What Would Keynes Do?
After the Obama stimulus seemed to fail, a Washington Post headline gibed: John Maynard Keynes, the GOP’s Latest Whipping Boy. On the left, of course, he’s still our guy, even if, like some “Keynesians,” we have never read a word of Keynes. Some pundits say that in the 2012 presidential election, the real candidates will be Keynes and Friedrich Hayek, the Austrian economist who raged against all forms of state planning (though Hayek liked national health insurance). If that’s the real presidential election, wouldn’t it behoove some of us true believers to ask, in this moment of double-dip despair, “My God, what would Keynes do?”
If we consult his writing, the scripture left by Keynes himself, we might be surprised to find that it would be a lot more than “prime the pump”—i.e., just run up the federal debt. For Keynes, the problem would be not just getting people into stores, or even getting employers to hire but getting our plutocracy to invest. It’s not just our jobless rate but our huge trade deficit that would appall him. He’d be aghast to see the United States bogged down in so much debt to the rest of the world.
I know: that’s not what people think. “Wait, wasn’t Keynes the one trying to get us into debt?” Yes, but not that kind of debt—in fact, as his biographer writes, Keynes personally hated debt. Especially in a recession, he hated to see a country with a trade debt, or trade deficit, which arises when a country’s imports exceed exports. Indeed, when the trade deficit is as jaw-dropping as the US trade deficit is now, it is harder to use Keynesian deficit spending to push employment back up. Keynes, unlike some of his disciples today, was quick to see this problem.
In 1936, when Keynes wrote his classic—The General Theory of Employment, Interest and Money—he was emphatic on this point: no country, ever, should run up any kind of trade deficit, much less the trade deficit on steroids we are running. Of course, in 1936 and for years after, the United States was the biggest creditor country in the history of the world. So Keynes never worried about our being a debtor country—rather, he spent much of his last days begging the United States to get other countries out of debt. If he came back and saw the colossal external debt we run now, he would be pushing for a serious plan to bring it down just as hard as he’d be pushing a stimulus for full employment.
I admit, Nation readers, that standing in line at Whole Foods, I occasionally pick up The Economist, if only to go to the back page and see the merchandise trade deficit the United States and other countries have been running in the past twelve months. It’s scary: $680.9 billion as of July 9. That puts us near $0.7 trillion in the red. But in the chart, much of the world is in the black. OK, the two US wannabes, Britain and Spain, have trade deficit disasters. And some have too much. “Low-wage” China has a surplus of $172.5 billion. “High-wage” Germany beats out China, with a surplus of $188.4 billion. But when I run my finger up this chart to the US deficit, it’s a shock. It’s as if I’m pressing on the sucking chest wound in the world economy.
Keynes would rattle that ripped-out page in front of us.
Actually, the trade deficit might be worse if there was full employment, our supposed goal, since we would have the money to buy even more hardware from abroad as we bite into more sandwiches at Jimmy John’s.
And that is just the surface trade deficit. Underneath that, there is a still bigger deficit, with US corporations outsourcing so many jobs. Here is a headline from the Wall Street Journal on April 19: Big US Firms Shift Hiring Abroad. During the 2000s, the Journal reports, while US multinationals have fired 2.9 million workers here, they have hired 2.4 million abroad. Some of these workers make parts to be shipped here, but when the parts are assembled into the gizmos or widgets that we sell abroad, we count them as “exports.” “Isn’t that true for other countries?” Sure—but the United States is much worse, because there is no government check (as in China) or organized labor check (as in Germany) to keep employment here. Our real trade deficit is much worse than the one on the back page of The Economist.
That’s what Keynes, spluttering, would be the first to point out. Indeed, he spent most of his life trying to get debtor countries out of debt. After World War I, he tried to get Germany out of debt. Read his famous 1919 essay “The Economic Consequences of the Peace.” By the 1930s Keynes had notoriously turned against free trade and was giving lectures on the need for “national self-sufficiency.” He concludes The General Theory with a long polemic against free trade and a paean to what the Bourbons and the Habsburgs used to do: knight any merchant prince who brought back a ducat from abroad. The one big (and smart) idea of absolute monarchy was to push exports over imports.
It’s all in the last part of The General Theory—which the wonderful Paul Krugman describes as “a kind of dessert course.” But Keynes’s attack on external debt comes as a crescendo to his whole argument. And he died trying to set up a system that would keep debtor countries out of debt. He pushed for the World Bank and the IMF. He even fought for a global currency: the bancor. In the last volume of Robert Skidelsky’s great biography, John Maynard Keynes: Fighting for Freedom, 1937–1946, there’s poor Keynes getting off his deathbed in 1944 and trying to set up a global system that would push creditor countries like the United States to pull debtor countries out of debt.
