
Keynes, Explained Briefly - aaronsw
http://www.aaronsw.com/weblog/keynes
======
biohacker42
This is not brief. It's not one of the better things I've red on Keynes. It
doesn't treat alternative economic theories seriously. And lastly and most
important of all, economics discussions on hacker sites are as bad if not
worse then political and religious discussions.

~~~
Perceval
I agree, it's a rather poor summary of Keynes. The author seems to be writing
it in order to cheerlead government intervention, not because Keynes is
particularly relevant to the current causes of the financial crisis. A great
deal of ink has been spilled since Keynes on topics like the endogenous money
supply and debt deflation. The author doesn't seem to show any awareness that
there are both post-Keynesian and non-Keynesian insights that significantly
complicate his neat little package.

~~~
aaronsw
It's a direct summary of Keynes' book _The General Theory_. Have you actually
read it? Keynes has often been misconstrued by later writers.

~~~
biohacker42
Keynes is self contradictory, he's not the most unambiguous of writers, a
particularly bad case of the two armed economist.

And as the parent pointed out, there are both anti-Keynesian theories, and
there are also many post or neo-Keynesian theories. There's lots of things,
and this doesn't concern itself with any of them. Which is fine, you can write
what ever you like, I just don't like seeing it on HN.

I don't like seeing on HN because there can not be good discussion from it.

Economics is just complex and interesting enough that geeks easily get into
it, have that great light bulb moment of understanding, and immediately start
opining about it, long before they've reached a deeper understanding.

It's akin to someone understanding Newtonian physic, being elated about
getting it, and getting into internet arguments with people who understand the
theory of relativity.

And you can't explain the differences between Newtonian and relativistic
physics in a short post And the time required to explain it to random Joe on
the internets, is just not worth it.

Thus good discussion is impossible.

~~~
arijo
I think what you mean is that because political economy is closer to dogma
than to natural science, rational discussion focused on discovering objective
truth is just a waste of time. Economical political decisions are made by men
to serve other men, and should be adjusted accordingly not to be incontestable
dogma supported by spikes of intellectual masturbation. Eppur si muove!

~~~
arijo
I ask HN fellows to reply with arguments not with anonymous downvotes.

~~~
cousin_it
No, arijo, biohacker42 didn't say anything close to "rational discussion
focused on discovering objective truth is just a waste of time". It's just
your idea, and a stupid idea to boot. I downvoted both of your comments
accordingly.

~~~
arijo
Disussing dogma is a waste of time and energy. Economic decisions should focus
on solving real people problems in pragmatic terms (in an agile way if you
wish). Elaborate intellectual theories, though eye-candy, do not stand on firm
reality grounding (think of Locke's madman concept - one who makes impeccable
and rigorous reasoning based on flawed data and assumptions). That's all I was
trying to express in my comment above.

------
sethg
_So those are Keynes’ prescriptions for a successful economy: low interest
rates, government investment, and redistribution to the poor. And, for a time
— from around the 1940s to the 1970s — that’s kind of what we did. The results
were magical: the economy grew strongly, inequality fell away, everyone had
jobs._

Until the 1970s, where inflation climbed up and up and up and finally peaked
at over 15%.

According to my amateur understanding, economists disagree about exactly how
the US got into that mess (which is why Keynes was regarded with some
suspicion), but it's important to note that the Fed got us _out_ of it by
raising the crap out of interest rates and triggering a recession (as Keynes
would have predicted).

------
startingup
Quote (supposedly "explaining" why unemployment happens):

 _It used to be, Keynes says, that wealthy men just thought investing was the
manly thing to do. They weren’t going to sit around and calculate what kind of
bonds yielded the greatest expected return. Bonds are for wusses. They were
real men. They were going to take their money and build a railroad.

But they don’t make rich people like that anymore. Nowadays, they put their
money in the stock market. Instead of boldly picking one great enterprise to
invest in, they shift their money around from week to week (or hire someone
else to do it for them). So these days, it’s the stock market that stimulates
most new investment. _

Even accepting this explanation, it is worth asking _why_ they don't make rich
people who invest in building real stuff rather than chasing paper anymore.
What happened to the innate human drive, curiosity and so on? Why is it that
downturns in 19th century corrected themselves, but now we need more and more
government intervention, progressively more every cycle?

In Economics cause and effect are often difficult to separate, but one
reasonable hypothesis is that the widespread adoption of Keynesian policies
_themselves_ caused rich people to chase paper, leaving it to
government/Federal Reserve to manipulate the stock market to try to stimulate
investment indirectly. In other words, Keynesian policies beget more Keynesian
policies, in the process generating a whole bunch of Keynesian economists who
can "correctly" claim "We told you"; we reach the point where the government
runs most of the economy, robbing people of initiative ("we don't make real
men anymore").

If you travel to socialist countries, you will observe this in effect. The
population displays a curious passivity ("that is the government's problem").
No one thinks about taking the initiative because the incentives systems are
all wrong.

~~~
catzaa
> If you travel to socialist countries, you will observe this in effect.

That is so true. There are countries in which government jobs are the most
prized jobs (high salary, flexible working hours and extremely high job
security).

This for me at least is a sad phenomenon.

------
bokonist
_So those are Keynes’ prescriptions for a successful economy: low interest
rates, government investment, and redistribution to the poor. And, for a time
— from around the 1940s to the 1970s — that’s kind of what we did. The results
were magical: the economy grew strongly, inequality fell away, everyone had
jobs._

Retribution and government investment may or may not be good ideas, but they
are orthogonal to the problem of the business cycle.

