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The question posed by author Nicholas Wapshott in his recently published book, “Keynes Hayek: The Clash that Defined Modern Economics,” is: Who prevailed — the renowned English economist John Maynard Keynes, likely the most influential 20th century proponent of government intervention and regulation of economic affairs, or Frederick Hayek, the Austrian economist, who emerged among the leading 20th century critics of both.
Hayek, best known for his 1944 book, “The Road to Serfdom,” and Keynes, author of the monumentally significant depression-era opus, “The General Theory of Employment, Interest and Money,” are grist for Wapshott's mill.
Current economic conditions described by A. Gary Shilling in his book, “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation” (Wiley, 2011), demonstrate convincingly that Wapshott posed the wrong question. The issue is not who prevailed but who, after six decades of experience, got things more right.
Wapshott fails to put the intellectual debate of the two into the context of real life, except on the level of influence. Who won? As Wapshott addresses the questions and concludes, as he must: Keynes and the latter-day Keynesians (from Paul Samuelson to Paul Krugman).
Wapshott gets one thing wrong when he credits Keynes and his followers with having saved capitalism twice in 80 years. With that conclusion, Wapshott unfortunately missed the larger point: How exactly did we get to replay 1929 in 2008?
In the decade preceding the market crashes of 1929 and 2008, government policies favored easy money and credit expansion. Easy money policies encouraged credit expansion by governments, businesses and individuals alike. The policy in the 1920s led to the point that heavily leveraged stock investors chose jumping out of windows when they could not meet margin calls. Others, less dramatic, quietly filed for bankruptcy.
But easy money led to inflated security prices to crash. The Fed then began shrinking money supply with a prolonged depression the result.
In the 2000s, similar leverage found its way into real estate and financial assets, such as mortgage-backed securities, producing price increases that increasingly attracted investors into a new investment paradigm. This time the remedies would be different.
As late as 2006, Federal Reserve Chairman Ben Bernanke and most other economic and financial commentators dismissed the possibility that the U.S. real estate market was experiencing a pricing bubble. Bernanke's response to the financial crises is do the opposite of what the Fed did in the 1930s. The Fed has increased the money supply by, among other things, quantitative easing, keeping short-term interests at or near zero, much to the cost of retirees who thought they would earn some interest income off their certificates of deposits and mutual funds.
The two financial collapses were not the product of the nature of the economic system as claimed by Keynes but of government planning and regulation. The point is that while government-interventionist Keynes prevailed on the level of influence, the consequences proved Hayek more correct: Government being composed of mortals does not have the capacity to plan the economic future centrally. Efforts to do so are more likely than not going to lead to a bad end.
In the 1970s, the government committed itself to the expansion of home ownership, concerned about declines in older communities and the stabilizing nature of home ownership. Congress passed and President Carter signed the Community Investment Act. To achieve these policy goals of community revitalization and expanded home ownership, the federal government directed the regulators to implement policies that would encourage, to the point of requiring, federally regulated financial institutions to make credit available to just anyone who wanted it.
Over the 30 years (1978-2008), federal regulators, many in the Federal Reserve and the U.S. Department of the Treasury, with the enabling aid of Fannie Mae and Freddie Mac, pushed the system toward achieving the central plan of community revitalization and expanded home ownership. Barring “red-lining” was a major regulatory goal of the federal regulators.
But the planning experiment proved to be a bi-partisan catastrophe, with which many will have to cope for years.
The result of the 30-year federal policy is where A. Gary Shilling, an economist and investment analyst, joins the fray. He describes in his book what he believes to be the consequence: a decade of deflation in asset values, especially real estate prices. Japan of the 1990s comes to America.
Is Shilling correct? Everything suggests to this point, yes.
What we do know is that the results borne by the many individuals who were unwitting pawns in the central-planning mandate will bear the burden for the rest of their lives. It is not the people who bought late in the housing rally and face foreclosure who will bear the greatest burden, although it would be hard to overstate the problems they face. The innocent bystanders who acted out the “American Dream” of home ownership — i.e. invest in your home, put 20% down, make it your principal asset for savings and use it as a store of value for the future — have and will suffer enormously. And yet they did nothing to deserve this.
Unfortunately, the dream of the planners has turned into a nightmare. Many homeowners approaching retirement find that the store of savings has been sorely compromised by the consequences of a misguided central plan.
While Hayek would not be happy with calamities facing so many today, he would not be surprised. Tellingly, Keynes would be very surprised.
— Daniel Joy is a Sarasota lawyer
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