America’s Money Machine

JOHN MAYNARD KEYNES was not the father of the trend toward government intervention in the economy that has been traced in the preceding pages, but he was its heritor and its most persuasive exponent of the twentieth century to date. Moreover, he provided the movement with such an array of documentation—particularly mathematical, so awe-inspiring to amateurs—and such formidable, if devious, logic, along with a variety of technical formulae for its execution, that he is generally accepted as its apostle. John Maynard Keynes indeed is a phenomenon of this century whose counterpart, in more ways than one, is John Law of the eighteenth, the execution of whose elegant proposals to convert the wealth of France into livres bankrupted that fertile kingdom and brought on the French Revolution.

John Maynard Keynes—later to become Lord Keynes—was at once a mathematician, a philosopher, a master of the complicated phrase, as well as an administrator and executive, who in addition to his writings in economics found time to head a large insurance company, help govern the Bank of England, edit a leading economic journal, and to sponsor ballet and drama. Educated as a mathematician, he had entered the Indian Civil Service, and soon won recognition as an economist for his book Indian Currency and Finance. This work, published in 1913, foreshadowed his philosophic tendencies and influence.

Keynes returned from India to become a lecturer at King’s College, Cambridge. During World War I he was attached to the British Treasury and was its official representative at the Paris Peace Conference up to June 7, 1919. He also sat as deputy for the Chancellor of the Exchequer on the Supreme Economic Council. Frustrated at what he regarded as the fruitlessness of the negotiations and persuaded of the hopelessness of abating the harshness of the peace terms being imposed, he resigned and wrote a book called The Economic Consequences of the Peace. His book was widely read, and its impact was profound. It was almost as influential as the course of events in the subsequent modification of the war settlements.

In fact, Keynes in this and later writings was to prove what he himself was to write, somewhat ironically, regarding the influence of economists:

The influence attained by Keynes is not easy to explain except by the profound respect—almost idolatry—paid to economics and its high priests in an age that worshipped the standard of living above all other reality, and in the United States gave the position of privy council to the Chief Magistrate exclusively to the profession of economics.1 What put Keynes above his competitors was partly his capacity for irony and scorn, of which we have just given an example, and his willingness to use it to reduce to ashes all other theories but his own. At the same time he had skill to dress his own ambiguities with such density of verbiage, such mystifying abstruseness, and such mathematical dogmatism as was exceeded only by Karl Marx. All of which served, just as it served the necromancers and astrologers of Babylon, to compel a submissive awe among his readers and listeners. Like Marx, also, Keynes had an infinite assurance in the immaculateness of his theorems, and they promised in the capitalistic order what Marx promised for the socialistic. Both offered a new world of arrangements that was perfectly explained in accordance with mathematical logic. Actually, while Keynes professed to hold a traditional view, and to uphold the capitalistic order that then seemed in such dire need of defenders, the effect of his theories was to lead mankind down the path of statism, of centralized, bureaucratic planning, and absorption of all energies and all decisions in the governmental apparatus as Marx himself had done.

Space does not here permit an extended discussion of Keynesian economics—a subject on which already libraries exist—beyond the outline of certain features as they bear upon the course of monetary development in this country, that is to say, Federal Reserve policy and practice.

The classical solution to this dilemma would be to reduce production costs accordingly—which meant mainly wage rates, since other costs, such as interest and depreciation, are relatively fixed. Such a reduction in the wage level, Keynes argued, might bring more jobs, but the total wage bill would not be affected (since a larger number of workers would be working at lower individual wages) and hence the total purchasing power of the community would remain at a depressed level. This would tend to throw more men out of work, for the reason that not all wages received go to buy goods that require men’s labor, but some part is saved. While some part of the saved portion will be invested in building new factories, houses or other enterprises that give jobs, and hence is returned to the stream of trade, a residue is not invested, but kept in the till or sock.

Out of this theoretical statement of how affairs go, Keynes developed several key propositions of which only two need concern us here.

The first is the Keynes’ theory of unemployment, which, to be brief, he traced to lack of adequate investment in new products or productive enterprise. Keynes’ significance in current politics arises from the remedy he proposed: monetary control and manipulation. Particularly after World War II, when the fear of economic dislocations following demobilization led to an obsession with “full employment” schemes, Keynes became the prophet of the new order.

Actually, for all that is made of the “Keynesian revolution,” Keynes was pretty much in the main stream of economic thought as it flowed out of the fountains of Adam Smith. That stream of thought had always been mechanistic in its treatment of economic phenomena. Adam Smith’s Wealth of Nations had appeared in the same decade—we might say the same year (1776)—that produced Isaac Watts’ steam engine and the Declaration of Independence. It was Watts’ achievement, rather than the political ideas fermenting in the New World, that created the profounder impression on Adam Smith. The immaculate working of Boyle’s law of gases, that had made the steam engine possible, was too fascinating not to influence a thinker grappling with the mysteries of human behavior in the livelihood activities of mankind. Could not equally universal and immutable laws of human behavior be discovered? Smith thought so: he posited several of them. The law of supply and demand is the most famous, along with the laws of rent and interest.

