The Keynesian endgame

In 1971, the dollar was officially relieved of its false promise of gold convertibility by creditors to the United States. In doing so, the full destructive force of Keynesian economics was unleashed. In an attempt to spare the world’s economies from the effects of creative destruction, free markets and the invisible hand were traded in for centrally planned economies. Instead of market participants determining who succeeded and failed, that task increasingly became the domain of academicians, central bankers and politicians.

At its very essence, modern Keynesian economics is based upon the notion that debt can be used to cure recessions. If spending in the private sector is down, then the government just needs to pick up the slack to get things moving again. Central banks work in concert by lowering interest rates to get consumers consuming again. Create a little debt to stimulate the economy – so the story goes – and soon enough, tax revenue and incomes come roaring back in sufficient quantity to pay off the newly created debts.

It’s an appealing sounding theory, but unfortunately it simply doesn’t work. We are way past the point of academic musings, as we have been engaged in this grand experiment for more than four decades now. The results are conclusive: Keynesian economics has been a unequivocal failure.

Only a single chart is required to debunk the entire notion of debt as a panacea. Ironically enough, that chart comes directly from the Federal Reserve Bank of St. Louis. If debt could truly stimulate an economy into greater production, then we would expect every increase in total debt to be quickly followed by a greater upturn in GDP to effectively cancel it out. As you can plainly see, this has simply never happened. In fact, our experience has been the complete opposite.

1) Every level of society, from individuals to the government, becomes saturated with debt.

2) Government grows to such a large size, that it effectively suffocates economic growth.

At the consumer level, it seems that the first condition has largely been satisfied. Those individuals willing to consume their future earnings today, have reached the limits of their ability to service existing debt. Those individuals with the resources to take on new debt, realize the folly of living beyond their means in the current environment and are unwilling to do so.

At the federal level, the situation is quite different. Although deficit spending in on an entirely new trajectory, the United States is in a unique position that will allow it take on significantly more debt before things finally reach a tipping point.

The implication for the second characteristic is that government interference in the marketplace is likely to grow much larger. Non-politically connected businesses, which are not favored by the bureaucracy, will find it increasingly difficult to sustain the additional overhead. The creeping malaise that gained a foothold on the world’s economy post 2008 will continue to stifle productivity. Eventually we can expect attempts at capital, wage and price controls.

Which is to say nothing of the coming clampdown on liberty – as ultimately – a free society cannot exist independently of a free market. This is the fundamental lesson of Keynesian economics that so few understand.