Book essay: Where Keynes Went Wrong

29 July 2010

Henrik R Clausen

After the crisis of 2008, there emerged a broad consensus to attack the crisis head on trough extensive stimulus measures, government spending, injection of new 'liquidity' and lowering interest rates to what would formerly be considered absurd levels. This is largely based on Keynesian thinking, but we have not been explained the nuts and bolts of why this is expected to work, or what Keynes even thought and said in the first place.

Hunter Lewis addresses this in his book Where Keynes Went Wrong.

Hunter Lewis sets out to survey what Keynes really said, and in particular why so many of his ideas seem out of touch with common sense. He does so by going through the “General Theory” and focusing on key concepts that made their way into mainstream politics, analysing these concepts for side effects, and through doing this undermines the foundations for many a political reaction to the 2008 crisis.

Why does this matter?

The politicians and central bankers in charge of coping with the crisis are gambling the economical future of the Western world. If their gamble fail, we shall face economical collapse and suffering on a scale that dwarfs the Great Depression of the 1930's. Thus, citizens and journalists alike need to understand what goes on, that we can challenge our elitist politicians and force them to come up with real solutions, based on how economics actually works.

In brief, the world – that is, the common world of common people – does not work like Keynes would lead us to believe. Keynes is a master broker in money, power & politics, and there are many reasons that politicians and central bankers will like his ideas, for they work to their benefit. The Keynesian ideas confuse the public as to what is economics, what is finance, and how to run things in an economically sound manner.

Keynes devises a plenitude of methods to manipulate money and prices to the apparent benefit of society. These methods, however, server more to disguise than to solve the problems, even though the writing of Keynes systematically diverts the attention of the reader from this quite serious problem. However, Keynes was not confronted with a systematic rebuttal of his General Theory, which proved hugely influential, and dominates economical discourse even today. As Gregory Mankiw put it:

If you [are] going to turn to only one economist to understand the problems facing the economy, there is little doubt that the economist would be John Maynard Keynes. Although Keynes died more than half a century ago, his diagnosis of recessions and depressions remains the foundations of modern macroeconomics.
Hunter Lewis tackles the problems of Keynesian thinking in a very readable book that does not require a degree in economics to understand, merely sincere interest. The book avoids heavy equations and talks in a common sense language that presents no particular barrier to the reader.

Another advantage over other books on economics is that it has a clear structure, with questions clearly framed, supported by quotes, and equally clearly answered. It is divided in two main parts, one focused on consolidating what Keynes actually said, and another (roughly 3 times the size) dedicated to refuting it. This works well.

One lesser flaw deserves mention: The book becomes repetetive after a while. This is in part due to Keynes himself being repetitive, but this could have been reduced somewhat in editing. That does not detract anything from the general impact of the work, and the devastation it causes to Keynesians. Or, as a review at put it:

One is left with a sense of astonishment that such a tissue of fallacies could have so deeply embedded itself in into the mainstream opinions of media and government and academic leaders - even public consciousness. Lewis smashes the edifice completely in this extremely well-done book.
For anyone interested in economics and the workings of money, and in particular in challenging the status quo, this book is highly recommended: 5/5

In case you are not already on your way out to get a copy, here are some sample presentations of Keynesian ideas. Lewis uses a blend of quoting and paraphrasing to clarify what Keynes really says, which easily exposes Keynes to ridicule.

Drive down interest rates (page 17):

The rate of interest is not self-adjusting at a level best suited to the social advantage, but constantly tends to rise too high. […] That the world after several millennia of steady individual saving, is so poor […] is to be explained by high rates of interest.
This opening quote exposes a fundamental Keynesian fallacy: The assumption that wealth equals money. It doesn't. Wealth consists of adequate housing, food, learning, medicine and what else makes life comfortable and enjoyable. Money is a useful tool to regulate the distribution of wealth, and to accumulate potential claims on wealth (savings, that is), but does not constitute wealth. This primary assumption is fatal for what follows.

