Economic Collapse: Dancing On The Grave Of Keynesianism

Guest Post by Gary North via the Ludwig von Mises Institute



The collapse of the Soviet Union in December of 1991 was the best news of my lifetime. The monster died. It was not just that the USSR went down. The entire mythology of revolutionary violence as the method of social regeneration, promoted since the French Revolution, went down with it. As I wrote in my 1968 book, Marxism was a religion of revolution. And Marxism died institutionally in the last month of 1991.

Yet we cannot show conclusively that "the West" defeated the Soviet Union. What defeated the Soviet Union was socialist economic planning. The Soviet Union was based on socialism, and socialist economic calculation is irrational. Ludwig von Mises in 1920 described why in his article, "Economic Calculation in the Socialist Commonwealth." He showed in theory exactly what is wrong with all socialist planning. He made it clear why socialism could never compete with the free market. It has no capital goods markets, and therefore economic planners cannot allocate capital according to capital's most important and most desired needs among by the public.

Mises's argument was not taken seriously by the academic community. Socialism was so popular by 1920 among academics that they did not respond to Mises for over 15 years. When finally one major economist, who really was not a major economist but was simply a Polish Communist, wrote a response to Mises, it got a great deal of publicity. His name was Oscar Lange. He was a hack. He taught at the University of Chicago. He had no theory of economics. Immediately after World War II, he returned to Poland, renounced his American citizenship, and became a major Polish government bureaucrat. He was Stalin's hand-picked first Polish ambassador to the United States. He was a Marxist. He was a Communist. He was a hack. He spent his career with his finger in the wind, seeing which way it was blowing. As for his critique of Mises, Poland never adopted his so-called practical organizational answer to Mises, and neither did any other Socialist Commonwealth nation.

So, the only major supposed academic refutation of Mises was made by a hack who switched sides to Communism when he got a better offer. Yet he was heralded as a brilliant economist because he had supposedly refuted Mises. The academic world never admitted what Lange was, which was a hack Communist. It never admitted that no socialist nation ever implemented his supposed alternative to the free-market system. The academic world simply clung for over 50 years to his completely hypothetical alternative to free-market capital allocation. The academic world would not learn the truth.
Finally, when it became clear in the late 1980s that the Soviet economy was bankrupt, a multimillionaire socialist professor named Robert Heilbroner wrote an article, "After Communism," for the New Yorker (September 10, 1990), which is not an academic journal, in which he admitted that throughout his entire career, he had always believed what he had been taught in graduate school, namely that Lange was right and Mises was wrong.

Then, he wrote these words: "Mises was right."
Heilbroner wrote the most popular textbook on the history of economic thought that has ever been written, The Worldly Philosophers. He became a multimillionaire off the book royalties. In that book, he did not even mention the existence of Mises. He, too, was a hack — a polished hack (though not Polish), but still a hack. Yet he was widely respected in academia. Academia made him rich.
The academic community is intellectually corrupt. It goes with fads, and it does not react to the truth. It suppresses the truth. I realized this very early in my career, long before I got a PhD. The guild in every university department operates as a guild, and it has no commitment to truth in matters controversial until one side or the other loses power. When one side is perceived as possessing power, which the Communists were perceived as possessing, 1917–1991, there is never any direct challenge by the academic community. Academia argued about this or that aspect of the Soviet system that was wrong, which generally related to freedom of speech. But, with respect to the basic operations of the Communist economic-planning system, there was never anything like a comprehensive critique of that system, and never did anybody inside the academic community look for the weakness of Communism in Mises's 1920 article.
The Soviet Union was always economically bankrupt. It was poverty-stricken in 1991. It was, in conservative journalist Richard Grenier's magnificent phrase, Bangladesh with missiles. Outside of Moscow, Russians in 1990 lived in poverty comparable to mid-19th-century America, but with far less freedom. Yet this was never told to students during the years that I was in school, which was in the 1960s. There were a few economists who did talk about it, but they got little publicity, were not famous, and their books were not assigned in college classrooms. The standard approach of the academic community was to say that the Soviet Union was a functioning economy: a worthy competitor to capitalism.
Paul Samuelson was the most influential academic economist of the second half of the 20th century. He wrote the introductory textbook that sold more than any other in the history of college economics. In 1989, as the USSR's economy was collapsing, he wrote in his textbook that the Soviet Union's central-planning system proves that central planning can work. Mark Skousen nailed him on this in his book Economics on Trial in 1990. David Henderson reminded readers in the Wall Street Journal in 2009.

