Sunday, February 15, 2009

Everything Old Is New Again — Part II

The letter that could have changed the world

Many economists and financial experts are citing comparisons between the economic crisis that occurred in the 1930’s and the country’s current fiscal problems. With that in mind, it is unlikely that anyone recently noted what could have been one of the most important letters that ever appeared on the editorial pages of the New York Times. It was addressed to the President of the United States, and read in part, “You have made yourself the Trustee for those in every country who seek to mend the evils of our condition by reasoned experiment within the framework of the existing social system. You are engaged on a double task, Recovery and Reform; –– recovery from the slump and the passage of those business and social reforms which are long overdue.”

The letter continues, “The object of the recovery is to increase the national output and put more men to work…. An increase of output cannot occur unless by the operation of one or other of three factors. Individuals must be induced to spend more out of their existing incomes; or the business world must be induced, either by increased confidence in the prospects or by a lower rate of interest, to create additional current incomes…or public authority must be called in aid to create additional current incomes through expenditures of borrowed or printed money…It is…only from the third factor that we can expect the initial major impulse.” Emphasizing that last point was this statement: “Thus as the prime mover…I lay emphasis on… governmental expenditure which is financed by loans and not by taxing… Nothing else counts…” [My underlines.]

That certainly sounds like a message to our new President Obama, the precepts of which he and his advisors seem to have already adopted. The new president has stated his intentions to stimulate the economy through the means of a governmental spending program consisting of lower taxes and infrastructure initiatives projected to be $850 billion –– and still counting. Remember the above headline: Everything Old Is New Again. That letter was actually published on December 31 st, 1933, over 75 years ago in The New York Times. It was written by the famed British economist John Maynard Keynes, and was addressed to the then President, Franklin Delano Roosevelt.

The letter that did not change the course of history

There is a little known story behind that letter. In 1933, when the U.S. was in the throes of a deep and catastrophic depression, in that letter Keynes beseeched President Roosevelt to follow his precepts as a solution to the depressing economic aftermath of the “Crash of 1929.” In fact, Keynes made a gesture that has received little press coverage. He had written the above letter with the title, “Open Letter to President Roosevelt” that was to be printed in the Times on December 31 st. In order to allow the president to read the letter before publication, on December 16 th Keynes gave a copy to the famed jurist, Felix Frankfurter who was also in London at the time. Frankfurter rushed it by courier to the ship The Bremen that was leaving for the U.S. that same day. (What a difference from today’s forms of instant communication). Apparently, Roosevelt was not overly impressed since he did not accept nor did he act on Keynes’ recommendations. Had he done so, that letter might have changed the course of history.

A failed meeting

Keynes did not give up however, since he actually met personally with the President in 1934, encouraging him to scrap his efforts to balance the budget and instead embark on a vast deficit spending spree. After the meeting, a bewildered Roosevelt remarked to his Labor Secretary, Francis Perkins, “He left a whole rigmarole of figures. He must be a mathematician rather than a political economist” (Keynes was actually both). That neither Keynes’ letter nor his visit resonated with F.D.R. was manifested once again by the President’s failure to accept and fully implement Keynes’ proposals.

Despite his efforts with the creation of his “New Deal” programs, Roosevelt’s funding of those programs fell short of initiating full-scale governmental intervention. Restricted by his basic fiscal conservatism, he neglected to adequately fund the mammoth spending programs (involving public service projects such as infrastructure) necessary to generate full employment. According to a number of economists, it was not until President Roosevelt finally did unleash an immense spending initiative by ramping up our arms programs as we entered into World War II that Keynesian concepts were fully employed. At that point, the economy finally recovered, substantiating Keynes principles and injunctions.

The failure of the New Deal

Paul Krugman, the latest Nobel Prize winner in Economics elaborated on the New Deal program in a November 2008 New York Times piece, “…the trouble is that the New Deal wasn’t as successful in the short run as it was in the long run. And the reason for F.D.R.’s limited short run success which almost undid his whole program, was the fact that his economic policies were too cautious.” According to Krugman, “The New Deal placed millions of Americans on the public payroll. However, the effects were not major, and after winning the 1936 election, Roosevelt cut spending and raised taxes in an effort to balance the budget.” Krugman writes “that precipitated an economic relapse that drove the unemployment rate back into double digits and led to a major defeat in the 1938 mid-term election.”

Krugman explains, “What saved the economy and the New Deal [and provided the verification needed to substantiate Keynes’ theories] was the enormous public works project based on World War II which finally provided a fiscal stimulus adequate to the economic needs.” Krugman ends his piece with this advice for the new Obama administration: “…figure out how much help they think the economy needs, then add 50 percent. It’s much better in a depressed economy to err on the side of too much stimulus than on too little.” Krugman’s view (as of the end of January) of the Obama “rescue package” is that it is far too little.

