by Michael Hiltzik Nov 24 2009
It's fitting, therefore, that the recent economic meltdown has begun to restore that great apostle of uncertainty, John Maynard Keynes, to his rightful position of influence in economic thought.
"Keynes asked why financial markets are inherently unstable," Robert Skidelsky told me the other day. "His answer was that we don't know what the future will bring. He talked about the inherent precariousness of knowledge, that when we estimate the future we're only disguising our ignorance."
If that sounds obvious, keep in mind that the financial disaster of recent times was born in the hubris that the financial markets are nearly flawless machines for assessing risk and that government regulation would make them inefficient.
Skidelsky is a British economic historian whose three-volume biography of Keynes came out on these shores from 1986 to 2001. We had a chance to talk last week while he was visiting the U.S. to promote his latest work, "Keynes: The Return of the Master," published in September, which aims to spotlight the relevance of Keynesian economics for modern times.
He argues that it's impossible to miss the connections: For one thing, the banking and credit collapse of recent years stems from precisely the same economic mistakes Keynes saw in the 1920s.
For another, the government stimulus programs that have stemmed the worldwide decline and begun the process of recovery are based on his precept that when confidence is shattered in the private investment market, the only remedy is "state intervention to promote and subsidize new investment" -- presumably by deficit spending.
"The most positive difference between now and the Depression," Skidelsky says, "is that we have Keynes' writing, so that governments didn't repeat the mistake of the early '30s of cutting their own spending when private spending was falling."
Keynes (1883-1946) is sometimes described as not an economist so much as a moral philosopher. His intellectual affinity was less toward bankers than artists -- he was part of the literary Bloomsbury Group, among whose most famous members were Virginia Woolf and E.M. Forster.
Yet he was the antithesis of the ivory tower intellectual. His ideas emerged directly from his experience running a sort of proto-hedge fund speculating in currencies and commodities between the world wars. In the process he experienced his share of personal ups and downs. He made healthy profits in 1920 by shorting the mark, franc and lira, but lost heavily in a highly leveraged bet against the pound when the Bank of England raised interest rates.
Keynes' Bloomsbury friends were among those he wiped out. But he recovered and made good some of their losses. He lost a second fortune in the Depression, but made it all back, and more, buying at the lows during the '30s. At his death in 1946, Skidelsky writes, he was worth about $20 million in today's terms.
"The instability of the financial markets was a crucial experience for him as a thinker and as a player," Skidelsky says.
The hallmark of Keynes' thought was the recognition that the efficient-market theory -- the notion that the market synthesizes all that is known and that needs to be known about current conditions and that it therefore can be left to regulate itself -- is flawed.
"If you have a self-regulating market," Skidelsky explains, "you don't have crashes like this. You don't have great contractions."
Keynesian economics and its implicit warning that the free market has inherent limitations and therefore demands regulation remained in vogue from World War II until the mid-1970s, followed by its nearly complete abandonment by British Prime Minister Margaret Thatcher and President Ronald Reagan in the 1980s.
Many of the problems that developed since then derived from the assumption that risk can be predicted, measured and accurately priced.
Banks were allowed to enter the securities businesses because surely they know how to manage risk. Subprime mortgages were packaged into securities, so investors could buy just as much risk as they thought they could handle. The outsized bonuses pocketed by derivatives traders were based on the idea that the profits for which they were rewarded were riskless -- that is, they wouldn't backfire down the line.
The uncertainty of real life eventually, and inevitably, came back to bite them where it hurts. (It's the rest of us who bear the tooth marks.)
Another Keynesian notion suppressed by the free-market lobby was the danger, not to say immorality, of increased income inequality. Skidelsky acknowledges that later Keynesians have made more of this than the master himself, but Keynes did feel that excessive inequality promoted speculation by those at the top of the income scale and reduced consumption by everyone else -- a formula for economic stagnation, or worse.
Indeed, it shouldn't escape anyone's notice that during the free-market heyday of the 1980s and beyond, living standards for most Americans plateaued while vastly more wealth became concentrated in fewer hands. The only way for the majority to maintain their economic place was to borrow, with consequences we've seen documented ad nauseam.
That brings us to what Keynes has to say about recovery and reform policy. Those who consider him the ultimate liberal might be surprised to learn that he might well counsel President Obama against moving too fast on financial reform.
As stated in a famous open letter to Franklin D. Roosevelt published on New Year's Eve 1933, Keynes' view was that recovery hinged on building trust and confidence in the business community. Too much reform too soon "will upset the confidence of the business world and weaken their existing motives to action." Only after recovery should reform, necessary as it was, be launched.
Keynes fretted that FDR had placed his public works program in the hands of his exceedingly frugal Interior secretary, Harold Ickes, who spent the money as though it came from his personal bank account.
Overall government spending in the '30s never came to more than a fraction of the $4.8 billion a year Keynes thought was needed to fill the investment gap -- one reason Keynesians believe the New Deal recovery was less robust than it could have been.
Keynes' theories don't all stand up to classical critiques, but his guiding principle, that it's wise to know how much you don't know, is unassailable. Given how right he was about the roots of economic collapse, we could do worse than follow his pointers about where to go from here.
Michael Hiltzik writes Mondays and Thursdays. Reach him at michael.hiltzik@latimes.com,
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