” rests on precisely this “optical illusion” and this “new-fangled view.” It rests on the assumption that there can be “saving” without “investment.”

What is involved here is partly a question of fact and partly a question of definition. If we define “saving” as including both money and goods, and “investment” as including both money and goods (the goods in both cases being measured in current money prices) then “saving” and “investment” are at all times necessarily equal and, in fact, merely two names for the same thing. On these definitions the terms “saving” and “investment” could be freely interchanged in any context without change of meaning. Or a common term, such as “unconsumed output,” could be substituted for either or both.

But if we define “savings” exclusively in terms of money or even of goods plus money, and if we define “investment” exclusively in terms of (capital) goods (either in “real” terms or at given prices), then there can frequently be discrepancies between “saving” and “investment.”

Here is where the “new-fangled view” has its importance. For when investment (by these definitions) exceeds “genuine” saving, there must be inflation; and when “saving” exceeds “investment” (by these definitions) there must be deflation. In fact, only on the assumption that “investment without saving” means that new money-and-credit has been created, and “saving without investment” means that some former money-and-credit has been retired or destroyed, is the discrepancy between saving and investment possible. With a constant money-and-credit supply, and constant prices, saving and investment even on these second definitions must be equal. (And they must be equal at every moment under all conditions, of course, if saving money is defined and treated as “investing” in money.)

But Keynes’s “propensity to consume” concept and “multiplier” concept would be meaningless unless he used the terms “saving” and “investment,” not as he has defined them in the General Theory, but rather as he defined them in his repudiated definitions in The Treatise on Money. He assumes that there can in fact be saving without investment and investment without saving.

And he makes this assumption in an extreme degree, to which nothing in the real world corresponds. For his “propensity to save” depends, for its alleged deflationary effects, on the tacit assumption that no part of savings is invested. His magically rejuvenating “multiplier,” to work out perfectly, assumes that this new investment comes into being without savings. In fact, the mathematics of the multiplier are upset if the recipients of the new income which the new investment is supposed to create do anything but spend the whole of the new income on consumption. If they “save” part of it, the multiplier is decreased. If they themselves “invest” part of it, the multiplier is increased. Yet this multiplier is supposed to be predeterminable by a mathematical formula, and used as a basis of policy and prediction!

4. “Investment” Means Government Spending

Close scrutiny reveals still another peculiarity of the “multiplier.” “Investment” is supposed to “multiply” employment and income. And yet the amount of investment, as such, appears to be entirely irrelevant to the mathematics of the multiplier or the reasoning on which it rests.

For in connection with the multiplier (and indeed most of the time) what Keynes is referring to as “investment” really means any addition to spending for any purpose. Keynes shows not the slightest interest in real purpose of real investment, which is to increase productivity, both in quantitative and in qualitative terms, and to reduce costs. All he is interested in is additional spending, for any purpose, to produce his multiplier effects. By “investment,” when he speaks of the multiplier, he means government spending, on no matter what, as long as it creates additional money.

This last idea is never explicitly introduced, but is constantly implied. “Loan expenditure,” he declares (p. 128), even if “wasteful,” “may nevertheless enrich the community on balance.” And then he explains in a footnote: “It is often convenient to use the term ‘loan expenditure’ to include both public investment financed by borrowing from individuals and also any other current public expenditure which is so financed.... Thus ‘loan expenditure’ is a convenient expression for the net borrowings of public authorities on all accounts, whether on capital account or to meet a budgetary deficit.” (My italics.)

What is really necessary to get the “multiplier” effect, in short, when we start calling things by their right names, is not “investment” but inflation.

“Investment” is irrelevant to the multiplier. If, to take another illustration, we find that the community is spending only eleven-twelfths of its income on goods whose names begin with the letters A to W, inclusive, then we get everything to come out right by having the community spend the other twelfth of its income on the goods beginning with the letters X, Y, Z. And it is of no importance whatever, for this effect, whether the A-W goods or XYZ goods consist wholly or partly of consumer goods or capital goods. The word “investment” is merely being used in a Pickwickian, or Keynesian, sense. And the great advantage of “loan expenditure” is not that it involves investment out of past income, but that it involves the printing of more money.

We shall have enough to do in this volume dissecting the errors of Keynes himself, without going into the supplementary or derivative errors introduced by some of the Keynesians. For that reason I shall make no effort here to analyze the “foreign-trade multiplier,” which contains, in addition to all the fallacies in the “multiplier” concept itself, additional fallacies based on crude mercantilistic concepts of the effects of imports and exports respectively.

But two criticisms of the “multiplier” remain to be made, and both are basic. In the first place, even granting all of Keynes’s other peculiar assumptions, it is difficult to understand just why the multiplier (except by sheer assertion) should necessarily be the reciprocal of the marginal propensity to save. If the marginal propensity to consume is ⁹/₁₀, we are told, the multiplier is 10. Why? How?

