And the Fat Man. A parable for our times.

A YouTube video.

A basic understanding of the price mechanism exposes the pseudo-science of Keynesian economics:

It was John Maynard Keynes .. who ultimately succeeded in rehabilitating a view long the preserve of cranks ..  He had attempted by a succession of new theories to justify the same, superficially persuasive, intuitive belief that had been held by many practical men before, but that will not withstand rigorous analysis of the price mechanism: just as there cannot be a uniform price for all kinds of labour, an equality of demand and supply for labour in general cannot be secured by managing aggregate demand.  The volume of employment depends on the correspondence of demand and supply in each sector of the economy, and therefore on the wage structure and the distribution of demand between the sectors.  The consequence is that over a longer period the Keynesians remedy does not cure unemployment but makes it worse.

It’s your Hayek Quote of The Day courtesy of Economic Thought.

“For persons entering economics in the 1940s, ‘Keynesian’ economics was shockingly ‘revolutionary’ because it was shockingly activist by comparison with all earlier, other than Marxian, economic teaching. Laidler’s book brilliantly traces the ‘fabrification’ of a textbook revolution in activist economics which in one generation replaced thoughtful Marshallian courses in economic inquiry with courses in soapbox oratory about economic fluctuations.  Laidler’s scholarship is impeccable; even the most knowledgeable professional has much to learn from reading his book.”  — Robert Clower on David Laidler’s Fabricating the Keynesian Revolution.

Gerald O’Driscoll explains the significance of the Hayek vs Keynes debate of 1932 for today.  Quotable:

“Is all spending equally productive, or should government policies aim to simulate private investment? If the latter, then Mr. Obama is following in FDR’s footsteps and impeding recovery. He does so by demonizing business and creating regime uncertainty through new regulations and costly programs. In this he follows neither Hayek nor Keynes, since creating a lack of confidence is considered destructive by both.”

UPDATE –  Can’t pass up another excuse to repost this:

After a month at the top of the Amazon charts and in the pages of America’s top newspapers, it’s time to say Hayek has indeed arrived.

“I regard him as a real genius but not as a great economist, you know. He’s not a very consistent or logical thinker. He might have developed in almost any direction. The only thing I am sure of is that he would have disapprove of what his pupils made of his doctrines.”

UPDATE:  Mario Rizzo has posted a pdf image of newspaper clips from the London Times of both the Hayek letter and the Pigou/Keynes letter.

Hayek vs Keynes is the watchword of the economic debate of your time, the debate between Merkel and Obama, Europe and America, over the the soundness of a government-led Keynesian consumption binge as a solution to the asset crash set in motion by the artificial malinvestment boom of the early and mid 00s.  The original debate played out in public in the pages of The Times of London in the month of October, 1932.  In reply to an invitation from The Times of London, John M. Keynes, A. C. Pigou, and other Cambridge and Oxford economists signed a letter advocating profligate spending by all British government entities on any and every projects they might imagine, as part of their patriotic duty to advance the public interest via consumption spending.

Two days later, Hayek and his colleagues at the London School of Economics provided their own response.  Writing for a British audience and targeted at a near decade old British macroeconomic situation marked by significant deflation and internationally overpriced labor which had begun in 1925 with Winston Churchill’s decision to return Britain to the gold standard at par despite a massive wartime inflation, Friedrich Hayek signed a letter along others reading as follows:

TO THE EDITOR OF THE TIMES

Sir, the question whether to save or whether to spend which has been raised in your columns, is not unambiguous.  It involves three separate issues:  (1) Whether to use money or whether to hoard it; (2) whether to spend money or whether to invest it; (3) whether Government investment is on all fours with investment by private individuals.  While we do not wish to over-stress the nature of our differences with those of our professional colleagues who have already written to you on these subjects, yet on certain points that difference is sufficiently great to make the expression of an alternative view desirable.

(1)  On the first issue — whether to use one’s money or whether to hoard it — there is no important difference between us.  It is agreed that hording money, whether in cash or in idle balances, is deflationary in its effects.  No one thinks that deflation is in itself desirable.