On forcing down interest rates (paraphrase):

If private “wealth-owners” withhold their funds from the loan market or refuse to accept reasonable rates, the government can help bring down rates by increasing the quantity of lendable funds. This is done by printing new money which is made available to banks to lend. The more money there is to borrow, the less it should cost to borrow.
And then a direct quote:
A change in the quantity of money is within the power of most governments. The quantity of money in conjunction with [lenders' willingness to lend] determines the actual rate of interest.
Advocating money-printing:
New money that has been printed by the government and injected into the banking system is […] just as genuine as any other savings … Since there is no special virtue in the pre-existing high rate of interest, there can be no evil in bringing it down by government intervention.
Sure there can be harm! Keynes is being disingenuous here: The pre-existing high rate of interest is set by those who own the money, based on their productive work and saving. Depriving them of the right to set the price of their money, the interest rate, is evil in itself. Worse, though, is that the government can print more money not based on actual productive, valuable work.

What makes the proposed money-printing distinct from actual fraud is hard to see.

Already at this point, one may feel like throwing Keynesian sillyness out the window. But there is much more to come:

Save less, spend more, become wealthy (page 27): Paraphrasing Keynes:

If savings are smoothly and fully invested, society will prosper. But that is the rub – there is no certainty whatever that savings will be invested.
This central piece of Keynesian thinking almost begs to be dissected. If savings are fully invested – do they even remain savings? Saving money for a rainy day, as Margaret Thatcher put it, means putting money in a safe place, from where it can be withdrawn later. Investment is, by definition, risky. When money is invested, it is at the disposal of others, which is probably what Keynes desires. He then objects to the idea that some savings may remain non-invested. As if the money do not belong to the citizen, rather to the state, and the citizen is not supposed to hold on to any.

But then, the idea of money 'not being invested' deserves scrutiny. If money is deposited on a bank account, it enables the bank to lend it to entrepreneurs, which is a form of investment indeed. That removes all bank deposits from the 'lamentable' non-invested savings.

Then money can be used to purchase bonds, private or government. That is also a form of investment, and incurs a risk. More obviously for private bonds, for the issuer could fail. Less obviously for government bonds, for governments are (by definition) too big to fail, and have a powerful means to always repay its obligation: The printing press. That method, however, ensures that government bonds is usually a loss-leader when it comes to investment.

The only non-investment that truly exists is that of hoarding pound or dollar bills at home. That is sure to cause a loss of value to the money, as central banks have a policy of creating inflation, and the loss will be borne by the 'hoarder'. But will this impair economical activity as such? Hardly, for less money in circulation will tend to lower the prices, thus empowering others to purchase more then they could otherwise afford.

The Keynes argument just falls apart under logical scrutiny. It is to the credit of Lewis that he presents the Keynesian points clearly, first without analysing them, for it is quite easy for the logically inclined person to take them apart himself.

Back to Keynes:

There are better or worse way to address the problem of a savings glut:

We could hope for [enough] unemployment to keep us sufficiently poor, and our standard of life sufficiently miserable, to bring savings down.

We could hope that millionaires find their satisfaction in building mighty mansions ton contain their bodies when alive and pyramids to shelter them after death, or, repenting of their sins, erect cathedrals and endow monasteries.

One way is for society to bring interest rates down so that businesses can afford to borrow all of it. As discussed earlier, savers may try to block this by refusing the rates they will accept. If so, governments can overrule them by printing new money and injecting it into the loan market.

An alternative is to consume more or work less. [This works] just as well as investment.These are so obviously silly that it hardly needs refutation... Sure, one reduces savings by spending more and earning less – but what to do on the day that the savings really are needed, like in case of undesired unemployment or the like?

The idea of millionaires spending their savings on building huge mansions once again underlines the fatal flaw of Keynes: He considers money to be wealth, not assets, and apparently assumes that distributing the money more evenly, even at the cost of asset accumulation by a select few, will cause a general economical improvement. Since people generally live in houses made of bricks, not money, this fallacy is almost too embarrassing to mention.

The idea of reducing interest rates to stimulate indebtedness is in widespread use today, and has the desired effect of impoverishing savers (except those who save in gold and the like). Governments and central banks have injected huge amounts of 'liquidity' (freshly printed money) into the market, hoping that this will save the banks, the states and other large debtors. This is Keynes on steroids, and we will soon live through the results of this monetary experimentation.

But what is a "Savings glut" in the first place? If people suffer from unemployment, underpayment, lacking supplies or other economy-related distress, it actually makes more sense to look directly at the problem than looking elsewhere for some money that can be confiscated, one way or another, to make the problem go away.