Government and academic acceptance of Keynesian Economics dominated our economic history until the 1970’s when the 1973 oil crisis precipitated a period of stagflation. As described in last month’s article, that triggered a resurgence of “monetary” economic policy (also termed supply side economics) advocated by what became known as the “Chicago School of Economics” represented by the economist, Milton Friedman. In a more recent article on January 5 th, Krugman writes, “[Milton] Friedman’s claim that monetary policy could have prevented the Great Depression was an attempt to refute the analysis of John Maynard Keynes, who argued that monetary policy is ineffective under depression conditions and that fiscal policy –– large scale deficit spending by the government –– is needed to fight mass unemployment. The failure of monetary policy in the current crisis shows that Keynes had it right the first time. And Keynesian thinking lies behind Mr. Obama’s plans to rescue the economy.”

Who are Keynesians now?

With the current economic meltdown, almost every economist of note is advocating a return to a Keynesian solution to our current economic recession. Corroboration for that view was voiced at the annual meeting of the American Economic Association in early January, where hundreds of economists gathered. A New York Times article reported that, “Frightened by the recession and the credit crisis that produced it, the nation’s mainstream economists are embracing public spending to replace the damage –– even those who have long resisted a significant government role in a market system. Janet Yellin, president of the Federal Reserve Bank of San Francisco said, ‘The new enthusiasm for fiscal stimulus government spending represents a huge evolution in mainstream thinking.’” This thinking is so prevalent, the Times reported, “…many [economists] said that once the recession ended, the nation should not go back to the system that held sway from Ronald Reagan’s election in 1980 to the present crisis. It was one in which taxes, regulation, and public spending were minimized.” Goodbye Milton Friedman. Hello Mr. Keynes. (It should be noted that although the Keynes concept of government stimulus spending programs seemed to be the catalyst that drove the economy for some 35 years, it has only been truly tested that one time).

After a 35 year hiatus, John Maynard Keynes, who as stated earlier is considered the most influential economist of the 20 th century, may yet attain that same reputational status when 21 st century economic history is reviewed. (That is assuming (and praying) that his precepts work once again). Not only is Everything Old New Again, it appears WeAre All Keynesians Now –– and that includes Barack Obama.

NOTE: Keynes, considered by many to be a true “renaissance man,” was also the originator of a great many aphorisms. Here are a few that you might enjoy:
  • Markets can remain irrational longer than you can remain solvent.

  • If you owe your bank 100 pounds you have a problem. But if you owe a million, the bank has.

  • There is nothing so disastrous as a rational investment in an irrational world.

  • If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid.

  • Long run is a misleading guide to current affairs; in the long run we are all dead.

  • Successful investing is anticipating the anticipation of others.

  • The avoidance of taxes is the only intellectual pursuit that still carries any reward.

  • Americans are apt to be unduly interested in discovering what average opinion believes average opinion to be.

  • Capitalism is the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone.

  • Education: the inculcation of the incomprehensible into the indifferent by the incompetent.

  • When the facts change, I change my mind. What do you do sir? (Reply to criticism during the Great Depression of having changed his position on monetary policy).

  • I should have drunk more champagne. (Keynes’ last words on his deathbed).

Sunday, February 01, 2009

Everything Old Is New Again — Part I

One of the more entertaining dance routines in the annals of film history was enacted exactly 30 years ago in the movie “All That Jazz” (it can be viewed on YouTube here). The music accompanying the performance was a song titled “Everything Old is New Again,” a fitting description of the current economic policies resurrected from the past, some already enacted, others being considered, all relating to today’s economic downturn. In fact, one line in the song provides a most appropriate point of quite relevant sage advice: “…don’t throw the past away, you might need it some day.” Well, no one can dispute the fact that the “some day” is here again.

Which reminds us of another “again” song, written some 80 years ago, sharply different in tone, citing what turned out to be a totally misguided upbeat title, “Happy Days are Here Again.” The timing could not have been worse; the song was published one month after the “Crash of 1929.” The uplifted sentiments were not wasted however, since in 1932 that song was used as the campaign melody for Franklin D. Roosevelt’s successful presidential run, and it ultimately became the theme song of the Democratic Party.

When trying to relate past events to the present, one of the most quoted aphorisms of all time, presented by the legendary philosopher George Santayana, comes to mind: “Those who cannot remember the past are doomed to repeat it.” It’s amazing how often that principle has been violated in the over 100 years since it was first formulated, and how well it has withstood the test of time. Also amazing is the repetitive nature of the past. Consider the following quote and the remarkable, almost eerie relevance to what has been determined as one of the fundamental causes of our current economic crisis: “Some of our banks have shown themselves either incompetent or dishonest in their handling of the people’s funds. They had used money entrusted to them in speculative situations and made unwise loans.” No! Those are not words spoken by Presidents Bush or Obama, although they could have been. This criticism from the past was part of the very first “Fireside Chat” given by President Roosevelt on March 12 th, 1932, almost 77 years ago. Not only was Santayana right, we could also certainly say, “Everything old is new again.”

