The Keynesians are Dead Wrong: Keynesianism is Fabian Socialism

By: Guest Authors

By: William L. Marcy IV, PhD

How many times must the American people be the witness to, and suffer from, failed economic policies that call for government intervention and regulation over the economy?


We have now seen once again, that Keynesianism is a short-term policy that does not work. Keynesian policies have only served to expand the power of the central government and have protected the interests of the privately owned Federal Reserve and its clients. Thomas Jefferson said: “If the American people ever allow private banks to control the issue of their money, first by inflation and then by deflation, the banks and corporations that will grow up around them (around the banks), will deprive the people of their property until their children will wake up homeless on the continent their fathers conquered.” The economic policies of the Federal Reserve, the Treasury, and recent presidential administrations have worked to undermine the property rights of American taxpayers, investors, and savers.


The solution of more Quantitative Easing (Q.E.) and stimulus to fix and ailing economy is like a junkie trying to end their addiction to heroin with more heroin. It is a short-term fix that has negative long-term consequences. The current situation facing the U.S. economy in the second quarter of 2012, is a repeat of the past three years. When things slow down, the Federal Reserve steps in to prop-up the ailing system with the cure that is the cause of the economic ailment.


We technically have already had Q.E. III in the form of Operation Twist, which ends in June 2012. Q.E. has served to suppress the bond market and has masked the true nature of inflation while enabling government spending. Contrary to Federal Reserve policy statements, there has been inflation throughout 2011. Year to year inflation has ranged from 3.6% in September 2011 to 2.6% in May 2012. This has been well above the Fed’s target rate. If one was to measure inflation in terms of how inflation used to be measured – as a basket of commodities rather than in the form of hedonics – inflation would be much higher. However, because the Federal Reserve uses hedonics (a method of calculating inflation based upon purchasing preferences), it claims that there is little or no inflation, which in turn allows it to justify its low interest rate policy.


The Federal Reserve buys and sells treasuries on the open market to control the Fed’s funds rate. The Fed buys or sells treasuries on the open market from primary dealers (banks associated with the Fed who are licensed to buy or sell treasuries) to give the appearance that the Fed is not buying treasuries outright with money printed by the Bureau of Engraving and Printing, which prints banknotes for the Federal Reserve. The Fed then puts the money into circulation through its open market operations. When the Fed increases its purchase of treasuries from primary dealers, it increases the amount of money in circulation and enables the Treasury to borrow more money at lower rates of interest. The Fed has used it open market operation to monetize U.S. debt and enable the Federal government to expand its power over the economy through Keynesian programs. The danger for the U.S. citizen is that these policies have the potential to replace the free market.


By suppressing the bond market, the Fed has allowed the expansion of government spending whereby the U.S. has $1.3-1.5 trillion annual deficits. This policy is not a sustainable long-term policy because government directed growth is artificial and unsustainable. Government directed growth is financed by higher taxes, borrowing from abroad, or monetizing debt (through the policy of printing money to purchase treasuries). As the privately owned Fed continues to intervene in the marketplace, the U.S. continues to spend beyond its debt limit. By the end of 2012, the U.S. will once again be facing a debt limit crisis similar to the one it faced in August 2011.


Although the U.S. is the largest buyer of its own bonds, the bond market has been propped-up because investors are seeking safety owing to the fact that most European nations have been fiscally mismanaged. The Europeans have not implemented the right medicine. They have conducted austerity measures while simultaneously raising taxes, but they have not made any significant reforms to their socialist systems. Because of their failure to reform European policies are faltering and investors are seeking the shelter of U.S. debt. The lack of reform and the maintenance of higher taxes have sabotaged the austerity programs in Europe. In the midst of a debt bubble, austerity will work only when reforms are conducted and taxes are not raised. With the exception of Germany, which benefited from the reforms of Gerhard Schroeder, Europe refuses to accept the required medicine and continues to hang on to its big-government socialist systems.


The low interest rate policy of the Federal Reserve is a major cause of stagnation. Low interest rates have created a situation known as the Keynesian liquidity trap. There is no growth in the United States exactly because of the policies of the Federal Reserve. Simply put, because rates remain so low there is no savings and investment. The low rates have made it impossible to make money from returns on investment. Banks will not lend because they know that treasury rates are suppressed and will lose money if they make loans that do not keep up with the rate of inflation. As a result, to protect themselves the banks buy short-term bonds which rollover quickly. Moreover, because of economic uncertainty owing to government taxation policies and nationalizations of industry, no corporation is willing to take large risks.