(2)  On the question whether to spend or whether to invest our position is different from that of the signatories [Pigou, Keynes et al] of the letter which appeared in your columns on Monday.  They appear to hold that it is a matter of indifference as regards the prospects of revival whether money is spent on consumption or on real investment.  We, on the contrary, believe that one of the main difficulties of the world today is a deficiency of investment — a depression of the industries making for capital extension, etc., rather than of the industries making directly for consumption.  Hence we regard a revival of investment as peculiarly desirable.  The signatories of the letter referred to, however, appear to deprecate the purchase of existing securities on the ground that there is no guarantee that the money will find its way into real investment.  We cannot endorse this view.  Under modern conditions the security markets are an indispensable part of the mechanism of investment.  A rise in the value of old securities is an indispensable preliminary to the flotation of new issues.  The existence of a lag between the revival in old securities and revival elsewhere is not questioned.  But we should regard it as little short of a disaster if the public should infer from what has been said that the purchase of existing securities and the placing of deposits in building societies, etc., were at the present time contrary to public interest or that the sale of securities or the withdrawal of such deposits would assist the coming recovery.  It is perilous in the extreme to say anything which may still further weaken the habit of private saving.

But it is perhaps on the third question — the question whether this is an appropriate time for State and municipal authorities to extend their expenditure — that our difference with the signatories of the letter is most acute.  On this point we find ourselves in agreement with your leading article on Monday.  We are of the opinion that many of the troubles of the world at the present time are due to imprudent borrowing and spending on the part of the public authorities.  We do not desire to see a renewal of such practices.  At best they mortgage the Budgets of the future, and they tend to drive up the rate of interest — a process which is surely particularly undesirable at this juncture, when the revival of the supply of capital to private industry is an admitted urgent necessity.  The depression has abundantly shown that the existence of public debt on a large scale imposes frictions and obstacles to readjustment very much greater than the frictions and obstacles imposed by the existence of private debt.  Hence we cannot agree with the signatories of the letter that this is a time for new municipal swimming baths, etc., merely because people “feel they want” such amenities.

If the Government wish to help revival, the right way for them to proceed is, not to revert to their old habits of lavish expenditure, but to abolish those restrictions on trade and the free movement of capital (including restrictions on new issues) which are at present impeding even the beginning of recovery.

We are, Sir, your obedient servants,

T. E. Gregory, F. A. von Hayek, Arnold Plant, Lionel Robbins

The significance of this letter for the debates of the current historical moment cannot be missed.

UPDATE:  Mario Rizzo, “It does not take much to see that the issues are basically the same today. The positions of the opposing sides are also the same. As I have said many times before, the great debate is still Keynes versus Hayek. All else is footnote.”  Read the whole thing.

More Hayek vs Keynes:

• Hayek discusses Keynes on YouTube.
• A collection of Hayek quotes on Keynes.
• Garrison’s Hayek vs Keynes PowerPoint.
• F. A. Hayek, Contra Keynes and Cambridge:  Essays, Correspondence.
• “The Pretense of Knowledge”
• Hayek discussing Keynes in 1978, part 1.
• Hayek discussing Keynes in 1978, part 2.
• The Hayek vs Keynes YouTube Rap.
• Article on macro, money & Keynes by Hayek.
• Books on macro, money  & Keynes by Hayek.

(I thank Richard Ebeling for sharing with me a copy of this important letter.)

Papers from the 2010 History of Economics conference (pdf):

• Stefan Kolev, “Hayek as an Ordo-Liberal”.
• Régis Servant, “The search for good social rules: object of science or of democratic choice? The case of Hayek as opposed to constitutional political economy”.
• Stéphane Longuet, “Hayek and monetary catallaxy”.
• David Andrews, “The Price Level in the Keynes-Hayek-Sraffa Exchange of the Early 1930s”.
• Yusuke Yoshino, “Are Their Evolutionary Theory Darwinian? –Examining dialogue by F.A. Hayek and Kinji Imanishi”.
• Robert Van Horn, “Comrades in Arms: An Exploration of the Political and Intellectual Relationship of F. A. Hayek and Aaron Director (1945-1950)”

ABSTRACTS: (more…)

Russ Roberts in the Wall Street Journal:

now that the [Keynes inspired] stimulus has barely dented the unemployment rate, and with government spending and deficits soaring, it’s natural to turn to Hayek. He championed four important ideas worth thinking about in these troubled times.