For some reason, Keynes missed the entirely obvious fact that the fall in
aggregate demand originates in collapsing credit bubbles. The credit bubbles
happen for a very specific reason - a bug in the Anglo-American tradition of
banking in which banks do not match their maturities. When the credit bubbles
collapse, and people's bank accounts are wiped out, they stop spending. The
supply/demand curve for luxuries and durables goes vertical as people cut
expenses in a futile attempt to fix their balance sheets. When they stop
buying cars, Detroit lays off workers.

The economy was more stable from the 40's through the 70's because the
creation of FDIC insurance de facto turned banking into 100% reserve, maturity
matched system (de facto, even though it still had a veneer of the old
system). Effectively, with an FDIC insured bank, the individual deposits their
money with the government, and then the government gives banks a separate
license to print money to make loans. This broke down when the shadow banking
sector grew up, and started maturity mismatching without the formal backing of
the government.

In summary - the business cycle is really misnamed. It's the "banking cycle".
To stop cyclical unemployment, fix the banks.

~~~
catzaa
Well, the simple fact is that the above quote from the article is completely
wrong.

The 80ies was one of the longest periods of sustained US GDP growth (and the
40ies&70ies weren’t that magical). During the 80ies the USA tacked on the
equivalent of Germany’s GDP to itself.

This article is poorly written and a waste of time. I suspect that the
author’s motivations for it are more political than it is economical.
[http://www.blogmybrain.com/stock_apps/graphical_economy/NIPA...](http://www.blogmybrain.com/stock_apps/graphical_economy/NIPA%20-%20Domestic%20Product%20and%20Income/6/1/a/Real+Gross+Domestic+Product%2C+Chained+Dollars+%5BBillion+Dollar%5D/____Gross_domestic_product)

[http://investintaiwan.nat.gov.tw/en/env/stats/gdp_growth.htm...](http://investintaiwan.nat.gov.tw/en/env/stats/gdp_growth.html)

~~~
bokonist
The business cycle has since the 1970's has been a bit worse than the cycle
from '45 to 75. Nothing like the current financial crisis happened during that
time.

I don't know how the overall growth rates compare. GDP calculations are full
of subjective assumptions. I think there is some truth to the statement that
the rate of economic growth has slowed, but that's a much longer argument, and
not relevant to my original point which was about the business cycle.

~~~
catzaa
> The business cycle has since the 1970's has been a bit worse than the cycle
> from '45 to 75. Nothing like the current financial crisis happened during
> that time.

Nothing like the current financial crises happened since the 1930ies. Then
again, the structure of the economy radically changed since that time (think
globalisation).

> I don't know how the overall growth rates compare. GDP calculations are full
> of subjective assumptions.

The 80ies and the 90ies was one of the best and longest periods of economic
growth for the USA. Since 1982 (before the current mess) there was only a
small recession in 1990 and a quarter long one in 2001.

GDP is probably one of the least subjective measures that there is. I don’t
know what other measure would be less objective. You also seem to ignore the
extremely high inflation in the 1970ies.

------
10ren
_You might think this means that someone who actually did the work and tried
to calculate expected profits would clean up, taking money from all the people
playing musical chairs._

Warren Buffett made his money like this. He's the most successful stock-
investor in the world, and the second richest person (after Bill Gates).

~~~
mikeryan
I'm not sure the point you're trying to make.

But Warren Buffet isn't really a stock investor (he is but thats not where he
made his money). So if you're saying he's one of the stock investors playing
musical chairs - I don't think you're correct.

Buffet buys "good companies" he invests in businesses more then stocks. If
you're saying Buffet made his money by doing what this article said then I
think you're right.. ;-)

~~~
barrkel
I think you're playing semantic games. Buying stock in a business _is_
investing in it. Either you're buying new issuance, in which case it goes
straight into the company's bank account, or you're increasing the stock's
price, thereby increasing the price at which new issuance can be expected to
be made, not to mention other things like stock options for incentives /
hiring, etc.

The other investment is lending, but I don't think you're suggesting that
Buffet is primarily making money buying bonds, or getting even more involved
with short-term loans.

~~~
mikeryan
You and Sam_Odio are both correct, it is a semantic argument (and I do realize
at the end of the day its all stock...)

I consider Buffet's traditional buy-and-hold strategy to be a different form
of investing then those that tend to buy based solely on the expected
performance of the stock price.

~~~
yummyfajitas
Buffet isn't buying based on the expected performance of the stock price +
dividends? Maybe buffet has a longer time horizon than most investors, but
that's the only real difference I can see.

------
cousin_it
_John Maynard Keynes’ great insight was to see that all of this was nonsense.
The job market is a very special market, because the people who get “bought”
are also the people doing all the buying. After all, why is it that people are
hired to farm wheat? It’s because, at the end of the day, other people want to
buy it. But if lots of people are out of a job, they’re doing their best to
save money, which means cutting back on purchases. And if they cut back on
purchases, that means there are fewer people for business to sell to, which
means businesses cut back on jobs._

Except this applies to all other markets too. If people can't sell stuff, they
won't be able to buy stuff, and this effect can balloon in the same manner.
Good luck with your economics, Aaron.

------
natmaster
People believing Keynes is the reason we're in this mess now, and why 'noone'
(the Keynesians) didn't see it coming.

Try this on for size: <http://mises.org/etexts/austrian.asp>

~~~
bendotc
Another excellent article from mises.org: <http://mises.org/story/2066>

And in case you're wondering: yes, I'm being sarcastic.

------
stevedekorte
The rise in unemployment is due to the mass mis-allocation of resources caused
by government intervention into the economy.

Principally, the creation of the central bank and it's long term policies of
credit expansion (with moral hazard), low interest rates (underpricing of
risk) and of debasement of the currency.

Also, the creation of government backed housing lending institutions (also
with moral hazard) that made low interest high risk loans (expanding credit
and risk) and tax distortions that encouraged investments in overpriced
assets.

------
jpwagner
Good read.

