Failure in a Keynesian World

0:00A year ago, George Malone wrote in the Wall Street Journal, We're all Keynesians now. You remember last January, change was on its way. We had a new rock star president. And he was going to get us out of this mess that Wall Street had gotten us into. He said at the time, now is the time to jumpstart job creation, restart lending, and invest in areas like energy, health care, and education that will grow our economy, even as we make hard choices to bring down our deficit.

0:48Of course, the new president had a world view that was all but in name Keynesian. And of course, we had a guy running the Federal Reserve who was an expert on the Great Depression. Ben Bernanke wasn't going to make the same mistakes that the policymakers made in the 1930s. After all, he pointed out back in 2002 when he was just a Fed governor, But the U.S. government has a technology, it's called the printing press, that allows it to produce as many U.S. dollars as it wishes, at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of the dollar in terms of goods and services, which is the equivalent of raising the prices and dollars of those goods and services.

1:46We conclude that under a paper money system, a determined government can always generate higher spending and hence positive inflation. Of course the new guy at the Treasury, well he used to run the New York Fed. He worked at Kissinger Associates. He worked for the Council of Foreign Relations. He even worked at the International Monetary Fund. So we knew, or at least Washington knew, that he knew how to fix the economy. The Treasury Secretary, he was so much in touch with the market that he and his wife tried to sell their $1.6 million home in 2009 for more than they had paid for it at the height of the bubble in 2004.

2:34Unfortunately, he's been unsuccessful at that, Forced to Rent the Place Out, the President's other top economic advisors, Larry Summers, Christina Romer, they're neo-Keynesians, and they've made it clear by their actions that they view the private sector left to its own devices as incapable of sufficiently investing in education, healthcare, infrastructure, and energy, and other areas of national well-being. Carl Horowitz wrote, they warn that in the absence of a greatly expanded public sector, the current business downturn will be even more prolonged and painful.

3:21So Washington continues to have faith in government expenditure correcting the downturns of private investment. And the financial press has bought into the scam. It's by time voting Fed Chairman Ben Bernanke, Man of the Year. The economy would be much worse off if not for the actions of Bernanke and the Federal Reserve as a thinking. He didn't just shape U.S. monetary policy, Times Michael Grunwald wrote. He led an effort to save the world economy. The Financial Times wrote, the greatest depression could easily have happened in 2009, but did not, and that's a tribute that the world owes to economics.

4:15Martin Wolf wrote, we could not in such times even take the survival of civilization itself for granted. Never before had I felt more strongly the force of John Maynard Keynes toast to the economists who are the trustees not of civilization, but possibly, but of the possibility of civilization. So the main reason that Ben Bernanke, his Times person of the year in 2009, is that he is the most important player guiding the world's most important economy, Times Grunewald explains. His creative leadership helped ensure that 2009 was a period of weak recovery rather than catastrophic depression.

5:07and he still wields unrivaled power over our money, our jobs, our savings and our national future. The decisions he has made and those that he has yet to make will shape the path of our prosperity, the direction of our politics and our relationship to the world. Boy, that's pretty heady stuff. This is, and Ben Bernanke can't get reconfirmed at the moment.

5:44So what kind of Keynesian world are Bernanke and the other wise ones in Washington shaping for us? See, Keynesians see depressions as a lack of aggregate demand, as opposed to Austrians, who know that a depression is the required cleansing of the malinvestments that were created by the preceding boom of the government's making. Policy makers following the Keynesian playbook enact policies to stimulate aggregate demand and offset the fall in private investment. On the fiscal policy side, Keynesian advocate higher government spending and on the monetary side, they insist on lowering interest rates to zero, if necessary. Now, the world has recent experience with attempts at resuscitating a bubble economy.

6:35The Bank of Japan cut interest rates six times between 1986 and 1987, and all that new money caused the Japanese economy to bubble over. As Bill Bonner and Addison Wiggin wrote, the problem with all money is that it's fickle Unreliable and Unreliable is a bad girlfriend. One minute she goes along with the flow, the next minute she turns silly and bubbly, and then she gives you the cold shoulder. The prolonged period of low interest rates in Japan created one of the largest domestic bubbles in the world. For a brief moment in 1990 the Japanese stock market was bigger The Nikkei 225 reached a peak of $38,916 in December of 1989 with a price-earnings ratio of around 80 times.