Samuelson had an amazingly tin ear about communism. As early as the 1960s, economist G. Warren Nutter at the University of Virginia had done empirical work showing that the much-vaunted economic growth in the Soviet Union was a myth. Samuelson did not pay attention. In the 1989 edition of his textbook, Samuelson and William Nordhaus wrote, "the Soviet economy is proof that, contrary to what many skeptics had earlier believed, a socialist command economy can function and even thrive."

The creator of the so-called Keynesian synthesis and the first American winner of a Nobel Prize in economics was blind as a bat to the most important economic failure of the modern world. Two years later, the USSR was literally broken up, as if it had been some bankrupt corporation. Samuelson never saw it coming. People who are conceptually blind never do.

The Keynesian Era Is Coming to a Close

I say this to give you hope. The Keynesians seem to be dominant today. They are dominant because they have been brought into the hierarchy of political power. They serve as court prophets to the equivalent of the Babylonians, just before the Medo-Persians took the nation.

They are in charge of the major academic institutions. They are the main advisers in the federal government. They are the overwhelmingly dominant faction within the Federal Reserve System. Their only major institutional opponents are the monetarists, and the monetarists are as committed to fiat money as the Keynesians are. They hate the idea of a gold-coin standard. They hate the idea of market-produced money.
There was no overwhelming outrage among staff economists at the Federal Reserve when Ben Bernanke and the Federal Open Market Committee (FOMC) cranked up the monetary base from $900 billion to $1.7 trillion in late 2008, and then cranked it up to $2.7 trillion by the middle of 2011. This expansion of the money supply had no foundation whatsoever in anybody's theory of economics. It was totally an ad hoc decision. It was a desperate FOMC trying to keep the system from collapsing, or at least they thought it was about to collapse. The evidence for that is questionable. But, in any case, they cranked up the monetary base, and nobody in the academic community except a handful of Austrians complained that this was a complete betrayal of the monetary system and out of alignment with any theory of economics.

The Keynesians are eventually going to face what the Marxists have faced since 1991. Literally within months of the collapse of the Soviet Union, when members of the Communist Party simply folded up shop and stole the money that was inside the Communist Party coffers, any respect for Marxism disappeared within academia. Marxism became a laughingstock. Nobody except English professors, a handful of old tenured political scientists, and a tiny handful of economists in the Union of Radical Political Economists (URPE), were still willing to admit in late 1992 that they were advocates of Marxism, and that they had been in favor of Soviet economic planning. They became pariahs overnight. That was because academia, then as now, is committed to power. If you appear to have power, you will get praised by academia, but when you lose power, you will be tossed into what Trotsky called the ashcan of history.

This is going to happen to the Keynesians as surely as it happened to the Marxists. The Keynesians basically got a free ride, and have for over 60 years. Their system is illogical. It is incoherent. Students taking undergraduate courses in economics never really remember the categories. That is because they are illogical categories. They all rest on the idea that government spending can goose the economy, but they cannot explain how it is that the government gets its hands on the money to do the stimulative spending without at the same time reducing spending in the private sector. The government has to steal money to boost the economy, but this means that the money that is stolen from the private sector is removed as a source of economic growth.

"The academic world rejected Mises's theory of socialist economic calculation. Everything in their system was against acknowledging the truth of Mises's criticisms, because he was equally critical about central banking, Keynesian economics, and the welfare state."