Further, any distinction between 'reasonable' and 'excessive' savings must necessarily be arbitrary, determined by politicans. No economical method exists to determine such a distinction.

Blaming a hypothetical "Savings glut" solves no real problems.

What to do about Wall Street? (Page 47) Lewis continues to relate some personal details of Keynes, then proceeds to what Keynes thinks of the stock market, including comments like investors being driven by

'animal spirit', depending on 'the nerves and hysteria and even digestions [of the players]'.
It is puzzling that anybody can consider this scientific. It looks more like a passionate rejection of the idea that any kind of scientific approach can even be applied.


Then, too, if money is invested in existing stocks, it will not be invested in new plant, equipment employees, products and services, which is what real investment is about. Much stock market investment is really sterile, not much better for society than keeping the money under a mattress.
For anyone understanding investing, this misunderstanding is almost hysterically funny! The fact that stocks generally are quite liquid, easily sold when one needs to return to cash, is one of the great attractions of a well functioning stock market, and a major impetus to voluntarily investing in stocks. Keynes simply does not understand this. And he even made his living off investing himself.


The psychology of [private investors is] disobedient and uncontrollable. […] The duty of ordering the current volume of investment cannot safely be left in private hands.
One wonders just which authority private investors are expected to be 'obedient' to? This comes next, of course: Not any free, private authority – thus implicitly government should control investing, not private persons risking their own money. Logically, the collapse of the Soviet Union should have discredited Keynes, but this has not been the case.

It deserves mention that Keynes writes under the impression of the 1929 stock market crash, which brought him very near a personal ruin, as his own investments failed spectacularly. Resentment over this personal crisis might be a contributing factor to the negative view of a free stock market – but Keynes again misses something vital: The 1929 crash was caused by exactly the kind of monetary manipulation that Keynes is the greatest advocate of. Details can be found in the book Americas Great Depression (free pdf here).

Look to the State for Economic Leadership (page 53) Lewis shows in chapter 6 how Keynes continues down the statist route, which is what really makes him loved among politicians and central bankers. On business cycles, Keynes wrote:

the right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.
One feels like throwing the hands up in despair over this. This exact policy was followed by the Federal Reserve during the 1920's, causing the infamous Wall Street bubble and the ensuring crash. Interestingly, Keynes seems to be aware that this is unsustainable, and hedges his opinion:
We must find of other means of [cooling the economy] than a higher rate of interest. For if we allow the rate of interest to [rise], we cannot easily reverse the trend.
Keynes opens the gates for all kinds of unspecified government intervention to rectify the dangerous results of what he proposed a minute ago. Finding these means remains a challenge for governments even today, who after years of near-zero interest rates are discovering that the stimulus has created a hazardous credit addiction rather than a healthy economy.

As to how this can be solved, and in particular who should be in charge of solving it, Keynes says:

I believe the right solution [to the economic questions of the day] will involve intellectual and scientific elements which must be above the heads of the vast mass of more or less illiterate voters.
The crucial point here is that Keynes does not specify these 'intellectual and scientific elements', and thus devolves into a generic adoration of the 'Elite' that is dangerously close to what is seen in genuine fascism. But one crucial element remains firm, we always need money to be plentiful. Thus we need to:
persuade the public that green cheese [government printed money] is practically the same thing [as real money], and to have a green cheese factory (i.e. a central bank) under public control.
Keynes takes care, though, to point out that his ideas do not constitute fascism, unfortunately without pointing out in technical detail the differences between his desire for state interventionism and classical Italian fascism.

This is Part 2 of the book, pages 17 through 85. The mere act of presenting Keynes in non-obfuscated language exposes key elements of his thinking, which the alert reader will easily recognize as faulty as well as deceptive. Lewis then proceeds in Part 3, 254 pages more, to analyze the mistakes of Keynes in detail. Anyone who reads this gains a solid understanding of why we should not use Keynes as a guide to policy.

In any case, if you followed this far, I suggest you get the book and read the complete story. On the surface, it reads like a comedy, yet also constitutes a tragedy, for this is what most of our politicians and still too many economists believe in. The remaining 270+ pages continues to shred the grandness of Keynes until nothing of use is left behind.

Finally, if after learning a lot of Wrongs about economics, you might want to read something more constructive, like Economics for Real People (free PDF here), Americas Great Depression (free PDF here) or What Has Government Done to Our Money? (free PDF here).