One glaring issue I see is that if you redistribute wealth and "give it to the
poor, who will spend it on something useful, like food and clothing", then the
next time they need money for useful things, where do you think they will
look?

This logic assumes that the poor will take the money they need, then go
forward continuing to look for employment as if they'd never been given a
handout. This is not practical.

------
perkoff
"Thus lowering interest rates increases investment — it reduces the cost of
getting money, which reduces the cost of making stuff, which means more things
can make a profit."

The problem with this reasoning is that Keynes only considers the demand side
for capital. What about the supply side? Will lower interest rates encourage
savings?

~~~
aaronsw
Huh? Lower interest rates are the result of an increased supply of capital --
by the government printing money.

~~~
startingup
Government printing money increases capital? Do you even know what "capital"
means? By your definition Zimbabwe has extreme amounts of capital ... that
seems to have done them a lot of good.

------
azgolfer
We are in the process of debunking Keynes yet again. How many times does his
theory have to fail before people stop believing it ?

~~~
hristov
When has it failed? Keynes has not really been followed since Reagan. It is
the neoclassists and the neoconservatives that are failing now.

~~~
bena
I'm beginning to think that Keynesian economics is a lot like communism: "It's
never worked because no one was doing it right."

Maybe it just can't be done right. Maybe the problem is people.

~~~
hristov
Oh, but it did work. It worked when it was actually practiced from the late
40s to the 70s when the US experiences the highest rates of economic growth in
its history. During the 70s the US had about the highest average income levels
in its history too (this was briefly matched during the Clinton administration
but then incomes fell again).

~~~
azgolfer
No, it failed to cure the depression - World War II cured the depression. It
was not practiced from the 40's to the 70's. The average family paid 4% in
federal taxes in 1950. JFK cut taxes in the early 60's which caused a spurt of
economic growth. Reagan cut tax rates (revenues actually INCREASED) in the
80's which again caused a period of growth. We have still not paid the price
for FDR (Social Security) and Lyndon Johnson's (Medicare) programs because we
have been borrowing money for 30 years. I guess you must think that trillions
of dollars of debt is a sign of a good economy.

------
cturner
I'm usually outspoken against obvious non-hacker news on this site. I'm being
a hypocrite because I've been looking to write up a folksy 'leaves on the
fire' economic analogy for a while and this presented a good opportunity.

    
    
        Although, honesty, it doesn't have to be things we all need.
        They could hire people to do anything. This is why inspecting
        the stimulus money for waste is so ridiculous - waste is
        perfectly fine, the important thing is to get the money into
        circulation so that the economy can get back on track.
    

The madness begins. You could hire people to throw bricks through the windows
of rich people. And - indeed - you _will_ get the economy moving. Once,
perhaps more than once. But people have memories, and your ability to pull
this trick declines every time you use it. The actions the government has on
the economy change the way that it responds to stimulus for subsequent events.
When Keynes wrote his stuff it was like putting leaves on the fire. Whoosh! A
century on... it's still like putting leaves on the fire.. except the heat has
gone and the leaves aren't getting hot enough to light up.

If you print and redistribute money to the unemployed on a means-tested basis,
you are directly punishing the people who have accumulated wealth (the
purchasing power of their money is eroded) for the benefit of those who didn't
(that's why they're able to pass the means-test). Why would rational people
expose themselves to economies that do this to them?

    
    
        Capitalism seems to go through frustrating cycles of
        booms and busts. [...] The right solution was to take
        their money away. Give it to the poor, who will spend
        it on something useful, like food and clothing.
    

No, the right solution is for the government to permanently stay out of it,
and let it stabilise of its own accord. That way, over the course of time,
people learn to moderate their behaviour, and you don't create moral hazard
traps all over the place that take the heat out of the fire.

A commenter wrote, "We are in the process of debunking Keynes yet again."
Although the stimulus is "Keynsean", it's operating in an environment that is
substantially different to that which he knew and wrote about. For this
reason, I don't think it's any more valid to use the current situation as a
criticism of Keynes any more than as a valid criticism of capitalism.

Another commenter wrote, "In summary - the business cycle is really misnamed.
It's the "banking cycle". To stop cyclical unemployment, fix the banks."

The current system does have a very influential banking cycle. However, the
perspective of 'business cycle' is preferable to 'banking cycle'. A certain
proportion of people overextend themselves. It's an aspect of human nature.
You have correction periods where they get pulled up for these errors. It is a
more universal perspective. There is an inevitability about the business cycle
regardless of government action, whereas the same is not true of a 'banking
cycle'. Adjusting banking policy won't change human nature.

A book about recursion effects (i.e. the way a stimulus event will cause the
system to respect to the same stimulus event differently in the future) is
_The Crash of 2008 and What it Means: The New Paradigm for Financial Markets_
(Soros, 2009). It's not really about the 2008 crash, that's just a cute veneer
he's put on it to sell more copies of a book that's really a book about
philosophy with a very economic bent.

For a stronger Keynsean defence, read Read _Animal Spirits: How Human
Psychology Drives the Economy, and Why It Matters for Global Capitalism_
(Akerlof/Schiller, 2009) for a purist criticism of recent politics and defence
of the Bush/Obama stimulus. Though I disagree with the core, the breakdown of
'animal spirits' is useful in its own right, and surely a better lens for
viewing what goes in in an economy than 'efficient markets'.

Something that's long-term scary about the current situation is that the
political might of nation-state governments has reached a point where private
banking is being eliminated globally. In the past it was possible for
successful people to look after themselves _and_ generate wealth for the rest
- but this is being undermined. The Swiss made the mistake of giving the banks
too much backing and have sold out whilst saving the furniture, Luxembourg and
Ireland are too European, South Africa is too African, Lietchenstein and
Carribean countries are too small, Iceland and the UK are beholden to
creditors.