7:35At the bubble's height, the capitalization value of the Tokyo Stock Exchange stood at 42% of the entire earth's stock market values. And Japanese real estate accounted for half the value of all land on earth, even though Japan only has 3% of the total area of land on earth. In 1989, all of Japan's real estate was valued at US $24 trillion. That was four times the value of all real estate in the United States, despite Japan having just half the population and 60% of US GDP. The Japanese asset bubbles were identical to other asset bubbles in the sense that they were essentially inflated by credit, according to Asian bank regulator Andrew Sheng. He writes that banks lent to highly leveraged developers to buy real estate against inflated collateral values, which then fueled the bubble further. Asset prices bore no realistic relationship to their return on capital, particularly since the cost of funding was exceptionally low.

8:50The minute the credit stopped, the bubble began to deflate and the main victims were the banks themselves. Should sound familiar. After the bubble popped in Japan, the government pursued a relentless Keynesian course of fiscal pump priming and loose fiscal policy, with the result being a Japan that has gone from from the healthiest fiscal position of any OECD country in 1990 to annual deficits of 6 to 7% of GDP and a gross public death that is now 227% of GDP. The Japanese tried to cure an alcoholic with heroin, writes Bonner, now they're addicted to it.

9:40Japan's monetary policy was to aggressively lower rates to half a percent between 1991 and 1995 and has operated essentially a zero interest rate policy ever since. Between 1992 and 1995, the Japanese government tried six stimulus plans totaling 65 and a half trillion yen. And then they cut taxes in 1994, they cut taxes in 1998, but government spending was was never cut. Also in 98, another stimulus package of 16.7 trillion yen was rolled out, nearly half of which was for public works projects. Later in the same year, yet another stimulus package was announced, totaling 23.9 trillion yen.

10:28The very next year, an 18 trillion yen stimulus was tried, and in October of 2001, another stimulus for 11 trillion was announced. As economist Ben Powell points out, overall, during the 1990s, Japan tried 10 fiscal stimulus packages totaling more than 100 trillion yen, and each failed to cure the recession, with Japan's nominal GDP growth being below zero for most of the five years after 1997. So after five years in the economic wilderness, the Bank of Japan switched during the spring of 2001 to a policy of quantitative easing, targeting the growth of the money supply instead of nominal interest rates, this in order to engineer a rebound of demand growth.

11:18The move by the Bank of Japan in the quantitative easing did finally stop the fall in land prices in 2003, and the Bank of Japan held interest rates at zero until it was seven when it boosted the discount rate back to a whopping half percent in two stages, but the BOJ quickly reverted back to its zero interest rate policy. In August 2008, the Japanese government unveiled yet another 11.5 trillion yen stimulus. The package, which included 1.8 trillion in new spending and nearly 10 trillion yen in and Government Loans and Credit Guarantees was in response to news that the Japanese economy in Japan had suffered the greatest contraction it had in seven years and inflation was 2% for the first time in a decade.

12:18Newswire reports said that the new measures would include assistance to the agricultural sector, support for part-time workers, find better employment and rebates on toll roads. Additional spending was also to flow to healthcare, housing, education and environmental technology. Now just this past April, Japanese government announced yet another 10 trillion yen stimulus Program. This was after Japan's economy shrank by a record 15.2 percent annually in the first quarter of 2009. This drop was on the heels of a 14.5 percent drop during the fourth quarter of 2008. Last month, Reuters reported that the Bank of Japan reinforced its commitment to maintain very low interest rates and may provide even further easing.

13:19The bank said that it would not tolerate zero inflation or falling prices. The bank left its policy rate at 0.1% and analysts see the rate staying low possibly in 2012. According to Reuters, the Japanese government is fretting over the risk of their economy economy flipping back into recession and is pushing the bank for action, economy flipping back into recession, I mean are they kidding? Japan's GDP at the end of 2009 was no higher than it was in 1992, so 17 lost years. But Keynesians are wont to grade on the curve. Nobel laureate and New York Times columnist Paul Krugman for one points to Japan's fiscal Stimulus Packages as having, quote, probably prevented a weak economy from plunging into an actual depression, unquote.

