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Saturday, May 13, 2006

Keynes: The World Economic Outlook

This essay that Keynes wrote in 1932 has been referenced recently in a few places, so I thought it might be of interest. It was written during the Great Depression and Keynes' primary concern at this point is to stabilize the financial sector. He also wants to find a way to stimulate output, but he makes it clear that this is of secondary importance, stabilizing the financial sector must come first. Note his concern over self-reinforcing deflationary episodes, something central bank remain concerned about today (this is one argument for an inflation target above zero as it provides an insurance cushion against such an outcome), and Keynes' hope that even the "deadheads" will come to understand that a new type of fiscal policy, deficit spending, can be used to overcome economic depressions:

Keynes: The World Economic Outlook: The immediate problem for which the world needs a solution to-day is ... to avoid a far-reaching financial crisis. There is now no possibility of reaching a normal level of production in the near future. Our efforts are directed toward the attainment of more limited hopes. Can we prevent an almost complete collapse of the financial structure of modern capitalism? With no financial leadership left in the world and profound intellectual error as to causes and cures prevailing in the responsible seats of power, one begins to wonder and to doubt. At any rate, no one is likely to dispute that for the world as a whole the avoidance of financial collapse, rather than the stimulation of industrial activity, is now the front-rank problem. ...

The immediate causes of the world financial panic ... are to be found in a catastrophic fall in the money value, not only of commodities, but of practically every kind of asset. The 'margins,' as we call them, upon confidence in the maintenance of which the debt and credit structure of the modern world depends, have 'run off.' In many countries the assets of the banks are no longer equal, conservatively valued, to their liabilities to their depositors. Debtors of all kinds find that their securities are no longer the equal of their debts. Few governments still have revenues sufficient to cover the fixed money charges for which they have made themselves liable.

Moreover, a collapse of this kind feeds on itself. We are now in the phase where the risk of carrying assets with borrowed money is so great that there is a competitive panic to get liquid. And each individual who succeeds in getting more liquid forces down the price of assets in the process of getting liquid, with the result that the margins of other individuals are impaired and their courage undermined. And so the process continues. It is, indeed, in the United States itself that this has proceeded to the most incredible lengths. ... But the United States only offers an example ... of a state of affairs which exists in some degree almost everywhere.

The competitive struggle for liquidity has now extended beyond individuals and institutions to nations and to governments, each of which endeavors to make its internal balance sheet more liquid by restricting imports and stimulating exports by every possible means, the success of each one in this direction meaning the defeat of someone else. Moreover, each country discourages capital development within its own borders for fear of the effect on its international balance. Yet it will only be successful in its object in so far as its progress toward negation is greater than that of its neighbors.

II

We have here an extreme example of the disharmony of general and particular interest. Each nation, in an effort to improve its relative position, takes measures injurious to the absolute prosperity of its neighbors; and, since its example is not confined to itself, it suffers more from similar action by its neighbors than it gains by such action itself. Practically all the remedies popularly advocated to-day are of this internecine character. Competitive wage reductions, competitive tariffs, competitive liquidation of foreign assets, competitive currency deflations, competitive economy campaigns--all are of this beggar-my-neighbor description. ... Thus, while we undoubtedly increase our own margin, we diminish that of someone else; and if the practice is universally followed everyone will be worse off. An individual may be forced by his private circumstances to curtail his normal expenditure, and no one can blame him. But let no one suppose that he is performing a public duty in behaving in such a way...

Unfortunately the popular mind has been educated away from the truth, away from common sense. The average man has been taught to believe what his own common sense, if he relied on it, would tell him was absurd. Even remedies of a right tendency have become discredited... Now, at last, under the teaching of hard experience, there may be some slight improvement toward wiser counsels. But through lack of foresight, and constructive imagination the financial and political authorities of the world have lacked the courage or the conviction ... to apply the available remedies in sufficiently drastic doses; and by now they have allowed the collapse to reach a point where the whole system may have lost its resiliency and its capacity for a rebound.

Meanwhile the problem of reparations and war debts darkens the whole scene. ... I cannot, therefore, extract much comfort or prospective hope from developments in this sphere of international finance.

III

Well, I have painted the prospect in the blackest colors. What is there to be said on the other side? What elements of hope can we discern in the surrounding gloom? And what useful action does it still lie in our power to take?

The outstanding ground for cheerfulness lies, I think, in this--that the system has shown already its capacity to stand an almost inconceivable strain. If anyone had prophesied to us a year or two ago the actual state of affairs which exists to-day, could we have believed that the world could continue to maintain even that degree of normality which we actually have? ...

