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Failure of the New Economics

Failure of the New Economics

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Published by: Educators of Liberty on Jan 25, 2009
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Just as Keynes was astonished to find that his "new" opin-
ions had been anticipated by the mercantilists of the seven-
teenth century, so he found that some of these opinions had
also been anticipated by modern monetary cranks. But in
the second case as in the first, instead of taking this as a
warning to re-examine his assumptions and deductions, he
greeted the agreement as a confirmation of his new doc-

And one of those whose reputation he tried to rehabili-
tate was "the strange unduly neglected prophet Silvio
Gesell" (p. 353). Gesell had attracted some attention in the
economic underworld by proposing a form of money that
would automatically lose part of its value every month, like
a rotting vegetable. His proposed method of achieving this



was to require the holder of every currency note to have it
stamped each month, with stamps purchased at the post of-
fice, in order to keep it good at its face value. This meant,
in effect, that people would have to pay interest to the gov-
ernment for the privilege of holding their own money.
Money held, without being stamped, would lose a fraction
of its purchasing power every month. The purpose of this
was to discourage people from saving; to make monetary
saving practically impossible; to force everyone to spend his
money, for no matter what, before it lost its value. Any one
who was wicked enough to wish to put aside money against
the contingency of illness in his family, for example, would
thus be effectively frustrated.
It is obvious that such money would never freely circu-
late except in a community of idiots unless it were made
legal tender and there was no choice but to accept it. There
was in principle nothing original in the proposal. It did not
differ essentially from the immemorial practice of coin clip-
ping, except that it would have occurred much more sys-
tematically and much more often. It combined nearly all
the evils of ordinary paper inflation with some special dis-
advantages of its own. Its sole advantage as compared with
ordinary paper money inflation is that the holder would
clearly recognize and identify the government tax, and
know precisely what the incidence of that tax was on him-


But Keynes takes it all very seriously, regrets that once,
"like other academic economists, I treated [Gesell·s] pro-
foundly original strivings as being no better than those of a
crank" (p. 353), and suggests exactly how much the monthly
stamp tax ought to be. "It should be roughly equal to the
excess of the money-rate of interest (apart from the stamps)
over the marginal efficiency of capital corresponding to a
rate of new investment compatible with full employment,"
and this figure could be determined "by trial and error"
(p. 357).

We need not linger over this particular absurdity. Even


most Keynesians maintain an embarrassed silence about it.
In this new wonderland into which Keynes has wandered, it
was the classical economists who suddenly seemed stupid
and lacking in common sense, and it was the works of the
currency cranks (for Gesell was only one of scores with simi-
lar schemes) that were full of ''flashes of deep insight."
I shall pause only to comment upon one sentence in the
course of Keynes's discussion of Gesell's ideas: "The prime
necessity is to reduce the money-rate of interest, and this,
he pointed out, can be effected by causing money to incur
carrying-costs just like other stocks of barren goods" (p.

Thus Keynes endorses the medieval idea that money is
"barren." But if money is "barren," and if (on Keynes's
own theory) interest is paid only for money itself, and never
for the yield of what it will buy, why are borrowers so fool-
ish as to agree to pay interest for money, and why are lenders
not happy to find themselves able to lend money at any rate
whatever above absolute zero? Why do people insist ei-
ther on borrowing or on holding on to something that yields
them nothing whatever? Such questions have already been
answered, not only in our previous chapters on the rate of
interest, but specifically by W. H. Hutt in his essay "The
Yield from Money Held," 6

in which he shows that money
"is as productive as all other assets, and productive in ex-
actly the same sense"; that its marginal productive yield is
constantly being equated with that of all other assets; and
that its yield, like the yield of so many other assets, consists
precisely in its availability at the moment when it is wanted
or needed. The reader may consult Hutt's essay for the ex-
pansion of this argument. It is simply necessary to point out
here that the failure of Keynes and his followers to recognize
the real yield enjoyed by the holder of money assets is one
of the most serious fallacies in their theory of interest.

6 Mary Sennholz (ed.), On Freedom and Free Enterprise: Essays in Honor of
Ludwig von Mises
(Princeton: Van Nostrand, 1956).