The Keynesian economic system makes no sense. But, decade after decade, the Keynesians get away with utter nonsense. None of their peers will ever call them to account. They go merrily down the mixed-economy road, as if that road were not leading to a day of economic destruction. They are just like Marxist economists and academics in 1960, 1970, and 1980. They are oblivious to the fact that they are going over the cliff with the debt-ridden, over-leveraged Western economy, because they are committed in the name of Keynesian theory to the fractional-reserve-banking system, which cannot be sustained either theoretically or practically.
The problem we are going to face at some point as a nation and in fact as a civilization is this: there is no well-developed economic theory inside the corridors of power that will explain to the administrators of a failed system what they should do after the system collapses. This was true in the Eastern bloc in 1991. There was no plan of action, no program of institutional reform. This is true in banking. This is true in politics. This is true in every aspect of the welfare-warfare state. The people at the top are going to be presiding over a complete disaster, and they will not be able to admit to themselves or anybody else that their system is what produced the disaster. So, they will not make fundamental changes. They will not restructure the system, by decentralizing power, and by drastically reducing government spending. They will be forced to decentralize by the collapsed capital markets.

When the Soviet Union collapsed, academics in the West could not explain why. They could not explain what inherently forced the complete collapse of the Soviet economy, nor could they explain why nobody in their camp had seen it coming. Judy Shelton did, but very late: in 1989. Nobody else had seen it coming, because the non-Austrian academic world rejected Mises's theory of socialist economic calculation. Everything in their system was against acknowledging the truth of Mises's criticisms, because he was equally critical about central banking, Keynesian economics, and the welfare state. They could not accept his criticism of Communism precisely because he used the same arguments against them.
The West could not take advantage of the collapse of the Soviet Union, precisely because it had gone Keynesian rather than Austrian. The West was as compromised with Keynesian mixed economic planning, both in theory and in practice, as the Soviets had been compromised with Marx. So, there was great praise of the West's welfare state and democracy as the victorious system, when there should have been praise of Austrian economics. There was no realization that the West's fiat-money economy is heading down the same bumpy road that led to the collapse of the Soviet Union.

It was not a victory for the West, except insofar as Reagan had expanded spending on the military, and the Soviets stupidly attempted to match this expenditure. That finally "broke the bank" in the Soviet Union. The country was so poverty-stricken that it did not have the capital reserves efficient to match the United States. When its surrogate client state, Iraq, was completely defeated in the 1991 Iraq war, the self-confidence inside the Soviet military simply collapsed. This had followed the devastating psychological defeat of the retreat of the Soviet Union out of Afghanistan in 1989. Those two defeats, coupled with the domestic economic bankruptcy of the country, led to the breakup of the Soviet Union.

The present value of the unfunded liabilities of the American welfare state, totaling over $200 trillion today, shows where this nation's Keynesian government is headed: to default. It is also trapped in the quagmire of Afghanistan. The government will pull out at some point in this decade. This will not have the same psychological effect that it did on the Soviet Union, because we are not a total military state. But it will still be a defeat, and the stupidity of the whole operation will be visible to everybody. The only politician who will get any benefit out of this is Ron Paul. He was wise enough to oppose the entire operation in 2001, and he was the only national figure who did. There were others who voted against it, but nobody got the publicity that he did. Nobody else had a system of foreign policy that justified staying out. His opposition was not a pragmatic issue; it was philosophical.

The welfare-warfare state, Keynesian economics, and the Council on Foreign Relations are going to suffer major defeats when the economic system finally goes down. The system will go down. It is not clear what will pull the trigger, but it is obvious that the banking system is fragile, and the only thing capable of bailing it out is fiat money. The system is sapping the productivity of the nation, because the Federal Reserve's purchases of debt are siphoning productivity and capital out of the private sector and into those sectors subsidized by the federal government.

