Currency Wars_ The Making of the Next Global Crisis - James Rickards [96]
Fundamentally, monetarism is insufficient as a policy tool not because it gets the variables wrong but because the variables are too hard to control. Velocity is a mirror of the consumer’s confidence or fear and can be highly volatile. The money supply transmission mechanism from base money to bank loans can break down because of the lack of certainty and confidence on the part of lenders and borrowers. The danger is that the Fed does not accept these behavioral limitations and tries to control them anyway through communication tinged with deception and propaganda. Worse yet, when the public realizes that it is being deceived, a feedback loop is created in which trust is broken and even the truth, if it can be found, is no longer believed. The United States is dangerously close to that point.
Keynesianism
John Maynard Keynes died in 1946 and so never lived to see the errors committed in his name. His death came just one year before the publication of Samuelson’s Foundations of Economic Analysis, which laid the intellectual base for what became known as neo-Keynesian economics. Keynes himself used few equations in his writings, but did provide extensive analysis in clear prose. It was only in the late 1940s and 1950s that many of the models and graphs associated today with Keynesian economics came into existence. This is where the conceptual errors espoused under the name “Keynesian” are embedded; what Keynes would have thought of those errors had he lived is open to speculation.
Near the end of his life, Keynes supported a new currency, which he called the bancor, with a value anchored to a commodity basket including gold. He was, of course, a fierce critic of the gold exchange standard of the 1920s, but he was practical enough to realize that currencies must be anchored to something and, for this reason, preferred a global commodity standard to the dollar-and-gold standard that emerged from Bretton Woods in 1944.
Our purpose here is not to review the field of Keynesian economics at large, but rather to zero in on the flaw most relevant to the currency wars. In the case of monetarism, the flaw was the volatility of velocity as expressed in consumer choice. In Keynesianism, the flaw is the famous “multiplier.”
The Keynesian multiplier theory rests on the assumption that a dollar of government deficit spending can produce more than a dollar of total economic output after all secondary effects are taken into account. The multiplier is the Bigfoot of economics—something that many assume exists but is rarely, if ever, seen. The foundation of Keynesian public policy is called aggregate demand, or the total of all spending and investment in the domestic economy, excluding inventories. For example, if a worker is fired, he not only loses his income, but he also then stops spending in ways that cause others to lose income as well. The lost income and lost spending cause a drop in aggregate demand, which can feed on itself, leading more businesses to fire more employees, who then spend less, and so on in a vicious circle. Keynesian theory says that government can step in and spend money that individuals cannot or will not spend, thereby increasing aggregate demand. The government spending can reverse the slide and contribute to renewed economic growth.
The problem with this theory of government spending to boost aggregate demand is that governments have no money of their