Keynesianism

Mish rails against Keynesianism in this blog post: How "Something For Nothing" Ideas Become Policy. I won't copy the entire thing. Although it's worth reading, it's too long for easy commenting.

First, the title. I don't see "something for nothing" in fiscal stimulus, at least not in a quantitative sense. If the government spends money, the amount, or at least the value comes from somewhere. Either it comes from taxes, or it is borrowed from investors, or it is printed. In the last case, the value of the printed money comes at the expense of the devaluation of the rest of the money supply. Thus far, I agree with Mish about "something for nothing." However, I am about to fork off onto another path. What Mish does not see, and what Keynes did, is that the distribution, and not the amount is what becomes important when money no longer moves, trust breaks down, and investors would rather accept 2.5% on government bonds than 20% on corporate bonds. Quality trumps quantity. When monetary policy, equivalent to pushing money into the economy stagnates, fiscal policy, which pulls money through the economy is the common sense alternative.

Germany has voiced the strongest principled objections to large-scale fiscal stimulus packages. Peer Steinbrück, the finance minister, has complained about the "crass Keynesianism" pursued by Mr Brown, accusing him of
"tossing around billions" and saddling a generation with having to pay off
British debt.

This quote comes from the Financial Times. Again, there is a technical manner in which Mish and the German finance minister could be viewed as right: British taxpayers will have to pay of the debt eventually. What they miss is that most of the government debt is not new debt. (If if was, you'd see interest rates on government debt increase, not decrease.) This is just a transfer of debt from the private sector to the public sector. In fact, I would argue that net debt has contracted. A sign of this is US consumer debt in November shrinking for the first time since the Great Depression. Another sign is bank lending contracting by 55% in the US in 2008. The increase in government debt worldwide has not expanded enough to offset the shrinkage in non-government debt due to repayment, writeoffs, defaults, etc.

Mish further argues that

the stagflationary 70's killed (or rather I say should have killed), Keynesian theory given that the "impossible" happened (rising unemployment and rising inflation).

I would say that had Keynes been alive, he may have recognized that the policies which got us out of the Depression would not solve the inflation of the 70's. It is unfortunate that his followers misapplied his theories. I am probably treading on thin ice here as I have not studied the economics of the 1970's in great detail. However, my guess is that inflation was so bad that it was causing consumption to fall, therefore causing unemployment to rise. When Mish explains how the Philips curve does not apply to a deflationary period, then maybe I'll reconsider a Keynsian solution.

Here's what Mish says about Keynesianism in Japan:

Japan pumped massive amounts of money into the economy and went on a spending spree and it did no good. Did Japan learn from this? Of course not.

How does Mish know it didn't help? Japanese asset values collapsed 70-90% in the 1990's, the same as the US in the 1930's. The difference was in GDP. Japan's GDP never fell, while US GDP fell by over 30%. My conclusion is that it depends on what you're looking at. If you look at stock and real estate values, it didn't help. If you look at GDP, it did.

Mish offers no solution: "There is only one way to defeat deflation and that is to not let the conditions that foster it to build up in the first place."

If the government had not stabilized the financial system earlier this year, there would have been a run on the entire banking system, ATM's would not have worked, and we might be facing roving bands of hungry looters and martial law. Doing nothing is not a solution. When Mish has a solution, then I will start to believe he understands the problem.

And a last word. I read Mish every day. He has a lot of great analysis, and he may be right. I tend to comment when I disagree, which may make it seem as if I believe that Mish is not one of the most intelligent economists in the world today. Mish may even be right; it would not be the first time I am wrong. This is just the way I see things to the best of my understanding today. I reserve the right to change my mind and declare myself wrong at any point in the future.