Monday, 31 December 2012

The US Fiscal Cliff and the failure of Keynesian Economics

As the Fiscal Cliff crisis hits the USA, I'm reminded again why I dislike Keynesian economics and the system with which we run our national markets. Even as we are in the midst of a recession caused by the failure of Keynesian over-spending, our main concern is maintaining government debt in the hopes that it will allow for enough economic development to stave off total system failure.

My first introduction to Keynes and Hayek was this video.* It is one of my favourite depictions of the macro-economic debate, not just because it is entertaining education but because of the brilliant introduction highlighting the relative attention paid to the competing theories. I have never understood, particularly in the USA, the reason that politicians and economists alike praise Keynes so highly. Surely in a country that so vocally champions the free market and liberal values it should be Hayek, with his reliance on the rationality of the market, that should be the posterboy. Yet instead we almost exclusively follow the advice of Lord Keynes, spending money we don't have to stimulate the economy.

When I first read about this theory, my first thought was of the South Sea Bubble. In the colonial era, the South Sea Trading Company was set up to take advantage of an English monopoly on South American trade. Given the war with Spain, the success of any such trade was improbable, but investment in the company and stock trading led to massive increases in share values. Unsurprisingly yet for many ruinously, the company collapsed and share prices plummeted. For all that investment money, there was never any real commodities supporting the shares and their only value came from continued investment.

Keynes advocates maintaining or even increasing government debt throughout a recession, taking money from the public sector and freeing it up for development and recovery in the private. To recover from the 2008 recession, the US passed several limited acts to reduce tax rates and increase government budgets, putting the government into considerable debt but pushing more money into private enterprise. The fiscal cliff that US policy-makers so fear is the expiration of these acts, which will increase taxes and slash government budgets. While this seems to be nothing more than a sound policy for government, reducing national debt (both foreign and domestic) and ensuring a more reasonable budget (not spending money that the government doesn't have), the impact of this on the economy would be extremely damaging, at least in the short term.

But is this a sound action long-term? Arguably the cause of the recession in the first place, as predicted by Hayek all along, was the very Keynesian approach of over-spending that the US Senate is clinging to now. Just like with the South Sea Company, the policy of spending money that does not exist, even for the purpose of stimulating economic growth, is one that seems doomed to not pay off. The hope is that future growth of industry, sparked by the initial investment of government over-spending, will balance out any debt that the government ends up in. In actuality, this creates a bubble that cannot be sustained forever. Every now and then, as with the 2008 crisis, the lack of real money in the system and growing government debt simply proves to be too much and the market collapses, with share prices plummeting, companies discovering that they have no free funds to pay employees or debts, and commodities growing more expensive. When more money is being spent than made, from the government downwards, the whole system turns into a delicate soap bubble, growing ever-larger by ever more unstable, filled with and supported by nothing but air.

*edit from Cassandra: "My first introduction to Keynes and Hayek was in THIS MOTHERF-CKING AWESOME VIDEO WHERE THEY RAP."

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