First, he and fellow Austrian School economists such as Ludwig Von Mises argued that the economy is more complicated than the simple Keynesian story. Boosting aggregate demand by keeping school teachers employed will do little to help the construction workers and manufacturing workers who have borne the brunt of the current downturn. If those school teachers aren’t buying more houses, construction workers are still going to take a while to find work. Keynesians like to claim that even digging holes and filling them is better than doing nothing because it gets money into the economy. But the main effect can be to raise the wages of ditch-diggers with limited effects outside that sector.

Second, Hayek highlighted the Fed’s role in the business cycle. Former Fed Chairman Alan Greenspan’s artificially low rates of 2002-2004 played a crucial role in inflating the housing bubble and distorting other investment decisions. Current monetary policy postpones the adjustments needed to heal the housing market.

Third, as Hayek contended in “The Road to Serfdom,” political freedom and economic freedom are inextricably intertwined. In a centrally planned economy, the state inevitably infringes on what we do, what we enjoy, and where we live. When the state has the final say on the economy, the political opposition needs the permission of the state to act, speak and write. Economic control becomes political control.

Even when the state tries to steer only part of the economy in the name of the “public good,” the power of the state corrupts those who wield that power. Hayek pointed out that powerful bureaucracies don’t attract angels—they attract people who enjoy running the lives of others. They tend to take care of their friends before taking care of others. And they find increasing that power attractive. Crony capitalism shouldn’t be confused with the real thing.

The fourth timely idea of Hayek’s is that order can emerge not just from the top down but from the bottom up. The American people are suffering from top-down fatigue. President Obama has expanded federal control of health care. He’d like to do the same with the energy market. Through Fannie and Freddie, the government is running the mortgage market. It now also owns shares in flagship American companies. The president flouts the rule of law by extracting promises from BP rather than letting the courts do their job. By increasing the size of government, he has left fewer resources for the rest of us to direct through our own decisions.

Russ Roberts can really write, and one of the things he’s written is a Hayek inspired novel:  The Price of Everything:  A Parable of Possibility and Prosperity.  The reviews for the book couldn’t be more outstanding, e.g. Tyler Cowen says “The Price of Everything is “the best attempt to teach economics through fiction that the world has seen to date.”  I recommend it to your attention.

Andrew Coyne on the failure of the great Keynesian experiment of 2008-2010.  Coyne is interviewed on the topic here.

A special shout out for Paul Krugman.

Lyrics here.

Arnold Kling:

insiders [policy makers and major financial executives] see this as a Keynesian moment, in which market breakdowns demonstrate a need for greater government involvement. I see this as a Hayekian moment, in which the dispersal and specialization of information has gotten so great that central technocratic control has become impossible.

Friedrich Hayek discussed Keynes, unemployment, general rules, and the notion of “society” with William F. Buckley, Nov. 7, 1977.  Read the PDF transcript here.  (Note well — the transcript contains a number of mistakes.)

Listen to Hayek on Keynes:

Asculta mai multe audio Diverse

From the transcript:

“Lord Keynes .. was operating [in the 1930s] in a very peculiar situation.  Now in Great Britain a successful attempt was made after World War I — which brought a good deal of inflation — to bring prices down to the pre-war level.  Prices came down but wages did not, so you had in the 1920s a position in Great Britain where wages were internationally too high and Britain had become noncompetitive on the world market.  The problem in Great Britain was to make Britain competitive again and it was clear that this required a reduction of real wages.

Notice these real wages had been artificially increased by increasing the value of the pound.  So because the pound was par to its former level, people receiving the same wartime wages, or inflated wages, could buy much more.  Wages had not come down.

Now his first argument was wages must come down.  Then the conclusion was that is politically impossible, so we must find another way, instead of getting money wages down, we must depreciate the pound so that given money wages should correspond to a lower level of real wages.

And then by a curious intellectual somersault, I would almost say, he led himself to believe that even bringing down money wages was not any use.  It involves a very complex economic argument and all he said, concluded, was that, a, well, we must inflate, in short.”