The situation presents a huge opportunity for Chile, Australia and New
Zealand. Australia has a gun banking sector already with strong foreign
exchange services in at least three centres and would be the strong option.
New Zealand cares far less about foreign policy links to the US and has a
libertarian party already in parliament. The natural party of government in
Chile is the left and they'd be suspicious of private banking but the right
are polling well. Chile and Australia have added benefit of metals in the
ground. Any could implement special trade zones that created private banks
with strong reserve criteria not linked to the government and suck all all the
wealth. They'd need to do a currency trick to avoid undermining their export
economies but could do this by having two currencies that float independent of
one another, or just by having the private banking system store the money in
gold or against a commodities index like Goldmans GSCI.

~~~
cromulent
It seems you are suggesting that the best solution to a stalled economy is not
to have government stimulation, but to let it "stabilise of its own accord".
Has this been tried? Any examples? For some reason I thought that there was a
general consensus that the government needed to prop up banks and stimulate
the economy.

edit: Honest question, btw.

~~~
btilly
Yes, it was tried. The attempt was followed by the Great Depression.

It is understandable that some are reticent to repeat the experiment.

~~~
yummyfajitas
Smoot-Hawley was "letting things stabilize"? What about the ERA and
Reconstruction Finance (spending on infrastructure like Hoover Dam)? How about
bailouts for financial institutions and subsidized home loans?

It's too bad Hoover let things stabilize on their own. One wonders what might
have happened if he actually did something!

~~~
btilly
People did things, no doubt about it. The wisdom of those things is another
matter. The ERA was a protectionist measure that is today cited as worsening
affairs. Reconstruction finance was a good idea, but started in 1932, after 2
years of financial disaster. Hoover's initial responses did not take
aggressive action to shore up the money supply or failing banks.

Of course debates on the causes of the Great Depression are endless. Which is
why I was careful to say that the Great Depression followed, but was not
caused, by that action. However many prominent economists including Milton
Friedman and Ben Bernanke have concluded that the primary cause was the
contraction in the money supply.

In their view the Federal Reserve did not act fast enough to counter the
shrinking monetary supply or to prop up failing banks. The result was multiple
rounds of bank panics, the closing of over 40% of all US banks within 4 years,
and (after Roosevelt came in) the declaration of a national bank holiday, and
an executive order forbidding private speculation in gold. The rapid loss of
1/3 of the money supply was both a cause and effect for the general economic
disaster.

Whether or not you agree with this theory, understanding that Ben Bernanke
believes it will help you understand why he took the actions he did last year.

~~~
yummyfajitas
_People did things, no doubt about it. The wisdom of those things is another
matter._

Exactly my point. In the beginning of the great depression, they did things.
They didn't try letting things stabilize on their own.

~~~
btilly
They did things. But they did not immediately try to shore up failing banks or
stabilize the money supply, which are both parts of the recipe that we use
now.

On a related note, the full crisis only hit last year after the Fed decided to
let a major financial firm fail.

~~~
cturner
Why are you confident to say that the full crisis has hit?

~~~
btilly
Heh.

I must admit that there are many potential financial disasters that could
still hit which would make last year seem minor. I have no clue how the fed
plans to unwind the what, half trillion in commercial ARM loans that are under
water and set to reset in the next year or two. Obama is incredibly dependent
on the Chinese willingness to continue borrowing from the USA. We have a lot
of work to do to get debt levels back to reasonable amounts. And I'm not at
all sure that the disaster was enough to really scare people into becoming
fiscally responsible.

However for the moment people seem convinced that the sky is not falling.
There are signs of economic recovery out there. There is even a chance that
when the official statistics are done we'll be no longer in a recession. So
even if a bigger crisis hit, there would be a good cause to call it a second
crisis rather than a continuation of the one last year.

And there would be historical precedent for that. Our current problems come
from an asset bubble that was pumped up from attempts to stimulate the
monetary supply to head off deflation after the dot com collapse. But people
don't think of the recent financial crisis as a continuation of the dot com
collapse, despite the connection.

------
nathanwdavis

      *The best solution is probably a small tax on each trade.*
    

Don't we already have a tax on stock market trades - The Capital Gains tax?
And since it is higher for short-term trades this already provides
disincentive to engage in speculative trading.

~~~
steamer25
The best solution is probably to let the speculators fall on their faces and
serve as examples for the rest instead of punishing the responsible investors
to create a bail out.

~~~
randallsquared
Indeed, as long as actual fraud isn't involved. The only way to prop up
failure is to punish success.

------
lionhearted
[I line-by-lined the entire post for Aaron pointing out some things, and it
came out really, really long. By far my longest comment here - Aaron and
others, I hope you find some value in this. I'm exhausted, and I've not edited
this with tremendous rigor, but I hope there is value here]

I actually know a lot of Keynes. He was a very smart man and had some
interesting ideas, but there were a lot of problems too. The original piece
had some problems with it, so I'm going to comment here and let Aaron know via
email. If it suits him, I would be happy to be republished, or to contribute
to his site so as to spread knowledge. I consider myself in the service of
humanity, as I believe he does, so the more we can fight ignorance, the
better. Last time I made a commentary like this he asked that I email him with
it, so I'm doing so this time at me@aaronsw.com, and I do so humbly this time.

In the article, there is a mix of interesting ideas, some not-so-good ideas,
and some ethical judgments. I think he and I have several of the same end
goals, so I'm just going to point out a few points that I think could be
tweaked so as to account for secondary effects and make the best world
possible.

> But they’re typically forced back to the fundamental conclusion of the
> textbook: that people are just demanding to be paid too much.