The Federal Reserve has backed the U.S. economy into a corner. If the Fed stops suppressing the bond market and enabling government growth by allowing rates to rise to normal levels, there will be an economic contraction owing to three years of ultra-low interest rates. However, because the Fed is the largest holder of U.S. Treasury debt, next to China, it cannot let rates rise. If rates rise, the Fed will be holding debt on treasuries that will not pay off in terms of inflation. For the U.S. government, a 1% rise in interest rates means $1 trillion added to the national debt – a prospect the U.S. cannot afford. Furthermore, the Fed also owns a great deal of toxic debt such as Fannie and Freddie’s bad debt, which it has not unloaded. Rising rates will hurt the housing market and ultimately the Fed’s balance sheet.


Going down the road into 2012 we are now facing taxmaggedon. This is the problem with what the Fed has done in terms of allowing the expansion of the U.S. government. The Buffet Rule of taxing those who make $200,000 or more is really a lie. Over ten years, it will only make roughly $1 trillion dollars. That is barely one year’s spending under President Obama. Obama’s policies of taxing people who make more than $200,000 significantly impacts S-Corporations which are small businesses who turned themselves into individuals in order to reduce their taxes. Therefore, all small businesses that became S-Corps (Joe the Plumber) will suffer if taxes are raised. The U.S. economy will not grow with higher taxes while the value of the dollar will continue to fall as the Federal Reserve enables the growth of big government which requires more and more taxes to feed itself.


The Occupy Wall Street movement complains about the 1%, but they fail to realize that the Federal Reserve and the U.S. government have been the greatest culprits in abetting the 1%. Through stimulus and Federal Reserve financing of the Federal government, the Obama administration has enabled wealth transfers to the 1% while the administration hypocritically attacks the 1% as the cause of the economies troubles (which they never were). With U.S. taxpayer money and by incurring national debt the current government in power (Republican or Democrat) chooses the winners and losers in the economy especially their well-connected patrons. While inflation has been hidden through hedonics and the suppression of the bond market, the policies of taxation and spending work to destroy the middle class which has less and less money to pay for things.


The Keynesian fallacy has strangulated growth. Their policies have increased the power of the federal government and its control over the economy. Moreover, their policies have favored an elite that is well connected to the government in power, including the public sector unions and banks that are associated with the Federal Reserve. As the government increases its control over the economy, individual freedom is reduced. Government expansion violates the concept of private property and how one chooses to act in their pursuit of happiness. Keynesianism is not capitalism, but rather an economy based on centralized planning, which is closer to Marxist theory. Marx even wrote that one of the steps to implement a Marxist society was to take control over a country’s banking system. Keynesianism has been called Fabian Socialism because it is based on directing markets rather than letting markets run their natural course.


As government increases its role in the economy, the Keynesian responses to stimulate the economy and unemployment have moved the U.S. closer to a debt crisis. Keynes argued that inflation and debt did not matter because “one day we are all dead.” He did not account for a fiat currency and that future generations had to one day pay for the spending of earlier generations. While his proscriptions appeared to be an attractive policy during the 1930’s, it is widely accepted by revisionist historians that Keynesian policies prolonged the Great Depression. Keynesianism becomes a cyclical driver of growth that requires greater and greater government interference and has been the major factor that has paved the way for multiple cyclical economic characterized by skyrocketing deficits and national debt, which at some point in time must be reconciled because we are not all dead.


Because of the apparent weaknesses in the world economy, Keynesian mouthpieces in the media are now arguing that more deficit spending (or in retrospect that we did not have enough) is required to prevent deflation. This is always the Keynesian argument. The Keynesians however, do not consider that deflation is a correction, which is brought on by the previous inflation, which they advocate for. The Keynesians oppose deflation although it means the currency (the dollar) is stronger. Because the U.S. has a fiat currency, deflation cannot be corrected by more inflation. The inflationary polices of the Keynesians papers over the deflation (pun intended) and piles on more debt while devaluing the value of a currency. Moreover, it creates the next cycle of deflation, which is even greater and harder to solve because of debt.