We have already tried to guess (p. 139) how Keynes might have arrived at this astonishing notion. But let us take an imaginary illustration. Ruritania is a Keynesian country that has a national income of $10 billion and consumes only $9 billion. Therefore it has a propensity to consume of ⁹/₁₀ But as in some way it manages to “save” 10 per cent of its income without “investing” the 10 per cent in anything at all, it has unemployment of 10 per cent. Then the Keynesian government comes to the rescue by spending, not $1 billion, but only $100 million on “investment.” For as the “multiplier” is 10 (because Keynes has written out a mathematical formula which makes it 10 when the marginal propensity to consume is ⁹/₁₀), this $100 million dollars worth of direct new employment somehow multiplies itself to $1 billion of total new employment to “fill the gap,” and lo! “full employment” is achieved.

(Expressing this in terms of employment, we might say: When the propensity to consume of Ruritania is ⁹/₁₀, then, unless something is done about it, only 9 million of Ruritania’s working force of 10 million are employed. It is then simply necessary to spend enough to employ directly 100,000 more persons, and their spending, in turn, will ensure a total additional employment of 1 million.)

The question I am raising here is simply why such a relationship between the marginal propensity to consume and the multiplier is supposed to hold. Is it some inevitable mathematical deduction? If so, its causal inevitability somehow escapes me. Is it an empirical generalization from actual experience? Then why doesn’t Keynes condescend to offer even the slightest statistical verification?

We have already seen that investment, strictly speaking, is irrelevant to the “multiplier”—that any extra spending on anything will do. We have already illustrated this by dividing commodities into those beginning with the letters from A to W, and those beginning with the letters X, Y, and Z. But a still further reductio ad absurdum is possible. Here is a far more potent multiplier, and on Keynesian grounds there can be no objection to it. Let Y equal the income of the whole community. Let R equal your (the reader’s) income. Let V equal the income of everybody else. Then we find that V is a completely stable function of Y; whereas your income is the active, volatile, uncertain element in the social income. Let us say the equation arrived at is:

V = .99999 Y

Then, Y = .99999 Y + R

.00001 Y = R

Y = 100,000 R

Thus we see that your own personal multiplier is far more powerful than the investment multiplier. To increase social income and thereby cure depression and unemployment, it is only necessary for the government to print a certain number of dollars and give them to you. Your spending will prime the pump for an increase in the national income 100,000 times as great as the amount of your spending itself.⁶

The final criticism of the multiplier that must be made is so basic that it almost makes all the others unnecessary. This is that the multiplier, and the whole unemployment that it is supposed to cure, is based on the tacit assumption of inflexible prices and inflexible wages. Once we assume flexibility in prices and wages, and full responsiveness to the forces of the market, the whole Keynesian system dissolves into thin air. For even if we make the other thoroughly unrealistic assumptions that Keynes makes (even if we assume, for example, that people “save” a third of their incomes by simply sticking the money under the mattress, and not investing it in anything) completely responsive wages and prices would simply mean that wages and prices would fall enough for the former volume of sales to be made at lower prices and for “full employment” to continue at lower wage-rates. When the money was taken out from under the mattress again, it would simply be equivalent to an added money supply and would raise prices and wages again.

I am not arguing here that prices and wages are in fact perfectly fluid. But neither, as Keynes assumes, are wage-rates completely rigid under conditions of less than full employment. And to the extent that they are rigid, they are so either through the anti-social policy of those who insist on employment only at above-equilibrium wage-rates, or through the very economic ignorance and confusion in business and political circles to which Keynes’s theories themselves make so great a contribution.

But this is a subject that we shall develop more at length later.

5. Paradox and Pyramids

In Section VI of Chapter 10 on the multiplier, Keynes lets himself go in one of the irresponsible little essays in satire and sarcasm that run through the General Theory as they run through all his work. As these essays rest on obviously false assumptions, and as Keynes writes them with his tongue more or less in his cheek, it might seem to be as lacking in humor to “refute” them seriously as to “refute” a paradox of G. K. Chesterton or a epigram of Oscar Wilde. But these little essays are the most readable and the most easily understood part of Keynes’s work. They are quoted by many laymen with chuckles of approval and delight. So we had better give them a certain amount of serious attention.

Keynes begins Section VI by assuming “involuntary unemployment” without explaining how it comes about. At the same time he assumes that the only way to cure it is by “loan expenditure”—no matter how wasteful. “Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better” (p. 129). (If our statesmen were really educated in the principles of classical economics, they would understand that unemployment is usually the result of union insistence on excessive wage-rates, or some similar price-cost maladjustment.)

