More Keynesian fallacies and the Great Depression

Gerard Jackson

Nottrampis posted a comment criticising my attack on Keynesianism. The following is my response. It is not meant to be a rebuttal but more of an outline of my views. In the very near future I shall expand in far greater detail on each of my points.

Now where to begin:

1. Demand springs from production, not the other way round, a fact that is patently clear in a barter economy. Of course, if it were a simple case of demand bringing fourth production then poverty would never be a problem. Keep on increasing ‘demand’ and eventually you will make everyone as rich as Warren Buffett.

2. Nottrampis is confusing GDP with growth, which is what the vast majority of economists do. However, genuine growth consists of capital accumulation. (It’s actually somewhat more complex than this). Throughout the Great Depression America suffered capital consumption, a fact that was commented on at the time. (Another term for capital consumption, as you should know, is “negative growth”). On the other hand, (economists used to love that phrase) Australia was able to maintain its capital stock, if not actually increase it somewhat. Therefore, I am genuinely baffled as to how America could have been experiencing rapid economic growth at the same time as it was consuming its capital stock. In fact, America was doing so well that on 9 May 1938 Henry Morgenthau despairingly stated:

We have tried spending money. We are spending more than we have ever spent before and it does not work … After eight years of this Administration we have just as much unemployment as when we started … And an enormous debt to boot!1

In 1938 unemployment stood at 19 per cent in America, about 8.7 per cent in Australia and 11.4 per cent in Canada. (Although the figures are estimates the difference between Australia and America is still striking. The same goes for Canada). When honestly presented we find Roosevelt’s economic record to be a thoroughly shocking one.

 3. In addition, there was no underemployment in Australian factories during this period while in Roosevelt’s America widespread underemployment in manufacturing was the order of the day, as well as capital consumption.

 4. If a balanced budget set the Australian economy back why did it not have any significant effect on production and unemployment trends? This leads to the fact that right up to WWII Australia ran surpluses at the same time as unemployment continued to fall and factory output continuously rose, excepting the slight downturn of 1937 which was followed by a rapid upturn.

 5. I do not know of any classical economist who promoted deflation. Moreover, any classical economist would advise a country with an overvalued currency to allow the currency to adjust downwards. To avoid confusion on this point I should add that if the country were on a gold standard then the economist would point out that restoring market exchange rate would require either a deflation or ‘devaluation’. In fact, Ricardo was very concerned about the British government’s post-Napoleonic war deflation policy to restore parity to the pound, saying that “I never should advise a government to restore a currency, which was depreciated 30 p.c. to par”2.

 6. Australia’s ‘devaluation’ did not fuel the recovery in manufacturing, though it initially contributed to it. Once again, any classical economist would have made this point. Anyone who suggests that devaluation is somehow a refutation of classical economics has not read the classical economists – and most certainly knows nothing of the history of British economic thought.

 7. ‘Devaluations’ are not inflationary. It is absurd to suggest that allowing a currency to be set at its true exchange rate is inflationary. Having made that error, Nottrampis argued that “monetary policy could then start to work as the liquidity trap was no longer with us”. But as I explained elsewhere, under a factional reserve banking system the money supply always expands once recovery gets underway. And this is precisely what happened in Britain under the classical gold standard3.

 8. The liquidity trap is a Keynesian fiction.

9. The history of the nineteenth century Britain demonstrates that every deflation was in fact followed by a recovery, though Malthus once thought it would be otherwise. Furthermore, every competent economist at the time understood what caused the deflations. I do not know of one who welcomed them.

 10. Real wages did not fall in Australia but money wages did. However, real wages continued to rise in the US. The idea that real wages (we really should say wage rates) fell during the Great Depression is a total myth.

 11. It is inconsistent to argue that depression is the result of demand deficiency while also arguing in favour of policies designed to cut real wages out of which production is said to spring. The purchasing-power fallacy of wages had tragic consequences for America and the world.

 12. Classical economists seem to be constantly misrepresented – and always by people who have never read them. We have, for instance, Professor John Quiggin stating:

The standard classical theory suggested that depressions should not occur and, if they did, would rapidly fix themselves4.

Complete balderdash. What the classical economists said is that there would be no “revulsions” so long as the correct proportions between investment and consumption were maintained. What was under debate was the actual cause of the “disproportionalities” that marked the trade cycle. Anyone with a passing knowledge of the currency school would have known this. Quiggin is obviously another one who has not read the classical economists.

Then on the other side of the fence we have Dr Steve Kates, lecturer in economists at RMIT (Royal Melbourne Institute of Technology), who argues that the classical view of the trade cycle “was essentially a theory based on the structure of production being out of phase with the structure of demand”.