We Are All Keynesians Now

It was during the period of Roosevelt’s presidency that the British economist, John Maynard Keynes, began to reach the pinnacle of his fame. Keynes is still considered by many to be the most influential economist of the 20 th century (perhaps the third most prominent economist of all time). With the prospects of the worst economic conditions since the Great Depression facing us, there is a resurgence and reactivation of Keynes’ economic theories. Politicians and academics of all stripes have become, or are becoming Keynesians, if not in name, in action. If the implementation of his polices are successful Keynes may yet go down in history as the most influential of the 21 st century as well, but more on that later.

That Keynes led a diversified career would be an understatement. Born in 1883, he was educated at Eton and Cambridge. During various periods of his life he was a British civil servant, a Cambridge don, chairman of a life assurance society, editor of several journals, a director of the Bank of England, and was knighted by the then King of England. He was also a speculator, a farmer, a prolific writer of manuals and books, and the head of the British Arts Council. He was a leader of the famous Bloomsbury Group consisting of avant-garde writers and painters known as the “Intellectual aristocracy.” In fact, Bertrand Russell, the Nobel Prize winning philosopher and mathematician (no intellectual slouch himself) named Keynes as the most intelligent person he had ever met. Based on his investment acumen Keynes amassed a substantial private fortune. His art collection, one of the largest private collections of 20 th century art, included a great number of impressionist artists. Early on he had several homosexual relationships, but in keeping with his “diversity” in his 40’s he married a well-known Russian ballerina some 15 years younger than himself.

His original claim to fame developed with his appointment as a delegate to the Paris peace conference of 1918-1919 at the end of World War I. He was violently opposed to the harsh reparations imposed on Germany by the Allies, and resigned from the delegation. In 1919 his first book, The Consequences of Peace was published outlining his prophecy that the reparations were so large they would insure the ruin of the German economy and ultimately lead to further conflict in Europe. The book not only sold well, it caused a great deal of soul searching and made Keynes an instant celebrity.

However, his final reputation resulted from his economic theories and the success generated as these theories were implemented. In 1936 these principles were outlined in a book titled The General Theory of Employment, Interest, and Money. (These were the precepts that formed the basis for my own undergraduate degree in Economics). At the time, Keynes was so sure of his theories that while writing the book he wrote to George Bernard Shaw, “I believe myself to be writing a book on economic theory which will largely revolutionize, not I suppose at once, but in the course of the next ten years –– the way the world thinks about economic problems.” That statement could not have been more prescient. With this book Keynes not only revolutionized the field of economics, but established theories that dominated the field over the next four decades. Here is a shortened version of his theories:

“The key to a successful economic climate is to maintain a constantly high level of what he called “aggregate demand”. To him that meant the total of all demand in the economy –– demand for consumption and for investment for both private and public purposes. His inescapable conclusion was that if private demand should flag and falter, then it had to be revived and stimulated by the only force strong enough to lift consumption: the government.

The pre-Keynesian classic economists had thought of the government too. But almost all of them had contended that, in times of depression the government should raise taxes and reduce spending in order to balance the budget. In the early 1930’s [in the midst of a world-wide depression] Keynes cried out that the only way to revive aggregate demand was for the government to cut taxes, reduce interest rates, spend heavily –– and deficits be damned.”

I warned you “Everything old is new again.” The above explanation of Keynesian Economics is a quote from –– believe it or not –– the December 31 st, 1965 issue of TIME magazine. The magazine cover of that issue pictured John Maynard Keynes (right).

The cover story title in that TIME magazine issue was “We Are All Keynesians Now.” That was a quote within the article from the famous economist Milton Friedman who originally was a strong advocate of Keynesian Economics, but later in his career stressed the advantage of the marketplace and the disadvantage of government intervention and regulation. In fact, it was Friedman who subsequently helped to popularize the concepts of “Supply Side” or “Trickle Down” Economics that President George H. W. Bush once called “Voodoo Economics.”

That theory, embraced by Ronald Reagan as well as by George W. Bush, was a throwback to early 20 th century “Classsic” economics, demanding that the government should not interfere with the “Free Market,” but should radically cut taxes even on the rich, and maintain a balanced budget. (Ironically, both Reagan and Bush spent the budget into deep deficits, thereby emulating Keynesian principles). This theory was the direct opposite of Keynesian Economics that while favoring lower taxes, especially during economic slowdowns such as those we now face, also encouraged massive deficit spending efforts on those problematic occasions in order to stimulate the economy. (President Obama is obviously a convert).

The actual thrust of the TIME magazine story described the remarkable growth of the U.S. economy in the previous quarter century (1940-1965), a growth pattern that TIME attributed to Keynes and to the implementation of his theories. The TIME magazine article opened with this quote from Keynes: “The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.” While Keynes has been dead for some 63 years, his principles are hardly defunct –– they are more alive today than they have been for the past 35 years. That will be explained in next month’s article as will Keynes’ relationship with President Roosevelt.