6. Manåevïile, Malthus, and the Misers

Section VII of Keynes's Chapter 23 comprises a discussion
of the anticipations by Bernard Mandeville, Thomas Mal-
thus, and J. A. Hobson of Keynesian under-consumption
theory. It opens, however, with a quotation from Professor
E. Heckscher's Mercantilism on the sixteenth and seven-
teenth-century "deep-rooted belief in the utility of luxury
and the evil of thrift. Thrift, in fact, was regarded as the
cause of unemployment, and for two reasons: in the first
place, because real income was believed to diminish by the
amount of money which did not enter into exchange, and
secondly, because saving was believed to withdraw money
from circulation." 7
Surely the Keynesians ought to conspire to suppress this
quotation! It so perfectly and nakedly sums up Keynes's
central "contribution" to economic thought.
Incidentally, though Keynes takes many quotations from
Heckscher's two volumes, and holds them up for admiration
of mercantilist thought, there are some passages in Heck-
scher's history that are conspicuously not quoted by Keynes.
I take one as an example—a passage concerning French
mercantilism during the seventeenth and eighteenth cen-

It is estimated that the economic measures taken in this
connection cost the lives of some 16,000 people, partly
through executions and partly through armed affrays, without
reckoning the unknown but certainly much larger number of
people who were sent to the galleys or punished in other
ways. On one occasion in Valence, 77 were sent to the galleys,
one was set free and none were pardoned. But even this vig-
orous action did not help to attain the desired end. Printed
calicoes spread more and more widely among all classes of
the population, in France as everywhere else.8

7 E. Heckscher, Mercantilism (London: Macmillan, 1935), II, 208.
8 Ibid., I, 173.


Would Keynes have presented this as another example of
the "realism" of mercantilist thought, "which deserves re-
habilitation and honor"?
Keynes next launches upon an extended series of quo-
tations from Bernard Mandeville's Fable of the Bees; or
Private Vices, Public Benefits,
which first appeared in 1714.
There is much wisdom in this remarkable poem, and
much fallacy. Keynes likes the fallacious part, and quotes ex-
tensively from Mandeville's doctrine that prosperity is in-
creased by expenditure and luxurious living, and reduced
by thrift and prudence and saving. It is a little late to start
answering this fallacy of Mandeville's; the classical econo-
mists did it quite adequately, and I shall excuse myself
from repeating the task. Besides, we shall have a chance to
answer the same doctrine as formulated (much more guard-
edly) by Malthus.
For after praising Petty for his statement in 1662 justify-
ing "entertainments, magnificent shews, triumphal arches,
etc." on the ground that their costs flowed back into the
pockets of brewers, bakers, tailors, and shoemakers (p. 359),
and after deprecating, by contrast, "the penny-wisdom of
Gladstonian finance" (p. 362), Keynes comes to "the later
phase of Malthus," where "the notion of the insufficiency
of effective demand takes a definite place as a scientific ex-
planation of unemployment" (p. 362). He quotes prac-
tically two full pages from Malthus, from which I shall take
two passages; for it is instructive to distinguish what was
right in Malthus's views from what was wrong:
Adam Smith has stated that capitals are increased by par-
simony, that every frugal man is a public benefactor, and that
the increase of wealth depends upon the balance of produce
above consumption. That these propositions are true to a
great extent is perfectly unquestionable. . . .9

It is important to notice that Malthus, unlike Mandeville
and Keynes, does not ridicule thrift as such, but only what
he considers an unreasonable degree of it.

9 Preface to Malthus's Principles of Political Economy, 1820, pp. 8-9.



It is quite obvious [he continues] that they are not true to
an indefinite extent, and that the principles of saving, pushed
to excess, would destroy the motive to production. If every
person were satisfied with the simplest food, the poorest cloth-
ing, and the meanest houses, it is certain that no other sort of
food, clothing, and lodging would be in existence.10

In still another passage (which is notable for its failure to
grasp the essential truth in Say's Law) Malthus asks: "What
would become of the demand for commodities, if all con-
sumption except bread and water were suspended for the
next half-year?" n
Now the conclusions of Malthus just quoted are perfectly
true, and even truisms, if we accept the quite unrealistic
assumptions on which they are based.
They tacitly assume
that everyone has approximately the same income, and that
everyone tries to produce more than he is interested in
consuming. And they explicitly assume that "every" person
is satisfied with the meanest house, etc. and that "all con-
sumption except bread and water" is suspended.
But it is very difficult even to imagine a community in
which everybody (or even any substantial percentage of the
population) would act in so irrational a manner as the
Malthus hypothesis assumes. It is true that there are nations
and communities that are poor because most of the people
are satisfied with low living standards. But these communi-
ties are poor not because they try to save too much out of
what they produce, but simply because they fail to produce.
Their characteristic mark is not thrift but laziness or im-
providence. They live from day to day; they are racked
periodically by disease and famine, because they do not pro-
duce enough in order to save enough to carry them through
years of bad crops or other contingencies. The people in a
community who produce above the subsistence level are in
the overwhelming majority precisely the people who want
to live and spend above the subsistence level. A community