One thing to remember is that an employee's "fully loaded cost" is more than
his take-home pay. There's employer-side social security tax tax and
unemployment insurance, benefits, and administrative costs on the business
side. On the employee side, they pay income tax and social security tax. So a
business might pay $107,000 to an employee in annual salary and expenses, but
the employee gets $50,000 after taxes. Generally, a gap between fully-loaded
costs and takehome compensation increases unemployment.

> But if lots of people are out of a job, they’re doing their best to save
> money, which means cutting back on purchases.

> Everyone knows why: put some money away today and it’ll be worth more
> tomorrow.

Okay - why is money worth more tomorrow? Because, the theory goes, by putting
it in the bank, you're asking the bank to lend it out for you. The bank
guarantees an interest rate to the saver while charging a higher rate to the
borrower. The borrower puts down collateral that the bank can sell if they
don't pay. So, when people save more, the banks immediately have more to lend,
so people who want to do interesting things can take the money and do the
interesting things. These interesting things - building computers, cars,
producing medicine, improving the quality of circuits, rennovating and
improving real estate, building new real estate, and so on - makes the world
"wealthier" - that is, there's new cool stuff, and better old stuff in the
world. With this new and better stuff, the borrower makes more money. They pay
the bank back plus interest, the bank pays the saver their money with
interest, and all is good. The saver's money is worth more tomorrow (the money
saved comes back, plus the interest) because it was used to better the world,
and someone paid for that privilege.

That's the theory anyway - in practice, banks don't actually do that any more.
Which brings us to our next point:

> Money isn’t worth anything on its own, it’s only useful because it can buy
> things.

Kind of true, yes - but what you're talking about is what's called, "Money as
a fiat currency". Anything can, and has been, money in the past. If I wrote a
certificate that said, "Sebastian guarantees he'll work ten hours for you in
the future on any legal project of your choice", and you trust me, I'll have
just created "money". That's money backed by my labor. In the past, to
standardize money, a few things have been done: It's been made into coins made
out of precious metals that are of uniform values. It's been a result of
trustworthy warehouses issuing certificates about the quality of goods in
their warehouse, such as wheat or tobacco. Then people can exchange those
certificates instead of carrying bushels of their crops around.

Fiat money (paper money, backed by nothing) is an illusion. And actually, if
you look at history, every paper currency eventually goes to zero, because
every government eventually ends. And when governments start to end, they tend
to get desperate and what's called "debase" their currency by creating more of
it. Debase: "to reduce the intrinsic value of (a coin) by increasing the base-
metal contents" (from Merriam-Webster online). So that'd be mixing brass in
with gold or iron in with silver. Looks like good stuff, but it's not.
Governments do this to try to stay alive - from a war, or riots, or going
bankrupt, or whatever. You can read about how it happened in Argentina
recently, or any Soviet country as it was falling apart, or various African
regimes, or the Confederacy during the U.S. civil war. Printing more paper
debases a paper currency like mixing iron with silver debases a precious
metals currency.

> But if everyone’s saving, that means people aren’t buying.

In normal banking, you can't save and get interest unless the bank is loaning
the money out for people to use. If no one takes the money that the bank is
getting in deposits, there can be no interest paid. The bank adjusts rates
naturally to a small spread between what people are willing to deposit at and
what people are willing to borrow at. It is possible for people to panic and
put their money in a mattress and not use it for anything, but this goes
against human nature: We like progress. Eventually, people stop panicking and
put their resources to use. This is a fundamentally human thing to do.

> This is the multiplier: each dollar that gets spent provides even more than
> one dollar’s worth of boost to the economy.

I was going to just point out errors originally, but this line is incredibly
important and a very important contribution Keynes made so I wanted to
highlight it. Basically, every hour someone works on something valuable
creates new wealth, which creates an incentive for other people to work, so
they're willing to work another hour to build new stuff. It's a good thing.
Very good.

> How do you decide how many trucks to make? Obviously, you make as many as
> you think you can profitably sell. But there’s no way to calculate something
> like that — it’s a question about what customers will do in the future.
> There’s literally no way to know. And yet, obviously, trucks get made.

There is very little certainty about the world, but "There's literally no way
to know" is a bit strong. There are many ways people work to figure things
out, and people have a decent but inexact idea about demand all the time. Yes,
people do make bad decisions (too many trucks) and then sell them at a loss at
times. Then companies with bad judgment die and their trucks are sold very
cheap to recoup as much of the loss as possible, while only the most
foresighted/lucky/skilled trucking companies remain. If all trucking companies
go under, and people still need more trucks, then new trucking companies will
be formed as the prices of older trucks start rising. One of the biggest
misconceptions about capitalism is that it's "smooth" - it's not. There's
bumps and breaks in the cycle, just like in humanity in general. Under all
economic or governmental systems, people are prone to bad judgment. Under
general freedom of action, these problems correct themselves over time though
it can be really unpleasant. That opens the door to thinking about whether
there's any general responsibility for people who make bad decisions or get
hit with bad luck - personal ethical judgment, I think there is. The next
question becomes where that responsibility, if any, might lie - I tend to
think at a smaller level, because it's more prone to reciprocity and good will
and less prone to corruption, but people can agree to disagree there. But
that's ethics which I'll generally refrain from whilst discussing economics.

> But they don’t make rich people like that anymore. Nowadays, they put their
> money in the stock market. Instead of boldly picking one great enterprise to
> invest in, they shift their money around from week to week (or hire someone
> else to do it for them). So these days, it’s the stock market that
> stimulates most new investment.

Whenever someone buys stock, one of two things happens:

1\. The company is selling the stock, and it gets the money put in. It hires
people, buys equipment (say, trucks), or does other things companies do with
money, all of which opportunities for work in aggregate. ("in aggregate" is a
fancy word meaning "in total" - one truck purchase might be an unused truck
somewhere, but all the truck buying in the world creates a demand for more
trucks, mechanics, etc)

2\. The buyer of stock buys it from another guy, who gets the money. There's
still the same mix of money in the world. Before, Charles had 10,000 shares
and 0 dollars. Paul had $10,000 and 0 shares. After, Charles has 0 shares and
$10,000. Paul has 10,000 shares and 0 dollars.