Keynes’ immediate predecessors had already developed the basic framework of Keynes’ principal proposition. His contribution lay in the modifications he gave to it, and even more in its applications. Actually, a dispassionate review of the literature leads one to conclude that Keynes was much more a synthesist than a philosopher or a seer. The vogue for his theories is certainly not due to his exposition. The clarity of The Economic Consequences of the Peace degenerates to a murky fen of abstractions in The General Theory of Employment, Interest and Money.

Other economists—like Schumpeter, Spiethoff, and Robertson, for ex-ample—had reasoned that the principal cause of the business cycle was investment fluctuations, and that the balance between savings and investment determines the interest rate. Although Keynes modified this theory of interest determination by his “liquidity-preference” postulate, the substance of his view was not significantly different. It was that the business cycle was caused by variations between the rate of investment and the rate of savings, and that fluctuations in prices are a result of discrepancies between savings and investment.

The dilemma of the day, as it appeared to Keynes and his school, was that when people save they have less money to spend on the products of the factories, and thus they restrict the employment opportunities. This can be overcome by investing in new factories or enterprises the amounts withdrawn by savings. The gap appears in the phenomenon—as it seemed to Keynes—that savings and investment are not the same: some savings are immobilized and do not return to the stream of purchasing power through the investment process. This could be true only when savings could be held in the form of coinage rather than instruments of debt—a remote possibility, the more remote as the so-called money stock consisted more and more of central bank notes and bank deposits.

What made Keynes’ theory of significance to central banking—and to this account of the Federal Reserve System—was his solution to the dilemma. This was that governments directly, or through their central banks, should fill in the gap by creating purchasing power. A corollary of this theory was that the public should, indeed, be discouraged from saving in order to use its funds to buy the goods produced by the investments made through the government’s manipulation of money. This is the way full employment would be achieved, the way everybody would be supplied with everything, and everyone made happy.

Keynes lived in a world of mathematical symbols: human beings were to him little more than integers in a statistic, or the functional element of an equation. From this viewpoint the errors of his synthesis are more evident, and the structure is seen to be no more than a house of cards. What is less evident is the ease with which this apostle of the mathematical man found such following, particularly in the U. S. where his views made their initial impact upon Franklin D. Roosevelt and governed the great experiment in economic manipulation by government that was the New Deal, and have since become well nigh settled public policy.

The simplest observation, for instance, should be sufficient to demolish the cornerstone of the Keynesian system—that employment is governed by the rate of investment. One need only walk down any street, observe two shops of identical frontage, side by side, selling the same merchandise, and note that one is doing more business and requiring more sales people than the other; that is to say, creating more employment with the same investment. An even simpler demonstration is that of doubling the shift in a factory; here employment has been doubled with no increase in investment.

The fact is, as is apparent to anyone who is willing to look behind the facade of economic theory, the chief factor in employment is human beings and their intelligence and morale. A well-managed enterprise can produce many times the amount of goods as an inefficiently managed one, and employees with good morale are more productive than employees with poor morale.

Some day, we may hope, economists will abandon their efforts to explain and to control the subject matter of their discipline by mathematical formulae and their corollary, laws and regulations, and instead consider it in the light of a moral reality within which human beings act and react.

We may note briefly one further fallacy of Keynes’ theory of employment. In today’s technology, investment is not made to create employment, rather to create unemployment. That, at least, is the immediate and direct purpose of the huge investment now going on in various processes of automation to replace men with machines, which means of course throwing men out of work. This was also a characteristic of the period in which Keynes was writing—a characteristic which brought forth a school of thinkers, the “technocrats,” who proposed to solve this problem not by monetary means but with the slide rule and the steam shovel.

The first task in the examination of any system of philosophy is to analyze its basic propositions. These rest, in every case, upon certain terms or concepts which require definition. This is peculiarly the case where a theorist like Keynes treats concepts as solid, palpable quantities or integers, which can be dealt with in mathematical formulae and equations, and from which can be derived immaculate, unchangeable corollaries. This has, of course, been the perennial failing of economists since Adam Smith. Keynes himself is caustically derisive of the vagueness and ambiguity of economic terminology.

Now this definition may be meaningful to an accountant drawing up the balance sheet and profit and loss statement of a corporation, in which he makes a subjective assessment of the loss of value of the plant and equipment due to wear and obsolescence, and deducts that value from operating income; but as a statement of an economic principle, on which to hang a whole system of corollaries, and on which a great and powerful nation may base its fiscal policy, it is sheer superficiality if not fatuity.