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Of course no country should run a trade deficit. That’s common sense. Maybe the economists whose courses Bush and Obama probably took at Yale or Harvard think it does not matter. But for Keynes, a trade surplus was a “stimulus,” and a deficit was a disaster. In Book VI, he states emphatically: “A favorable balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression.” OK, I supplied the emphasis. But Keynes was amazed at the indifference of most economists to the problem. “The extraordinary achievement of the classical theory was to overcome the beliefs of the ‘natural man’ and, at the same time, to be wrong,” he wrote.
On a 1930s gold standard, a trade deficit was bad in part because we paid it out in gold. But it’s just as bad to pay for it year after year by giving up our industrial might—by melting down America, Inc.
Keynes believed that practical leaders would always see the supreme importance of keeping the country out of external debt—indeed, he seemed to see this as the first duty of the state. For Keynes, in his later years, it was the economic analogue to defending one’s country. Avoiding an external debt was an act of patriotism and national self-preservation in a sense that even reducing unemployment was not. It’s “fighting for freedom,” in Skidelsky’s phrase. Keynes would not believe how Obama, the Tea Party, the Democrats, the Republicans—our leaders—pay so little attention to our whopping trade deficit, as if it had nothing at all to do with our slump.
The right, the Tea Party, the Concord Coalition, Mr. Bowles and Mr. Simpson, Peter Peterson—they want to bring down the federal deficit. The left, our side, generally wants to go deeper into debt and get to full employment. Then we’ll bring down the federal deficit. Then we’ll have full employment and all will be well.
But until we bring down the trade deficit and fix our balance of payments, there is no way out of debt.
Some readers will raise their hands: What’s the difference between the trade deficit and the balance-of-payments deficit? Well, over a year, the balance-of-payments deficit is an accounting statement—it’s the difference between all the payments to foreign nations and the receipts we get from foreign nations. It’s not the same as the trade deficit because it also counts up our foreign investments and investments by foreigners, loans, tourism, foreign aid. But we have a big balance-of-payments deficit because of our trade deficit—that’s what explains it, since we hold our own in the nontrade transfers.
We should put the accent on the first word in “balance of payments” because an accounting statement has to balance. As long as there is a balance-of-payments deficit, someone in the United States has to go into debt. Under Bush it was mostly the private sector: you and I. We ran up our Visas and MasterCards. We took out subprime loans. We did our home equity financing. Now we in the private sector are cutting back. So if you and I aren’t going into debt, Uncle Obama has to go into debt.
Let’s suppose we on the left do run up a debt, get back to full employment (ha!) or not-so-bad unemployment, and then bring the federal deficit down to zero.
Is all well?
No, because now you and I in the private sector have to go into debt. It’s simple arithmetic. Somebody in this country is going to have to go into debt to make the balance-of-payments balance. Who’s going to do it? It’s the government or us. One day Uncle Obama or his successor will say, “I’m done going into debt to make the balance ‘balance.’ It’s your turn to go into debt to make the balance ‘balance.’”
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Personally, I’d prefer that the government go into debt. As a taxpayer I’d rather pay the current low rate on US Treasuries than have to pay 25 percent to 30 percent on my Visa. The Tea Party and the GOP keep saying we can’t saddle our grandchildren with all this debt. Actually, we might be doing them a favor to saddle them with public sector instead of private sector debt. At least with public sector debt, none of our grandchildren will be hauled into court and sued.
What is the right thinking? But the left has no real plan to get out of this mess either.
Of course, others (even in the pages of this magazine) have pointed out that the US external trade debt is a bad thing, though it gets very little mention in our political debate. But it has a whopping big role in the current global crisis. The world filled up with foreigners holding dollars. They put the money back into the US economy in the form of loans—Treasury bonds, to be sure, but also corporate bonds, financial instruments, prime loans, subprime loans, payday loans and all manner of corporate debt. And the bloating of the financial sector—unregulated—led to the collapse.
But what’s behind it all is the fact that the United States cannot pay its way in the world. And while a smaller country would have expired long ago, we keep stumbling along, getting sicker, losing industrial weight, because the rest of the world has an interest in continuing to hold us upright.
