The Free Market: Keynes the Great?

The Mises Institute monthly, free with membership

November 1998
Volume 16, Number 11

Keynes the Great?
Shawn Ritenour

No sooner is John Maynard Keynes declared irrelevant for modern economics than some establishment figure declares him the god of the age. It happened again, in the pages of Fortune Magazine (August 17, 1998). The writer was MIT's Paul Krugman, one of the most famous economists alive. His article, "Why Aren't We All Keynesians Yet?" was a hymn of love to the man who made government management of the economy a worldwide practice.

The problem with Krugman's piece is that it is wrong at every point.

Krugman's litany of praise begins with a mischaracterization of Keynes's Economic Consequences of the Peace, a book forecasting the economic consequences of the Versailles Treaty. French Economist Etienne Mantoux demonstrated in 1944 that Keynes was wrong in his details as well as his central thesis.

Keynes predicted that, as a result of the Treaty, iron and steel production in Europe would decline. Instead, it rose. He predicted that German pre-war coal output could not be sustained. It was sustained. He predicted that Germany could not export coal. In fact, it did.

In other words, Keynes was wholly wrong about the strictly economic consequences of the Versailles Treaty.

Regarding Keynes's theorizing about later German economic conditions, Krugman fails to point out that Keynes himself recognized that his own policies were more National Socialist than free market. In the Preface to the 1936 German language edition of his General Theory, Keynes told his German readers that his theories were much more suited to a totalitarian state, like the one the Nazis had in place, than to a free market.

And contrary to Krugman, the stability of the world economy after World War II, to the extent that it was stable, was maintained despite the Keynesian Bretton Woods agreement, not because of it. Such stability proved to be superficial as the inflation of the late sixties and early seventies demonstrated. Richard Nixon's closing the gold window in 1971 was a direct consequence of the inflationary incentives put in place under the Bretton Woods agreement.

Krugman's claims regarding Keynes's General Theory are repeatedly in error. Krugman states that he "tried going through the pre-Keynesian business-cycle literature" and found it to be "a vast wasteland." If he did, he did not try hard enough. In 1912, Ludwig von Mises's Theory of Money and Credit, was published. Among other things, Mises did explain, more coherently and correctly than Keynes did, why depressions occur and what should be done about them.

Keynes cited "insufficient aggregate demand" stemming from unstable business investment as the cause of depression. He offered no explanation for why an economy should suddenly experience insufficient aggregate demand. Mises, on the other hand, explained that the business cycle is due to credit expansion stimulated by the central banking authority.

Keynes wrote a generally favorable review of Mises's book but criticized it for being unoriginal. He later admitted that he could not read German well enough to understand original ideas. Such was the integrity of Keynes.

In 1931 Mises's student F.A. Hayek published his Prices and Production outlining and developing Mises's theory. Hayek then followed in 1941 with The Pure Theory of Capital. Hayek's contributions to Krugman's "vast wasteland" were rewarded with a Nobel Prize in economics in 1974.

Finally, Krugman gets it wrong about Keynes's supposedly original "coherent explanation of the hyper-inflations" underway in Europe in the 1920s. Mises's Theory of Money and Credit had already provided a general explanation for the stages of hyper-inflation experienced by Germany in the 1920s. In 1923, Mises applied his general theory to the case of Germany in a book on monetary stability submitted to the printer more than eight months before the final breakdown of the German mark. And Mises was able to explain Germany's monetary breakdown without referring to anything like the chimera "too much aggregate demand."

The reason that Keynes is not and should not become a cultural icon is that Keynes was wrong. For example, the problems that Japan is facing now are not due to consumers and investors suddenly "spending too little." They are the necessary outcome of massive, state-sponsored credit expansion coming home to roost. For a better understanding of today's economic crises, we should look back not to Keynes and those who would continually attempt his rehabilitation, but to Mises and the Austrian School.

* * * * *