Unpaid national debt is – in the long run – unsustainable, because it must be paid back. The only solution to an economy with massive debt issues is de-leveraging. However, the solution for the U.S. economy has been only more debt through low rates from the Federal Reserve and through continued deficit spending and stimulus. Ultimately, the U.S. will face a major economic crisis when it is forced to raise rates to attract financiers to service its debt, or it will face massive inflation owing to the monetization of its debt. The Federal Reserve has bought into the failed Keynesian policy of debasing the dollar in order to create inflation, which they believe will drive growth and consumption. However, they have failed to see that their weak dollar policy is the real danger. Rather than focusing on savings and investment to drive production, the artificial government debt-driven growth has postponed any long-term growth by preventing a de-leveraging of the economy.


The Keynesians think very short-term and never look at the long-term secondary effects of their policies. While stimulus may look good for group A, B and C do no benefit from the initial inflation. A receives the money first before inflation sets in while B and C are negatively affected because costs are higher for them. There is no multiplier from Keynesian policies because inflation increases costs. Keynesianism argues for conspicuous consumption driven by government growth rather than savings. However, savings is exactly what is needed to create the capital needed to increase investment for growth.


The Keynesians also argue that austerity does not work owing to the fact that it reinforces unemployment. According to the Keynesians wages are sticky and cannot not fall in a deflationary cycle. This is why they argue that inflation is necessary to to stimulate the economy. However, the real reason why recovery does not occur is because wages and prices are not allowed to fluctuate freely. If wages were allowed to fluctuate, they would match falling prices, which would then keep wages at equilibrium with the costs of production. This scenario would mean a stronger dollar and a speedier recovery because business would not be saddled with the high costs of production from artificial price supports, which consequently prevent job creation. On the other hand, inflation with fixed wages and prices reduces production, because wages are higher than the costs of production. Therefore, in a deflationary environment fixed wages and prices restrict growth. Compounded with taxation, the Keynesian inflation leads to less growth and production because its artificial price supports (stimulus) increase costs in an environment when there is less money available. Therefore, the Keynesian solution of government stimulus works against its stated purpose of creating employment. Moreover, the crisis is exacerbated because of increasing debt and taxation as the government extends its control over the economy. Over the last forty years, the central government has expanded its influence over the economy during each recession. The consequences have been increasing jobless recoveries and an expansion of government debt and regulation.


When the day of reckoning from the United States’ Keynesian profligacy does come due, a major economic crisis will occur, because in order to rectify the economy, credit will have to be tightened and harsh austerity implemented which means a massive correction as the government is forced to unwind its position in the economy. If the U.S. continues down the current fiscal road it is on, the other solution is an inflationary depression.


The choices for the U.S. are stark. The policy of austerity and a stronger dollar offers short-term pain, which would lead to long-term gain, but it is politically unpopular in the short-term. The policy of government austerity can create a quick rebound in the economy though, if taxes are lowered and government restrictions on businesses are lifted at the same time, because such a policy would promote savings and risk reward, which is the ultimate driver of entrepreneurship. The current policy of debt, borrowing, and monetization, offers a devastating collapse of the financial system with the weakening of the dollar to the point where it is worthless. It will end in a massive depression owing to the lack of savings and investment for production. The only cure will be a painful de-leveraging process, which would be less painful if austerity and a stronger dollar had been conducted before the dollar collapsed.


The economic question now turns towards the presidential election. It is clear what President Obama stands for. Obama will continue to expand the role of the economy in order to transform the United States into a socialist economy similar to the failed models that already exist in Europe. Obama will use government programs to win over votes for his presidency at the expense of the principles set forth in the U.S. Constitution. However, it is not clear what Mitt Romney stands for. Does Romney have the courage to do what is necessary? If he is opposed to big government, then he will have to oppose the Keynesians and take a stance against the Federal Reserve’s policies, which have enabled big government. He argues correctly that the economy is not working, but is he willing to chart a different course than his predecessors and do what is right in the long-run for the economy, especially when it is means short-term pain during his presidency? Will Romney have the conviction to reject the influence of the large contributors (including the military-industrial complex), who have grown rich from the Federal Reserve’s and federal government’s policies. Finally, will Romney be able to oppose those in his own party by diminishing the power of the neo-conservatives who continue to push for big-government and costly interventionist foreign policies (in terms of blood and treasure)? If not, is America inexorably destined to become a socialist state and what does this mean in a global context?

UPDATED 6/9/2012

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