For Keynes that would be the challenge—not just to bring down but to eliminate it: the whole thing. The failure to do so has real implications for other parts of Keynes’s theory. The answer to our crisis is not to “hire and rewire,” or to have a lot of public works. Let me add, by the way: I’m a labor lawyer; I want the government to spend. I love public works. I’d love a new O’Hare Airport. I’d love a repaving of Lake Shore Drive. And certainly Keynes loved public works. He saw people starving; he had a heart. We have to do something. We can’t wait for the trade deficit to come down. But that’s not the answer—it’s urgent, to be sure, but it’s just a first step. The answer is to get rich people to put their money into real “investments” and not “loans.” It’s to induce the rich in this country to invest “by employing labor on the construction of durable assets.” Call them widgets; call them iPads. Call them anything we can wrap, ship and sell to somebody abroad.
“Oh, but he wouldn’t put that ahead of the stimulus.”
No—but he’d put them together.
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For a while in 2009 it seemed everyone was a Keynesian. Skidelsky even rushed out a book, Keynes: The Return of the Master. Just after Obama took office, my colleague Mike was on the El and had his Financial Times, like everyone else in our office. A commuter spotted him and said, “Isn’t this a great time to be a Keynesian?” But now we’re not so sure. Even on the left some might ask: Was Keynes right about all of that, or should we look elsewhere for a prophet? Of course Keynes was right! His General Theory may not be quite as verifiable as Einstein’s. There is no Mariana Islands where we can set up our instruments and observe an eclipse. But we can look at other countries, like Britain and Spain, that have chosen austerity. They’re basket cases, just as Keynesian theory would predict. And East Asian countries that used Keynesian principles to stimulate their economies bounced back. Germany is an exception, but it has an enormous stimulus coming from its trade surplus—much of it from East Asian and BRIC country demand. With our not-quite-big-enough stimulus, the United States came out in the middle—the economy is not in deep freeze, as in Britain or Spain, but neither is it hot.
Part of the reason the United States isn’t doing better is that, thanks to the trade deficit, Keynesianism has lost its punch. On the evidence of The General Theory Keynes would argue that a stimulus has to be bigger, or work harder, as long as we have this external debt. Consider a twist on Keynes’s famous Aesop-like fable about the Bank of England. Let’s drop the Bank of England and make it all about the Federal Reserve. As Keynes would put it, rather than do nothing in a slump, it would be better for the Fed to bury bank notes in bottles and pay Americans to dig them up. Not only do we goose employment but there is a multiplier effect.
But Keynes did not say we should put bank notes in bottles and bury them in China and have Chinese workers dig them up. Why not? Well, it doesn’t do us any good. It does not employ any US workers. And of course, there would be no “multiplier.” The beauty of the stimulus is the “multiplier” effect. OK, I will oversimplify: if we hire Americans to dig up the bottles with bank notes, they have cash to spend. In 1936 they might go to spend it at the corner bar. The bar hires more wait staff. They go out and buy more groceries. Someone buys an extra truck and truck driver to bring the fructose syrup in from Iowa for our Froot Loops, and… should I stop?
It just goes on and on… jobs, jobs, jobs, multiplying to the Pythagorean heights.
But it’s not 1936. It’s 2011. Now after digging up the bottles, Americans will go to Target and Walmart and spend on bags of kitty litter made by child labor in China. And what’s going to happen to the multiplier when the Obama bucks we spend end up over there? In Chapter 10 of The General Theory Keynes writes, “In an open system with foreign trade relations some part of the multiplier…will accrue to the benefit of employment in foreign countries.” Or, as he said, there will be a bit of “leakage.” But that’s OK if they buy back from us. If there is a balance of trade, it’s OK. But they aren’t buying back from us. They are buying more from Japan and Germany, so our stimulus goes out of China and over to those countries.
It’s bad enough that we’re transferring all that wealth even in a good time. But when we’re counting on a stimulus, we’re leaking on a scale Keynes could hardly even imagine, and even in 1936 he already worried enough.
Given the leakage of the multiplier, the stimulus has to be huge. Let’s be honest—it freaked out independents, and even our base, to see how deep in debt Obama initially tried to go. So when a seemingly huge stimulus did not deliver, the country soured on it. “They don’t understand Keynes.” But maybe we don’t understand Keynes. Is the public so irrational? As we run up an annual public deficit of $1.3 trillion, our jobless rate is a stunning 9 percent, and the real rate is much higher. Thanks to the Tea Party, alas, we know too well that the government borrows 40 cents for every dollar it spends.
There are other reasons Keynesianism has lost its punch.
First, by making their own cutbacks, our state governments can nullify the federal stimulus. In 1936 the states were just toy governments. The New Dealers hated them. But now they are far bigger public sector employers than Washington. By virtue of state constitutions requiring balanced budgets, they have to cut when Keynesian theory would have them spend. If the stimulus did not stimulate, we can partly blame our fifty Tea Party constitutions, which require a foolish “austerity” in the states. In our system of federalism, a Keynesian-type stimulus is half unconstitutional.