So it's impossible for "all the rich to buy stock", thus running out the cash
in the world. For every buyer there's a seller than now has the cash, or a
company that now has the cash with which to build trucks, railroads, hire a
marketing person, or whatever. Actually, it's funny, there's no way to create
wealth without actually building stuff. Many of Paul Graham's essays cover
this. (Fake paper wealth is eventually destroyed, and is unpleasant when it
happens. Whether society has an obligation to people unskilled/unlucky enough
to be holding fake paper wealth when it is destroyed is back to the earlier
ethical question. Ethically, I have less sympathy for people with fake paper
wealth than people whose routine of working is disrupted, but they probably
deserve a bit of help too)

> But how does the stock market figure out what profits are supposed to be? In
> truth, it has no more clue than you do.

This is akin to asking, "How does an eggplant figure out what dish it should
be cooked in? In truth, it has no more clue than you do." I'm NOT joking or
being snarky. The stock market is not designed to, and never can, make
judgments about what profits should be. The stock market ONLY matches the
lowest asking price of a stock to the higher buying price of a stock until
they even out and become the same (with people continuously selling if someone
is willing to buy for more than what they want, and someone continuously
buying if people are willing to sell for what they want). People say, "The
stock market reflects value, and people's trust, and blah blah blah..." This
is nonsense. The stock market is not smart. It mixes buyers and sellers. The
rest is propaganda spread by finance people. If people are buying and selling
at stupid prices, then the stock market will be stupid. It doesn't figure out
prices. It can't. It just lets people buy and sell to each other at the prices
they want to. But...

> We forget about the most basic fact: that nobody has any clue what the stock
> price should be to begin with.

...this is untrue. There's plenty of information that goes into it. The
easiest is "price/earnings ratio", called P/E. That means, how much does one
dollar of profit cost you to buy? I was going to go on to describe P/E and
other things of "fundamental investing", but it's beyond the scope of what I'm
trying to explain here. There's lots of literature on it. Suffice to say, P/E
is rather unsubjective, but the judgments you make on it are. Here's
literature for the curious (there is problems with it, it's not meant to be a
complete answer, it's just a good jumping off point):

<http://www.investopedia.com/terms/p/price-earningsratio.asp>

<http://en.wikipedia.org/wiki/P/E_ratio>

When people are buying things for an idiot crazy P/E ratio, bad things will
happen to them. There's few guarantees in life, but that's almost one of them.
Idiot crazy P/E ratio, you're getting burned. That almost always happens.
"Fundamental investors" - that's people who invest based on how much money a
company is making, their sales, their debt, and other objective factors like
that, combined with a little information about the industry and an opinion on
the company's management - they have ways of valuing companies. They can
usually figure out what a company is "worth" beyond the hype and fads and
craziness. It is not random or unpredictable.

> It’s like a giant game of musical chairs — everybody’s rushing not to be the
> one left standing when the music stops.

These people are called speculators, as opposed to fundamental investors. They
do provide some valuable roles to society (liquidity is the big one), but this
is not all the stock market is. Not by a longshot (and I'm not even a huge fan
of the stock market, by the way).

> Or, you could say, it’s like those newspaper competitions where you have to
> pick the six prettiest faces from a hundred photographs. The prize goes to
> the person who picks the faces that are most picked, so you don’t pick the
> faces you find prettiest, but instead the faces you think everyone else will
> find prettiest.

This is true for speculators - you just described speculating pretty well. But
fundamental investing doesn't work like that - if other people don't like a
great company, you buy it all up and distribute the profits every year in a
dividend to the investors. Companies used to offer dividends a lot by the way,
it's just our brave new world where people don't. Why they don't is a long
topic, but suffice to say, there is an "out" for people who like good
companies that other people don't like. It's getting lots of dividends
(profits from the company, in cash). It works pretty well.

> Calculating expected profits is really quite hard.

In new fields, like Facebook's profit in 2011, yes. In volatile fields, like
Exxon in 2011, yes. In semi-stable fields, you can usually make some pretty
educated guesses.

> It’s in the fundamental nature of your strategy that your investments seem
> crazy to everyone else.

This doesn't matter. If the company turns a profit, you can get dividends. You
don't need people to like your stock unless you want to sell it all, which you
don't want to do too often if you're investing for the long term.

> And when your stocks aren’t doing well (which is most of the time — they’re
> long-term picks, remember), people will take this as evidence of your
> failures and pull their money out.

This is true. It's also exceedingly stupid. A stock's price isn't what it's
worth - it's what someone's willing to pay you RIGHT NOW. That'd be like if
someone walked up to you, said, "Hey, I'll give you $200 for your $1,000
watch", and you panicked and sold it to them. It's really crazy.

> And that’s scary because — recall — the whole point of the stock market is
> to decide the crucial question of what we, as a society, should build for
> the future.

You need to be really, really careful writing things like this. The stock
market is not a sentient being and has no general sense of ethics. It is a
place where people exchange stocks for money at the "clearing price" (where
people will buy and sell). There is no value judgment. It does not tell
society what to build. It's simply where stocks are all the stocks are sold at
the highest price someone will pay, and sold at the lowest price someone will
sell, until everyone is stable. There is no intelligence or value judgment.
The stock doesn't tell you _anything_ except what the price people are
currently willing to buy and sell is at.

> The best solution is probably a small tax on each trade.

