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Dancing on the Grave of the Keynesian Economic System

Politics / Economic Theory Aug 27, 2012 - 06:21 AM GMT

By: Gary_North

Politics

Best Financial Markets Analysis ArticleThe 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 of Robert Heilbroner wrote an article, "After Communism," for The New Yorker (Sept. 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 Ph.D. 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 which 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' 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 twentieth 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 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 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 advisors 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 cranked up the monetary base from $900,000,000,000 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 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 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.

Read the rest of the article

Gary North [send him mail ] is the author of Mises on Money . Visit http://www.garynorth.com . He is also the author of a free 20-volume series, An Economic Commentary on the Bible .

http://www.lewrockwell.com

© 2012 Copyright Gary North / LewRockwell.com - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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