14:21But the Nobel Laureate's crystal ball seems to be getting cloudy, told the Guardian newspaper. What we do know is that recessions normally end everywhere because the monetary authority cuts interest rates a lot and that gets things moving. And what we know in Japan was that eventually they cut their interest rates to zero and that wasn't enough. And so far, although we've made cuts faster than they did and cut them all the way to zero, it isn't enough. We've hit that lower bound the same as they did. Now everything after that is more or more or less speculation. Now when pressed Krugman says he believed that there were two economic stories taking place in the world.

15:12The Japan story where central banks can't cut interest rates anymore to promote economic growth and the Argentina story where everything falls apart because of balance sheet problems. So Krugman sees what he calls a nepanization of world economy with a bunch of argentinifications playing a role in the acute crisis. Of course, what that means is that Krugman, the Keynesian, is saying that the entire world will suffer from a lack of aggregate demand punctuated by the occasional financial crisis. But as Ben Powell points out, Japan's problem is not a lack of aggregate demand, but a structure of production that does not meet consumers' particular needs.

16:04Government Keynesians want to stimulate the economy by pouring taxpayer and inflated money into their pet projects. What they would spend money on for stimulus is different than, say, what Tiger Woods might Spend His Stimulus Money On. And you may have noticed that energy, health care, education, infrastructure and environmental technology are where Keynesians want stimulus money spent on whether they're American Keynesians or the Japanese variety. Producing things that nobody wants and propping up malinvestments cannot possibly help any Any Economy, writes Powell. This policy is equivalent to the old Keynesian depression nostrum of paying people to dig holes and fill them. Neither policy will revive the economy because neither forces businesses to realign their structures of production to match consumer demands. And why don't those low interest rates get things moving? Well, With distressed banks, reflation fails to induce another bank credit expansion, Professor Jeffrey Herbiner wrote in the Asian Wall Street Journal back in 99. Keynesians have mistaken the impotency of the Bank of Japan to restart credit expansion as a liquidity trap. But

17:38the problem is not that interest rates are so low, everyone expects them to rise and and therefore hoards cash. Banks refuse to lend because of the overhang of bad credit. Any cash infusion is held to reserve against that bad credit. Businesses refuse to borrow because of their debt burden built up to expand capacity during the boom and their overcapacity resulting from their malinvestments. Murray Rothbard explained in America's Great Depression that in an economic downturn, the positive thing that government can do is to drastically lower its relative role in the economy, slashing its own expenditures and taxes, particularly taxes that interfere with saving and investment, thus greatly lowering the time required for returning to a prosperous economy.

18:37of government expanding its size and reach, propping up failed businesses, lowering interest rates to zero, printing money and attempting to dictate what sectors of the economy thrive and which fall by the wayside. The proper government policy in a depression is strict laissez-faire, including stringent budget slashing and coupled perhaps with a positive encouragement for credit contraction. However, committed Keynesian Paul McCauley of bond fund giant PIMCO says that an all-in reflationary policy is what is needed in Japan. Japan's problem is deflation, he says, not inflation as far as the eye can see. But the other side of the argument is the telegraph's Ambrose Evans Pritchard, who fears that the Japanese authorities may take McCulley's advice, and with Japan's economy now on the verge of blowing up, the beginnings of debt monetization by a terrified central bank will ultimately spin out of control, perhaps crossing into hyperinflation by the middle of the decade.

19:52Just as Japan's malinvestments of the 1980s have been liquidated, should have been liquidated, And so should America's of the last two decades. As Herbiner explains, when the government attempts to prevent liquidation with bailouts, socialization, fiscal expenditures, reflation and the like policies, as Japan in the thirties and America, Japan in the nineties and America in the 1930s, then depression will linger. That Japan, or now America, expects to restore prosperity for the long term, central bank monetary inflation and credit expansion, whether justified on monetarist or Keynesian grounds, must be repudiated.

20:40There is no means of avoiding a final collapse of a boom brought about by credit expansion, Ludwig von Mises wrote. The alternative is only whether the crisis should come sooner or result as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved. Well it's easy to despair if you're an Austrian and you know what havoc Keynesianism has is and will react on not only our economy but the world's economy. But a friend of mine always reminds me of something that Charles McKay wrote so long ago. Men think in herds, go mad in herds, but recover their senses one by one.

21:33That's what we do every day at the Mises Institute. We help the masses regain their senses one person at a time. It's a long process, a labor of love, but especially satisfying on days like today when 600 people turn out to help us with our cause. Thank you.