That's actually an interesting idea. I always wondered why a company didn't
issue stock that said, "Trading this stock requires the buyer to pay the
company $1 to gain official voting rights and become legitimate owner of the
company. Trying to exchange ownership or control of this stock or otherwise
circumvent this agreement consists breach of contract and forfeits the stock."
That would slow down stock trading and all speculation would bring new capital
to the company. I don't know why it doesn't happen (laws, I'm guessing?).

> Even more perversely, it means economic performance depends in no small part
> on keeping businessmen happy.

Everyone is a businessman. Anyone who interacts with humanity in any way is,
seriously, a businessman. There is no gap between a businessman and the rest
of society. It's a relatively recent phenomenon that large conglomerates
provided so much of humanities needs and wants, but we're actually shifting
away from that as small businesses can get large-business economies of scale
from competing providers. In short, the above quote is false. If the
businessmen give up and leave, as long as someone half competent is willing to
do anything that others are willing to pay for, the economy will not halt.
(Though, talented managers - as rare as they are - are actually woefully
unappreciated, and an economy losing them would really take some blows. This
happened to the USSR, Red China, Nazi Germany, and various other totalitarian
places - when a place gets evil enough, the most talented, enterprising,
smart, and resourceful people dedicate all their talent to getting the hell
out of there, which does in fact hurt an economy's growth quite a bit - for
fun, look at how many of the wealthy people in the USA, Hong Kong, Israel, and
other havens came from direct immigrants or first generation resourceful
people fleeing totalitarian places)

> Most costs are pretty clear — you need to buy equipment and hire people.

This strikes me as a general flaw of Keynes - he doesn't recognize that buying
and selling are always the same transaction. Any unclear demand is an unclear
supply. A clear cost of equipment is a clear price of equipment. Whenever
someone "puts their money in stocks", someone else has "taken their money out
of stocks", or the company has gotten the money and will (presumably) start
putting it to use.

> But since you need to make stuff now that you can only sell in the future,
> one of your big costs is going to be money to use in the meantime. And the
> cost of money is just the interest rate. (If you get a loan for a million
> dollars at 5% interest, you’re essentially paying $50,000 for the right to
> use the money now.)

Huge Keynes wrongness here - this one is ugly because it seems so correct on
the surface. But this only applies to fiat, paper currency. The fake, illusion
money you referenced earlier. You can't just "set" an interest rate, unless
you're a government that doesn't mind debasing your currency. Debasing your
currency makes the value of every bit of your currency go down. "And the cost
of money is just the interest rate" - the interest rate is set by the same
process everything else is: The price people are willing to sell (deposit) and
buy (borrow) meet. Same as the stock market, same as the truck market, same as
the labor market. Let's pretend for a moment that the government set the
interest rate at zero percent - well, then people would borrow tons of money.
But who would deposit it? Who would risk their money to get nothing back?

No one. So the government debases the currency by printing more. Again,
"debase" is just the historical term from mixing the metals, it's not a value
judgment. We could call it "making the value of all the currency that exists
go down by printing more" instead, but the word already exists, and it's
"debase". I'm not crazy about the word myself - it's just a historical
throwback to people mixing base currencies (iron, brass) with precious metals
(silver, gold) to create fake, lower quality, debased precious metal money.

Anyway, government manipulating the currency = debasing or inflating the
currency artificially. The former leads to depression, the latter leads to
inflation. (Why is complicated - in short, people stop using a kind of money
if it gets debased too much - this is actually where ticking off rich people
hurts - they stop signing and issuing contracts in USD, instead using
something else. Remember, a paper currency always eventually loses all its
value. Always, it's happened every time)

> Well, if the interest rate is the cost of money, the obvious answer is the
> amount of money in circulation. If there’s a lot of money lying around, you
> can get some pretty cheap.

The other things I've commented on are general details-based errors, whereas
this is completely incorrect. Interest rates on non-fiat currencies in a free
market are set at the rate where people are willing to sell (deposit) and buy
(borrow) meeting, just like all other markets. The amount of money in
existence _does not matter_ \- if someone has a gigantic pile of, say, gold or
wheat or tobacco, but they're perfectly happy having a pile of it, they won't
lend it out unless you blow them away. But most things have their price -
someone credible starts offering 50%, 100%, 150%, maybe you lend your gold or
wheat. Or put another way - how much money would you want back to lend a
stranger your car? A hell of a lot more than 10%. What if they crash it? Break
it? General wear and tear? Don't give it back? But if someone credible offered
you, say, 100% of what your car is worth to borrow it for a year, you might
just say yes to that. Maybe it's 1000%? Who knows? Yes, generally, more stuff
unused will make people more willing to deposit (sell), but not always.
Interest rates are set by people talking, negotiating, and where the buying
price and selling price meet, just like everything else.

> Which means that, fundamentally, unemployment is caused by a lack of money:
> more money (assuming people don’t hoard it all) means lower interest rates,
> lower interest rates (assuming expected profits don’t crash) means higher
> investment, higher investment (assuming people don’t stop buying) means more
> employment, and more employment means higher prices, which means we’re going
> to need more money.

Keynes made a lot of good points. This part of his work - the "we can play
with fiat currency to create wealth" part - is not some of his good stuff.
Interest rates artificially low is what we had the last ten years - it meant
people got stupid and crazy and wasteful with the free money. Interest rates
artificially high means people develop less than they could and progress
doesn't happen. With a non-fiat currency, based in real stuff, this balances
naturally. Governments playing with fiat currency always - always - abuse it
and bring it to zero.

Remember, it's not just the leaders that you like that are insightful that get
to play with the currency. For every Thomas Jefferson or Marcus Aurelius, you
get a George Bush or Nero. For every good Chancellor, you get a Hitler. These
people get to play with the fiat currencies too. They make it go to zero to
fund their warmongering and corruption and destruction. But inevitably, every
government gets run by a bad person. Also inevitably, every fiat currency goes
to zero.