Rubbish. The The real classical theory of the trade cycle was developed by the currency school and it was a monetary theory. What Kates is preaching is basically the old Tooke-Mill banking school fallacy. Curiously enough, Kates never mentions the currency school, not even in his two books, despite its importance.

 13. Bruning implemented a policy of massive devaluation in the hope of evading reparations, not because some mysterious classical economist advised him to do so. In any case, the painful and unnecessary experience of British restoration of the pound to par after the defeat of Napoleon is proof that even extremely deep deflations can be made to work.

 14. The German devaluation did not produce Hitler, the myth that Germany was stabbed in the back, the Weimar hyperinflation and the rising power of the Communist Party produced the Nazi Party. And it was not the free market that produced the Great Depression but a gross misunderstanding of the problem that still haunts us today.

Some readers are asking why I bother with Nottrampis. Simple, you cannot refute an argument by running away from it. Nottrampis brings to this site the arguments that Keynesians use to defend their theories. He should be thanked for that. I suspect he does so not just because he knows I will answer him politely and to the best of my ability but also because experience has probably taught him that the likes of Professor Sinclair Davidson, Steve Kates and Alan Moran refuse to seriously engage Keynesians, including post-Keynesians, though they seem to be forever sneering at Keynesianism.

1Franklin D. Roosevelt Library, Hyde Park, New York, Henry Morgenthau Diary, Microfilm roll #50, May 9, 1938

2Letters of David Ricardo to Hutches Trower and Others 1811-1823, Oxford at the Clarendon Press, 1899, p 16.

3A highly detailed description of the normal process of recovery was given by Wesley C. Mitchell in Business Cycles, University of California Press, 1913, pp. 452-3. See also Part III in the same work.

4John Quiggin, Zombie Economics, Princeton University Press, 1970. p. 20.

15 thoughts on “More Keynesian fallacies and the Great Depression”

  1. after looking at these facts I don’t know how anyone could seriously argue that Roosevelt’s conomic record beat Australia’s

  2. What Gerry said about capital consumption was stunning. That ought to be a clincher but Nick is right about Keynesians, they don’t care about facts.

  3. I think the info about factory employment and capital consumption is very important. I googled our right on this and the Great Depression. There was nothing. Absolutely nothing. But I did find an article in an American magazine on the Great Depression in Australia by our very own Hal G.P. Colebatch. All he did was parrot steve Kates word for word.

    What a bunch. They really hate anybody contradicting them.

  4. Jackson is always attacking the right. Why doesn’t he go after the left for a change? It’s time Sarah and the other Jackson disciples woke up to what he is really doing.

  5. Gerry is not attacking the right. He is exposing their errors and their cowardice. It isn’t Gerry who lied, it was Sinclair Davidson and Steve Kates. And it was Davidson who told people not to read Gerry because he doesn’t know anything. Gerry doesn’t know what he is talking about? If that’s not a bloody lie then what is? It was Davidson who told catallaxy readers that this blog is a “hate site”. talk about a nasty piece of work.

    Gerry isn’t afraid to defend what he writes but they are scared stiff to defend their rubbish. Youre the one who has to wake up and not us.

  6. okay I am back from hospital.

    So firstly i would like to thank Gerry. I might not agree with him but he always brings interesting insights.

    Does production bring on demand? Well If I WANT a banana then I produce something to barter for it so I am afraid it doesn’t..

    I think on 2) we will have to disagree and I will stay with GDP.

    In terms of the US recovery. It was going along very nice thank you until the disastrous budget following the 1936 election.Moreover if Roosevelt adopted the fall in real wages wanted by Keynes (and Hawtrey) then the US economy would have gotten to full employment like Germany did in 1936.
    Roosevelt had an absurd labour market policy and was severely criticized by Keynes for this and other measures.

    If you compare the US and Australian economies from when the Depression hit then there is no comparison. They nearly got to double digits for 4 years and we had tepid growth.

    The beauty of devaluations is that they do bring on inflation which was desperately needed in Australia and the US.
    It is inflation which reduces real wages thus boosting employment and enables monetary policy to work.

    Sorry to hear to do not agree with a liquidity traps, Most central banks do! most have had to deal with it since the GFC. the BOJ has had toi since the 1990s!

    You may not know your Hayek. He strongly backed Bruning’s economic policies which produced severe unemployment , deflation and thus Hitler and no recovery.
    Hayek eventually recanted on his support for those policies.

    Are you sure about Germany and devaluation. My memory has it they left the gold standard and never devalued. I could be wrong though.

    Back to bed!

  7. and Gerry I look forward to it.
    Yours is a great blog if someone wishes to ensure their beliefs are up to speed.

    Keep it up. simply because I disagree doesn’t mean at all I do not enjoy reading your stuff.

  8. Thanks for the compliment, Nottrampis. I strive to make my stuff as informative and as accurate as I can.

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