One of the most revealing paragraphs in this section is the footnote on page 128, which I have already quoted (p. 148) and which I quote again with different italics: “It is often convenient to use the term loan-expenditure’ to include both public investment financed by borrowing from individuals and also any other current public expenditure which is so financed.... Thus ‘loan-expenditure’ is a convenient expression for the net borrowings of public authorities on all accounts, whether on capital account or to meet a budgetary deficit.” This explains what Keynes really means by “investment” in his multiplier equations. It is not investment in the traditional or the dictionary sense. It means any government spending, provided the money is borrowed, i.e., provided the spending is financed by inflation.

Keynes then goes on to write what he evidently considers a perfectly devastating satire on gold and gold-mining. “Gold-mining,” he tells us, “which not only adds nothing whatever to the real wealth of the world but involves the disutility of labor, is the most acceptable” to the orthodox of all methods of creating employment. “If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again... there need be no more unemployment” (p. 129).

This sentence tells us a great deal more about the prejudices and confusions of Keynes than it does either about gold, gold-mining, the principles of private enterprise, or the purposes of employment. There would of course be no need for private enterprise to dig up the “banknotes.” The Treasury could simply run off more on its printing presses for no more than it cost for the ink and paper. But there is a slight difference between digging up gold and digging up paper money which Keynes neglects to mention. This is that gold has kept its high value over the centuries, not only when it was the international monetary standard but even since it was “dethroned,” whereas paper currencies, by an almost inexorable law, have sunk into worthlessness.

(A compilation by Franz Pick in 1957 of the depreciation of fifty-six different paper currencies showed that in the nine-year period from January 1948 to December 1956, for example, the American dollar, to which so many other currencies were ostensibly tied, itself lost 15 per cent of its purchasing power, while the British pound sterling lost 34 per cent, the French franc 52 per cent, and the paper currencies of Chile, Paraguay, Bolivia, and Korea, from 93 to 99 per cent.)

The reason for this difference is that the quantity of gold that could profitably (i.e., with a surplus of proceeds over costs) be dug up and refined depends on natural factors largely beyond human control, whereas the amount of paper dollars that are printed, or that would be buried and then dug up under Keynes’s scheme, would depend solely on the caprice of the politicians or “monetary authorities” in power.

Keynes proceeds to patronize gold mines further. He tells us that they “are of the greatest value and importance to civilization” because “gold-mining is the only pretext for digging holes in the ground which has recommended itself to bankers as sound finance” (p. 130). Only? One can think also of oil wells, water wells, canals, subways, railway tunnels, house foundations, quarries, coal mines, zinc, lead, silver and copper mines.... But it seems a pity to spoil the noble lord’s rhetoric.

It is one of Keynes’s fixed convictions, as it was of the churchmen and philosophers of the Middle Ages, that gold is absolutely worthless and “sterile.” “Ancient Egypt was doubly fortunate, and doubtless owed to this its fabled wealth,” he writes, “in that it possessed two activities, namely, pyramid-building as well as the search for the precious metals, the fruits of which, since they could not serve the needs of man by being consumed, did not stale with abundance” (p. 131).

Keynes did not think that gold had value because he could not understand the source of its value. The fact that nearly all men through the ages have valued gold only indicated, in Keynes’s eyes, that they were incurably stupid. But perhaps the stupidity is with the critics of gold. It is true, as those critics are always insisting, that you cannot eat it or wear it; but it is more satisfactory than custard pies or overcoats as a medium of exchange. And it is enormously more satisfactory as a medium of exchange and a store of value, as we shall see, than paper money issued in accordance with political pressures or bureaucratic whim.

¹ See Alvin H. Hansen, A Guide to Keynes, p. 95, for a confirmation of this interpretation.

² Alvin H. Hansen, A Guide to Keynes, pp. 89-90.

³ An analysis and a wealth of references will be found in Gottfried Haberler, Prosperity and Depression, (Geneva: League of Nations, 1941), pp. 455-479.

⁴ Though this originally appeared in Business Cycles, published in 1913, Part III was separately republished in 1941 with the title Business Cycles and Their Causes (Los Angeles: University of California Press). The above excerpts are from pp. 1-5.

⁵ Cf. Benjamin M. Anderson, Economics and the Public Welfare, p. 397: “The soldiers’ bonus payments by the Government under Mr. Hoover made no difference in the business picture. On the other hand, the soldiers’ bonus payments under Mr. Roosevelt in 1936, at a time when the business curve was upward sharply, appear to have intensified the movement.”

⁶ “In historical fact, as far as I know, unemployment on the scale of a serious social problem is not a typical state of affairs, and in every known case such a situation has followed at no long remove a period of relatively full employment... and, similarly, periods of serious unemployment have in due course come to an end. But the question of how unemployment comes to pass is excluded from this work [the General Theory] by the predetermination to make it a ‘normal’ phenomenon, characteristic of an enterprise economy in stable equilibrium.” Frank H. Knight, Canadian Journal of Economics and Political Science, February, 1937, p. 106.

⁶ I am indebted for this illustration to a forthcoming book by Murray N. Rothbard.