Moreover, there has been a still recent and, in my judgment, most blessed event of which we have not yet had time to gain the full benefit. I mean Great Britain's abandonment of the gold standard. ... If Great Britain had somehow contrived to maintain her gold parity, the position of the world as a whole to-day would be considerably more desperate than it is, and default more general.

For Great Britain's action has had two signal consequences. The first has been to stop the decline of prices, measured in terms of national currencies, over a very considerable proportion of the world. ... Outside Europe there are no countries in the whole world except South Africa and the United States which now conform to a gold standard. France and the United States are the only remaining countries of major importance where the gold standard is functioning freely.

This means a very great abatement of the deflationary pressure which was existing six months ago. Over wide areas producers are now obtaining prices in terms of their domestic currencies which are not so desperately unsatisfactory in relation to their costs of production and to their debts. ... There are several countries of which it could be argued that their economic and financial condition may have turned the corner in the last six months. ...

As regards Great Britain herself, the world has a little overlooked, I think, the ... if not ... absolute, at least ... relative improvement. ... And the explanation is an encouragement for the future. For the explanation lies in the fact that over a wide field of her characteristic activities Great Britain to-day is once again the cheapest producer in the world. ...

IV

But there is a second major consequence of the partition of the countries of the world into two groups, on and off the gold standard respectively. For the two groups roughly correspond to those which have been exercising deflationary pressure on the rest of the world, by having a net creditor position which causes them to draw gold, and those which have been suffering this pressure. Now the departure of the latter group from gold means the beginning of a process toward the restoration of economic equilibrium. It means the setting into motion of natural forces which are certain in course of time to undermine and eventually destroy the creditor position of the two leading creditor gold countries. ... France ... and the ... United States.

Thus a process has been set moving which may relieve in the end the deflationary pressure. The question is whether this will have time to happen before financial organization and the system of international credit break under the strain. ... I am not confident, however, that on this occasion the cheap-money phase will be sufficient by itself to bring about an adequate recovery of new investment. It may still be the case that the lender, with his confidence shattered by his experiences, will continue to ask for new enterprise rates of interest which the borrower cannot expect to earn. ...

If this proves to be so, there will be no means of escape from prolonged and perhaps interminable depression except by direct state intervention to promote and subsidize new investment. Formerly there was no expenditure out of the proceeds of borrowing that it was thought proper for the State to incur except for war. In the past, therefore, we have not infrequently had to wait for a war to terminate a major depression. I hope that in the future we shall not adhere to this purist financial attitude, and that we shall be ready to spend on the enterprises of peace what the financial maxims of the past would only allow us to spend on the devastations of war. At any rate, I predict with an assured confidence that the only way out is for us to discover some object which is admitted even by the deadheads to be a legitimate excuse for largely increasing the expenditure of someone on something!

V

In all our thoughts and feelings and projects for the betterment of things, we should have it at the back of our heads that this is not a crisis of poverty, but a crisis of abundance. It is not the harshness ... of nature which [is] oppressing us, but our own incompetence and wrong-headedness which hinder us from making use of the bountifulness of inventive science... The voices which--in such a conjuncture--tell us that the path of escape is to be found in strict economy and in refraining, wherever possible, from utilizing the world's potential production are the voices of fools and madmen. There is a passage from David Hume in which he says: 'Though the ancients maintained that, in order to reach the gifts of prophecy, a certain divine fury or madness was requisite, one may safely affirm that, in order to deliver such prophecies as these, no more is necessary than merely to be in one's senses, free from the influence of popular madness and delusion.'

Obviously it is much more difficult to solve the problem to-day than it would have been a year ago. But I believe even now ... that we could still be, if we would, the masters of our fate. ... Unluckily the traditional and ingrained beliefs of those who hold responsible positions throughout the world grew out of experiences which contained no parallel to the present, and are often the opposite of what one would wish them to believe to-day...

In the United States it is almost inconceivable what rubbish a public man has to utter to-day if he is to keep respectable. Serious and sensible bankers ... have to go about assuring the world of their conviction that there is no serious risk of inflation, when what they really mean is that they cannot yet see good enough grounds for daring to hope for it. ...

Nothing could be a greater advantage to the world than that the United States should solve her own domestic problems, and, by solving them, provide the stimulus and the example to other countries. But observing from a distance,--a nearer view of the prospect might modify my pessimism,--I am unable to imagine a course of events which could restore health to American industry in the near future. ...

    Posted by on Saturday, May 13, 2006 at 01:02 AM in Budget Deficit, Economics, History of Thought, International Finance | Permalink  TrackBack (0)  Comments (5)

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