In an economic bust like today foreclosures, bankruptcy and failed financial instruments and institutions insuperably forces economic actors to deleverage and move closer to solvency, in the process raising uncertainty and individual demands for money.   But note well, heterogeneous changes in demand for moneys among different economic actors will alter various different production processes and various different relative price relations in significant non-uniform ways — the great poverty of the economics of Keynes and Malthus and Yglesias is to imagine a magic universe where there isn’t a system forcing folks toward solvency and away from leverage and debt invested in endeavors which consume and destroy wealth rather than produce it.  In magic land the creation of money and debt can magically “coordinate” everything because in Keynesian/Malthusian/Yglesiasian economics THERE IS NOTHING TO COORDINATE — by fiat of assumption.  There are no endeavors involving leverage and debt continually consuming and destroying masses of wealth (such as those recounted in Michael Lewis’s The Big Short or John Taylor’s Getting Off Track).  And so the magic wand of dumping more money into “the system” — including into those wealth destroying endeavors — is seen as a “solution”.

Hayek puts a spotlight on Keynes and the poverty of his approach here:

“The relative prices of the various types of goods and services, and therefore the rate of profit to be earned in their production, will always be determined by the impact of the monetary demand for the various goods. And unless we study the factors limiting the supplies of these various types of goods, and particularly if we assume, as Mr. Keynes does, that they are all freely reproducible in practically unlimited quantities and without any appreciable lapse of time, we must remain in complete ignorance of the factors guiding production.”

I encourage everyone to read Michael Lewis’s The Big Short — you won’t find a more powerful pro-Hayek / anti-Keynes account of the impossibility of a dump-more-money “fixing” of the Fed / finance industry / Fannie created artificial boom and unavoidable bust than the final chapter of Lewis’s book.

Quote of the Day:

“It is not surprising that Mr. Keynes finds his views anticipated by the mercantilist writers and gifted amateurs: concern with the surface phenomena has always marked the first stage of the scientific approach to our subject. But it is alarming to see that after we have once gone through the process of developing a systematic account of those forces which in the long run determine prices and production, we are now called upon to scrap it, in order to replace it by the short-sighted philosophy of the business man raised to the dignity of a science.”

Here.  Quotable:

“The common ground [between Hayek and Keynes] was created by the run-up to the war, and by the war itself. The war clarified for both men the values they shared. ‘Our object in this mad, unavoidable struggle’, Keynes declared on 12 December 1939, ‘is not to conquer Germany, but…to bring her back within the historic fold of Western civilisation of which the institutional foundations are…the Christian Ethic, the Scientific Spirit and the Rule of Law. It is only on these foundations that the personal life can be lived’. The full employment which the war produced also whittled away their differences in economics. Hayek praised Keynes’s anti-inflationary pamphlet How to Pay for the War: ‘It is reassuring to know’, Hayek wrote to Keynes after reading his anti-inflationary pamphlet How to Pay for the War, ‘that we agree so completely on the economics of scarcity, even if we differ on when it applies’. In turn, Keynes cordially welcomed Hayek’s Road to Serfdom: ‘It is a grand book…Morally and philosophically I find myself in agreement with virtually the whole of it; and not only in agreement, but in deeply moved agreement’.”

Russ Robert pushes back against Barack Obama and the leftist attack on market theory in an outstanding podcast explaining the foundations of the 2000-2010 boom & bust cycle.  Roberts identifies government sponsored creditor bailouts as the central ultimate cause of the current boom and bust cycle, including within this cause the famed Greenspan Put — the assurance of a Keynesian monetary bailout for unsustainable creditor loans financing unsustainable capital investment bubbles in high tech, housing and elsewhere in the economy.

“Fear the Boom and Bust” has won a Sammie.  The video is now at 1,076,897 views:

Marshall Auerbach reports on the kickoff discussion of the Institute For New Economic Thinking at Cambridge University, with Robert Skidelsky advocating the cause of Keynes and Bruce Caldwell holding the fort for Hayek.  The irony here is that this account of the Hayek vs Keynes debate is itself rather stale, and the debate over the Hayek / Keynes debate could itself use some fresher thinking.  Read Skidelsky’s paper here and Caldwell’s paper here.

The Institute for New Economic Thinking web site is here.  The absurd irony of the institute, of course, is that the thoughts of financial backer George Soros on the free market as explained by Hayek are as stale and and as erroneous as anything you can anywhere.  And the most fatal pathologies of the economics profession are well represented by the work of the very economists who are now working for the Institute.

The conference schedule is here, and you can read more on the conference here.