After the Crash

There will be a great scramble ideologically among economists and social theorist as to why the system went down, and what ought to replace it. On campus, there will be no coherent answers whatsoever. The suppression of the truth has gone on so systematically on campus for half a century, as manifested by the universal praise of the Federal Reserve System, that the reputation of campus will not recover. It shouldn't recover. The entire academic community has been in favor of the welfare-warfare state, so it will not survive the collapse of that system. It will become a laughingstock.
It is not clear who is going to come out the victors in all this. That could take a generation to begin to sort out. There will be many claimants, all pitching their solutions, all insisting that they saw the crisis coming. But that will be hard to prove for anybody except the Austrians.

This is why it is important that people understand what is wrong with the prevailing system, and that they say so publicly.
This is why the Christian churches will not have much of a say in any of this, because the churches, and Christianity in general, have had nothing independent to say about the development of the welfare-warfare state.

The analysts with the best arguments are the Austrians. As to whether they are going to be able to multiply fast enough, or recruit students fast enough, or train them fast enough, with some of them going into positions of authority, is problematical. But we do know this: there has been no systematic criticism of Keynesian theory and its policies except by the Austrians over the past 70 years. Only the Marxists gave comparable criticism, and their ship went down in 1991.

Keynesians talk to each other. They do not seek converts. They do not think they need to. Austrians, being in a small minority, seek to persuade non-Austrians. Keynesian economists get tenure for writing gibberish and including meaningless formulas that begin by assuming away reality. Austrians begin with reality: individual human action. Keynesians, when writing for the public, offer conclusions, not explanations. Austrians seek to explain their position, since they know the public is unfamiliar with the fundamentals of Austrian economics.

In a time of breakdown, Austrians will explain why it happened, and pin the blame on Keynesians: "Their system failed. They had control ever since 1940."
Keynesians will pin the blame on Keynesians who did not go far enough: "more of the same." We see this already "Krugman vs. Bernanke."
Which version will the public be ready to believe in a crisis? In the late 1930s, we found it: the Keynesians, who blamed the free market, not the neoclassical economists. "The present system is basically OK. We just need more time."

Housebroken Austrian Economists

The battle will be fought and won outside of academia. Here is where Austrians must learn to do battle.
Inside academia, to gain tenure, every assistant professor must go through the motions of genuflecting in front of the Keynesian altar. After they gain tenure, most anti-Keynesians cannot break the habit. They sugarcoat their criticisms of Keynesianism. They play the role of loyal opponents. This even includes some Austrians — those who are appalled by the rhetoric of the Mises Institute and Lew Rockwell.com. They are housebroken.

I recall one academic Austrian economist who told me that I am far too dismissive of Keynesianism, and far too contemptuous in my rhetoric. "You just can't say such things!" he told me, not grasping his grammatical error. I responded: "Yes, I can. And I do." That was in 1992. He has not changed. Neither have I.
We have different audiences. He teaches 130 students, three days a week, eight months a year, in a government-funded minor university with no clout within the economics guild. I have 120,000 people on my mailing lists, 70,000 of them five days a week, plus readers on Lew Rockwell.com two days a week, 52 weeks a year. I can play hardball with Keynesian twits. He must guard his words so as to curry favor with those whose opinions count in academia. He has spent his career looking over his shoulder at Keynesians, who exercise power in all of the social-science academic guilds, by whose rules he must play as an outsider who is barely tolerated inside the economics guild. I have spent mine telling the crowd that the emperor has no clothes, and that his tailors are mostly Keynesians, with a few monetarists pretending to hem the invisible garments. I do not abide by the rhetorical rules — "gentle, be gentle" — that Keynesian academics impose on their critics inside academia. "You sit in the corner and wait for your turn. You will get your 15 minutes. Be polite when you get your turn." That is not my style.

Conclusion
I offer this optimistic assessment: the bad guys are going to lose. Their statist policies will bring destruction that they will not be able to explain away. Their plea will be rejected. "Give us more time. We just need a little more time. We can fix this if you let us get deeper into your wallets."

In the very long run, the good guys are going to win, but in the interim, there is going to be a lot of competition to see which group gets to dance on the grave of the Keynesian system.
Get out your dancing shoes. Keep them polished. Our day is coming.