Second, the rich are so much richer now than they were in our Keynesian golden age (let’s say 1940 to 1975). If Obama gets GDP growth up by 1 percent, most of that goes to the superrich. It’s beyond their capacity to consume it—i.e., to unleash a multiplier effect. The Financial Times has a regular supplement called “How to Spend It,” but it’s beyond their human strength. There’s too much to spend.
A stimulus can wake up an egalitarian country’s economy, since everyone is spending. But a stimulus cannot wake up the economy of a super-plutocracy: the people at the very top just roll over in bed.
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The whopping trade deficit should be the dream issue for Democrats: “We’re the party that will really get the country out of debt.” That’s how we connect with the voters: show the connection between the private and public debt and the external debt. The GOP has nothing to say on this. We have the whole issue to ourselves.
So what would Keynes do?
Here’s what he would not do:
“Vote down free trade treaties.” Though he blasted free trade, Keynes thought tariffs were ridiculous. While knocking free trade, he also wrote that “the reader must not reach a premature conclusion as to the practical policy to which our argument leads up…. The advantages of the international division of labor are real and substantial, even though the classical school greatly overstressed them…. A policy of trade restrictions is a treacherous instrument.”
“Devalue.” He acknowledges sometimes it can work to make the country’s goods cheaper abroad. But we now live in a world of fluctuating and not fixed exchange rates. In Keynesian theory, no one is going to make a long-term decision to invest based on a day-to-day fluctuation in the dollar. The dollar has dropped a lot at different times, against the euro as well as the renminbi, and it has never put a big dent in any serious way in the trade deficit. Other countries will compete as hard as we do to devalue, so it will never work.
“Let’s spend on infrastructure.” I’m all for it. But even if we pave the interstates with gold, it won’t help us sell more goods abroad.
So what’s Keynes’s answer? It’s simple. While he believed in public works, to say the least—he practically invented the concept—he never presented the public sector as the real key to the economic problem. Rather, as he writes in The General Theory, “The weakness of the inducement to invest has been at all times the key to the economic problem.”
We have to get the rich to invest. Specifically, we have to get the rich to invest “by employing labor on the construction of durable assets.” We don’t have to get the rich to consume. They will gag. And we don’t really have to get the rich to work. Who cares if they work? They can stay at home in bed in silken sheets.
The real point is to get them to invest—not save, not speculate in financial instruments, but invest in widgets we can wrap and ship and sell abroad. And Keynes would put that question to the left, to us: How can we get the rich to invest?
Well, in The General Theory he has one big idea—lower the rate of interest. By cutting the rate of interest on loans we can prod the rich to put their money into less liquid investments, in the kinds of things we can sell abroad.
I know: everyone will say, “Keynes is nuts. The Fed has zero rates. It’s like Japan. ‘We’re pressing on a string.’”
But it’s not. Sure, the Fed has zero rates, and mortgage rates are low. But even after Dodd-Frank, look at the colossal returns to the financial sector—i.e., to commercial and investment banks. For Keynes the key to getting the rich to invest in labor on the construction of durable assets was to hold down the windfall returns from loans, buyouts and financial speculation—the income he would call “interest.” That’s the nub of our country’s trade deficit problem. In Book VI, Keynes adumbrates the one big thing he learned from the Bourbons, the Habsburgs, John Locke and even Adam Smith about the importance of holding down the rate of interest to stimulate trade, to make it less attractive to “invest” in short-term derivatives and relatively more attractive to invest for the long term in widgets. Keynes put it this way: “It is impossible to study the notions to which the mercantilists were led by their actual experiences, without perceiving that there has been a chronic tendency throughout human history for the propensity to save to be stronger than the inducement to invest.”
Everything in the United States is set up to encourage the rich to put money into financial instruments rather than long-term investments. What would Keynes do? Get the rich to think outside the Wall Street banking box. Get them to put money into the part of Main Street that used to trade abroad. How do we do that? For starters, put in usury laws—limits on interest rates. In a general way, cut down the appeal of being a creditor and not an investor.
Keynes quotes Locke on this point: “High Interest decays Trade. The advantage from Interest is greater than the profit from Trade.” And by trade, Locke does not mean day trading.