> Money is created by the central bank (the Federal Reserve in the US), which
> decides what they want the interest rate to be and then prints new money
> (which they use to buy up government debt) until the interest rate is where
> they want.

Yes. They got us into this mess with their "low low rates!" of the last ten
years. Now people are hoping they'll get us out of it. They've done so, so
far, by lowering rates more. There's even talk of having a negative interest
rate - paying people to take money! I could point out how crazy that is, and I
will if the reason why is unclear, but suffice to say, the people at the
Federal Reserve are just as prone to knuckleheadery as the rest of us, if not
more so.

> What do you do if the interest rate is zero and people are still out of
> work?

A very easy one would be to cut taxes, actually. Let's say currently, for
every dollar an employer pays, the employee receives 50 cents. Well, now
there's a big problem on your hands - the employee needs to be offered TWICE
the money that makes it worth it for him to work to take a job. If the
employee wants $3,000 after-tax per month, but the employer would have to pay
$6,000 in employer-side taxes, employer-side insurance, administrative costs,
employee-side taxes, employee-side insurance, etc, etc, well, you've got a
problem. Now, there'll always be some gap - administrative costs, management,
and so on. But cutting income taxes always reduces unemployment and fairly
quickly. Actually, it's the only answer when the "debase the fiat currency"
plan isn't working.

> The government has to step in.

Agreed.

> Instead of waiting for billionaires to build pleasure-domes, the government
> can hire people to build things we all need — roads, schools, houses, high-
> speed Internet connections. Although, honesty, it doesn’t have to be things
> we all need. They could hire people to do anything. This is why inspecting
> the stimulus money for waste is so ridiculous — waste is perfectly fine, the
> important thing is to get the money into circulation so that the economy can
> get back on track.

Okay, I was going to make a joke or be snarky, but I won't. This is a fallacy.
Debasing the currency just moves the problems around. It means people won't
want to hold U.S. currency, and won't want contracts written in U.S. currency.
And remember, USD is "illusionary money", as you already mentioned and
covered. Debasing it (making everything in existence already worth less) is a
good way to get people to stop buying the illusion. Now, I didn't quote it,
but you alluded to billionaires not wanting to buy pleasure domes and that
being the problem. Actually, billionaires usually don't hold their billions in
cash - they hold it in real estate, stocks (as already covered), and other
assets. When a currency is debased, the price of everything rises pretty
quickly. That means the billionaires get hurt less. You know who gets hurt the
worst? That would be poor and middle class people who tend to keep much of
their net worth in cash, and also people who have contracts that call for them
to get paid a set rate in the future. Debasing the currency means the price of
all their materials will rise, making their contracts not profitable at the
rates they guaranteed to sell. So the break their contracts. It's a big mess.
Debasing isn't the answer, especially past zero percent.

> Another good solution is redistributing income. Poor people are a lot more
> likely to spend money than billionaires. If we take some money from the
> billionaires and give it to the poor, the poor will use it to buy things
> they need and people will get jobs making those things.

1\. This is a value judgment.

2\. Wealth redistribution never hits the billionaires the hardest. EVER. Much
of the stimulus went to already wealthy people. Wealthy people get better
access to universities, police, parks, and public transit. The don't build
public transit to very poor areas, and if they do, the areas become wealthy
quickly with the poor people moving out. Poor areas aren't as well policed.
And so on. It's very hard to redistribution involuntarily - by definition,
you're creating a power vacuum that's supposed to take money and wealth from
some people and give it to others. Who do you think is going to win in that
arrangement - the most resourceful, educated, sophisticated, driven, ambitious
people (the wealthy), or someone else? That's a serious question without any
value judgment - I'd very much like to fight poverty. Personally, I fight
children's cancers. I've run charity events for St. Jude's Children's Hospital
in the USA and Great Ormond Street in London. But I'll tell you, I've seen
some sickening things with laws that are meant to redistribute. I know some
people that've gotten the money. Then they throw a "cash for clunkers" bone to
poor people to get them stuck in more consumerism. A guy pays $10,000 in
taxes, and they give him back $3,000 to buy a car he doesn't need or want. I
know a guy that owns a bunch of unprofitable farmland and receives the
subsidies. He just bought it on the math on government subsidies. But I
digress - I'm with you ethically - raising the standard of living globally is
important, and some people can have their standard of living go up faster. But
"debase the currency" isn't the answer - it ruins nations. Other
redistribution plans tend to make the wealthy get wealthier frequently. And if
they're very, very successful, you get a USSR situation where your smartest
people leave.

> Remember that money is just a kind of illusion.

Fiat money is an illusion, this is true. Debasing ("hey? what the hell? why
does a cheeseburger meal cost $12 and a movie ticket cost $18?") breaks that
illusion.

I apologize, I was going to go through the whole piece, but I've writing for a
quite while and I'm getting tired. Aaron, I'm going to email you - if you'd
like me to clean this up so it can be a formal post on your blog, or if I can
otherwise be of service to you, please call on me. I'll shoot you an email
now, and you have my best wishes. I think you're one of the most passionate,
charismatic, and intelligent people I've seen write. I think you can be a
tremendous difference maker in the world. I believe our goals are in line, so
with the best methods, perhaps we can serve as champions of humanity.

~~~
aaronsw
This is a long post, mostly filled with things that are either irrelevant to
what I said or obviously wrong. But the basic place where it disagrees with
Keynes is that it adopts the old-time monetarist view that printing money
always "debases" the currency. This seems intuitive, but it's been proven just
wrong. During the period I mention when we kept interest rates low, the
economy grew steadily. When monetarist targeting was tried (under Volcker), we
got a huge recession. The recent problem wasn't caused by low interest rates
but a housing bubble. If Greenspan had simply given a speech pointing out the
bubble instead of repeatedly denying it, it could have been averted.

