How did we get here?

Unlike many economists, Keynes had already played a significant role in policy-making; his bold wartime leadership at the Treasury resulting in his appointment as its chief representative at the Versailles Peace Treaty negotiations that concluded the First World War (before resigning in disgust at Britain’s acquiescence to US President Woodrow Wilson’s short-sighted insistence that Germany should bear heavy punitive reparations). He was to play an even larger role in the future as the chief architect of the Bretton Woods currency system that endured from 1944 until 1971. 

Whilst Bretton Woods was still to come in 1936, his practical achievements to date leant huge credibility to his views, which challenged head on much of the received wisdom of classical economics, whose authority was torn to shreds by the widespread global manifestation of the Great Depression. In particular, “The General Theory” offered the first credible alternative to the no-longer-tenable classical belief that market economies tend naturally to full employment, even after temporary shocks. Keynes’ counter-argument was that, in the absence of stimulatory policies, under-employment and sub-par economic activity growth are inevitable. 

Keynes’ theory stood above other contemporary responses in the coherence of its big-picture understanding. While many observers focused on single inputs or measures, Keynes had already recognised that the problems facing the world in the 1930s were complex and inter-connected.

“Today we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time – perhaps for a long time.”

The greatness of “The General Theory” was its advancement of economic understanding, its persuasive refutation of long-held economic misconceptions and its appreciation of the intricacies of economic inter-connectedness, in the way that it unearthed universal truths with a particular relevance to the highly charged issues of the 1930s, not least the debate between democracy and totalitarianism.

“The theory of output as a whole … is much more easily adapted to the conditions of a totalitarian state, than is the theory of the production and distribution of a given output produced under conditions of free competition and a large measure of laissez-faire.”  

However, the defining flaw of Keynes’ thinking throughout was that governments could be trusted to make the best long-run decisions. “The General Theory” was so named because Keynes intended it to apply throughout the economic cycle, not just at specific instances. The assumption that governments would be able to judge how and when to implement prudent policies, and how and when stimulus was required – whether in a democracy or a dictatorship – was shown to be as flawed, as a general theory, less than 40 years after the publication of “The General Theory.” 

Affirming Mark Twain’s view that “history doesn’t repeat but it does rhyme”, “The General Theory” baby was thrown out with the Keynesian bathwater and replaced by the dogma of monetarism, advocated by its own high priest, Milton Friedman, because of the relative attractiveness of controlling the monetary supply as an immediate solution to the problems of the 1970s and 1980s. In turn, the shortcomings of monetarist economics as a general theory have been evident since their consequences started to become apparent in the slow-motion economic implosion of the last dozen or so years, leading for many to call for a return to policies inspired by Keynes and “The General Theory.”

“The General Theory” may be both flawed and dangerous but it still casts a giant shadow today over many issues that remain unresolved and questions that remain unanswered. 

 

Paul Gambles, managing partner of MBMG International, is a regular speaker at events. He is featured regularly on CNBC’s “Squawk Box”, and most days on Money Channel’s “News at Ten” programme. Paul’s regular MBMG updates can be found at www.mbmg-group.com/mbmg/blog and he can be contacted at [email protected].