Now, as Richard Posner recently wrote, part of the problem with understanding Keynes is the vocabulary. So, for example, it is puzzling to us to hear that the rich don’t make enough “investments.” Don’t they invest like crazy? They invest in stocks, bonds, financial instruments, all sorts of things we would never call loans. But to Keynes these “investments” are loans. They’re liquid. They often have a fixed rate of interest. Corporate takeovers on Wall Street may look like “investments,” but if you get up close, many are just loans—i.e., transactions in corporate debt. Keynes could pick up the Wall Street Journal and give the real name for one “investment” after another: loan, loan, loan.
Strip away the pretense of investment, and too many a financial instrument is either a loan or just the inflated price of a paper asset. When Keynes talks about the importance of usury laws, he means laws limiting interest rates but also laws and regulations that hold down profits on financial instruments.
Keynes would point out that the rise in the US trade deficit—which became serious in the 1980s—coincided exactly with the astonishing deregulation of the financial sector. We knocked down usury laws. We allowed the first end runs around the Glass-Steagall laws.
Wait—that’s our problem? Not China or the world economy? Well, it’s hard to channel Keynes now, but look at the back page of The Economist. Not just Germany but a lot of other high-wage countries are doing well in the global economy. It’s hard to account for the difference with labor cost alone.
Readers who took Economics 101 (or Economics 1001, as it later became as a result of inflation) may remember something about a “liquidity preference.” That means keeping money “liquid.” For Keynes the first duty of the state is to ensure that the “liquidity preference” is low, to prod people not to keep their money liquid but to lock it up in a long-term investment where it will not be so easy to get.
To some, this all sounds very nice for the future, but right now we need to get people out there to repave the interstates. Fine, let’s get back to work: but as long as the trade deficit keeps on draining us of wealth, the middle class will keep on going down the drain.
In the end there is one way out of this economic mess—Keynes would say we have to shock, push, lure and sweet-talk the rich in this country to part with their money and start enterprises that get us out of debt. But how are we going to do that? We can’t even get employers sitting on hoards of cash to hire a few extra workers.
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So what would Keynes do? Well, I don’t know: he’s dead, as we all are in the long run. But I have a hunch what he would do. As the solon or lawgiver of modern social democracy, Keynes would look at the most successful social democracy in the world right now. What do the Germans, with their hefty trade surplus, do?
First, they have a whole different type of corporation—with workers making up half the directors on the board. And workers have privileged positions in the firms, real power and responsibility. It doesn’t guarantee that corporations invest, but it’s a big help to have workers in director chairs sitting in the boardrooms.
In addition, the Germans have government-sponsored banks, like the Sparkassen, that lend to businesses. We have the Federal Reserve printing money like crazy, but the banks sit on it and don’t lend it out, just as American CEOs who have never met a worker except on reality TV sit on their money and don’t hire.
We can’t adopt these things wholesale, but we can take baby steps, as I wrote in a Nation article last year [see “Ten Things Dems Could Do to Win,” Sept. 27, 2010]. But the Keynes of Book VI would also be interested in anything beyond Dodd-Frank that discourages financial speculation and loans. He’d be in favor of denying tax breaks for leveraged buyouts that leave companies in debt. I think he’d love the idea of a financial transactions tax, which Dean Baker has proposed here and the Europeans are considering.
The one standard way of being competitive abroad is to cut wages here—to improve the terms of trade. Keynes hated the idea of cutting wages. It was the standard remedy of classical theory, and he loved to point out that cutting demand at home might only prolong a slump. But suppose the government could dramatically cut nonwage labor costs by assuming the cost of health insurance? If our government could deliver just one Keynesian “shock” to make us more competitive, it would be single payer national healthcare. At least right now, we should expand Medicare coverage (lower the eligibility age) and adopt a public option, so that the government can have more bargaining leverage to beat down by decree the stupefying prices we pay to get well in an ever more concentrated healthcare sector.
It is horrifying to see even the “tough” new President Obama proposing to shrink Medicare—aside from leaving people uncovered, shrinking coverage means shrinking the government’s power to dictate the price and leaves employers and the rest of us exposed to higher healthcare costs. If the president wanted to increase the trade deficit, the best thing he could do would be to cut Medicare coverage and give the government even less power to hold down the healthcare costs that make us even less competitive abroad than we are now.
Finally, I think Keynes would hold up on the small stuff—i.e., the cuts in the payroll tax or the proffer of one more investment tax credit—for none of that will matter (if it ever matters) until we get people out of loans. In one way or another, in keeping with the ancient wisdom of the Bourbons and the Habsburgs divined by Keynes, we have to take down the scaffolding of this creditor-debtor economy in which our country is imprisoned.
Now more than ever: it’s a great time to be a Keynesian. Remember to vote for Keynes in 2012.