In Keynesian economics, when a plant manager buys a high powered vacuum sweeper to rid the factory floors of dust and debris that impede efficiency or reduce an accident hazard, that is capital investment; when a housewife buys a one horsepower vacuum sweeper to keep her floor clean, that is consumption expenditure. Why this distinction? Both serve the same utilitarian purpose; both affect the stream of economic activity in the same degree; both have the same economic effects.

What are these economic effects? Contrary to the Keynesian theories which we have quoted above, the investment in both cases tends not to increase employment but to create unemployment. Thus the vacuum sweeper in the factory releases the toil of workmen who formerly at the end of the day were compelled to go about with brooms to clean up the litter. Undoubtedly, the introduction of the machine sweeper allowed the factory manager to dispense with a certain amount of hired labor. Likewise, the vacuum sweeper in the hands of the housewife relieves her of a certain amount of labor and to that degree makes her unemployed. Simple observation discloses that vacuum sweepers, refrigerators, and the various household appliances of the modern world have been main factors in freeing women from household work and permitting them to enter the “labor market,” where they add to the number in the statistical compilations of the employed—or unemployed.

Thus, the observed fact is quite contrary to the Keynesian thesis that employment increases pari passu—step by step—with investment: actually employment initially tends to decrease pari passu with investment. The secular decline in manufacturing employment, along with a tremendous rise in manufacturing output, is so plain in the statistics that the influence of Keynesianism becomes all the more extraordinary. Since these forces were obvious even when Keynes was writing, it is still more remarkable that he should have proclaimed such a theory, and that intelligent men should have accepted it.

The weakness of this concept, apart from the absurdity of trying to devise the weights for “special labor,” lies in its misunderstanding of the true key to economic production, or output, which has nothing to do with monetary demand and everything to do with human morale—by which is meant the skill and intelligence of management, the skill and intelligence of workmen, together with their common understanding of their task, its importance, and their own importance and significance as human beings. It is well known that where plant morale is good, productivity can be increased with little reference to added capital investment. Some of the best equipped factories have the lowest output.

Until the 1930s Keynes was regarded in Great Britain as an orthodox economist of brilliant if eccentric tendencies, but he never was admitted to the inner circle of policy advisers. His star began to shine when the world grew dark with the credit crisis of 1932. In 1929 he had championed Lloyd George’s proposal for public spending to stimulate employment, and in a visit to this country he had met and expounded his views to Franklin D. Roosevelt. They found fertile soil here. An administration that was then grasping at any flotsam that would hold the economy afloat after the 1932 debacle seized upon his theories as the framework of the New Deal. To these developments, as they turned upon Federal Reserve policy, we may now give our attention.

_______________

3 The President’s Council of Economic Advisers.

4 “In dealing with the theory of employment I propose to make use of only two fundamental units of quantity, namely, quantities of money value and quantities of employment.” (Op. cit. p. 41.)

• 1Mrs. Fish’s social invasion of Washington may have been the result of the intimacy that existed between her husband and Roosevelt. It is important to recall this camaraderie in any attempt to understand the tangle of subsequent events. Both were New York aristocrats; both were Republicans; they had a common fondness for rural estate life; they had gone together on hunting trips to the South. It is reported that during the Fish residence in Washington, Roosevelt, who was accustomed to early morning canters in Rock Creek, would ride over to the house and shout up, “Stuy!” and when the railroad president came to the window would joke with him for a while before continuing his ride.
• 3Theodore Roosevelt returned from a year of big game hunting in Africa and a triumphal tour in Europe to find again an opprtunity and a demand for his political talents. Drawn by an appeal to public service, and perhaps to a considerable degree by ambition,* he began to angle for the leadership of the insurgent wing. In a speech at Osawatomie, Kansas, on August 31, 1910, on “The New Nationalism” he backed the Supreme Court’s attitude toward social legislation and announced the political doctrine “that every man holds his property subject to the general right of the community to regulate its use to whatever degree the public welfare may require it.”
• 4Wilson came into office under considerable popular momentum toward centralization of government. Ten days before his inauguration the Sixteenth Amendment to the Constitution, which had been proposed only three years before, was finally ratified and declared in effect. This revolutionary fiscal measure, authorizing a tax on incomes, vested in the Federal government almost unlimited taxing power and gave it the financial means by which it could dominate and eventually overwhelm the state governments. On February 28, 1913, the Pujo Committee investigation into the “money trust,” which had been authorized the February before,* reported an unwholesome concentration of money and credit through bank consolidations, company mergers, interlocking directorates, security syndicates, and increased banker representation on the boards of insurance companies, railroads, public utilities and industrial corporations.