10 Ibid., pp. 8-9.
11 Ibid., p. 363, footnote.


in which everybody strove to work enough and earn enough
to live at ten times or even twice the subsistence level, but
refused to live above a subsistence level, and insisted on sav-
ing the rest, would be a community possessed by a psychol-
ogy so irrational and so difficult to imagine that the
implications o£ the hypothesis are hardly worth working out
in much detail.

But even if we assume such a community with such a
psychology, it would at least be possible to imagine it sur-
viving successfully for the six months assumed in Malthus's
rhetorical question. For it could invest its money in capital
goods, and these capital-goods industries would give the
necessary employment to those laid off from employment on
consumption goods, and the capital-goods industries would
even earn a profit, provided they were capital goods for
which there was a real demand, and the community at the
end of the six months gave up its Spartan frugality and used
its income to buy the added consumption goods that the
new capital equipment was capable of producing. Many a
country has done something closely equivalent to this in
wartime, when it lived on a subsistence level of consump-
tion in order to support armies and produce implements of

And if, moving from Malthus's violent hypothesis toward
less unrealistic but still grossly oversimplified assumptions,
we assume a community with only two income classes, in
which the great mass, consisting of nine-tenths of the popu-
lation, has a per-capita subsistence income of x dollars, and
spends it all as it goes along, while the remaining tenth of
the population has a per-capita income of 3% dollars, but
consists entirely of misers who also spend only x dollars a
year and save two-thirds of their income, or 2x dollars per
capita, we have a community which (assuming that pro-
ducers' expectations are based on this situation) would
nonetheless progress and grow constantly richer. For the
misers would invest their money in capital equipment.
This would be used to increase production of consumer



goods, to improve the quality of such goods, and to lower
production costs. The real wages and income of both the
Masses and the Misers would increase; and as the consump-
tion of both the Masses and the Misers would increase by
the hypothesis (for the Masses would always spend their
whole incomes, and the rich Misers would individually
spend as much as, though not more than, the poor Masses
spent individually) consumption, production, and saving
would all increase pari passu.
Suppose we change the names of our classes and call the
upper 10 per cent, with the 3x incomes, the Capitalists, and
the lower 90 per cent, with the x incomes, the Workers.
Then it is the implied contention of the Aíandevilles,
Malthuses, and Keyneses that (assuming the Workers had
no surplus incomes to save) the Capitalists would maximize
prosperity by spending their full incomes, but produce de-
pression by spending only as much as the Workers spend on
consumption, and saving and investing (or vainly looking
for investment "outlets" for) the other two-thirds of their

But nothing could be further from the truth. For if the
Capitalists spent all their income on luxurious living there
could be no capital investment. In that case there would
be no increased production, and no lowering of production
costs, hence no increase in the real wages or incomes of the
Workers and no increase in their consumption. But if
the Capitalists saved and invested the whole of the excess of
their own incomes above the Workers' incomes, then all this
investment would necessarily go into capital equipment for
increasing the production of mass-consumption goods. The
investment would not only produce jobs (which is the only
consequence that Keynes seems to recognize), but it would
increase the average productivity of all jobs.
Hence it would
increase the production of consumption goods, lower pro-
duction costs, increase average marginal labor productivity
and average real wages.
In brief, even if we make the extreme assumption that


the Capitalists, or upper income class, spend no more on
consumption than the Workers, or lower income class, we
find no necessary insufficiency of investment "outlets" or
investment opportunities. Production will be increased by
the new capital investment, real costs will be lowered by it;
hence prices will be lowered (in the absence of inflation)
and real wages will therefore increase to buy the additional
product. (We are assuming by our hypothesis that there is
no sudden, uncaused, or irrational saving, but that workers
increase their consumption in proportion to their increase
in incomes and that the Capitalists consume at least as
much as the Workers.)
And directly contrary to the Mandeville-Malthus-Keynes
thesis, this extreme thrift on the part of the Capitalists
would not only not retard economic progress; it would max-
imize it. It would particularly maximize the progress of the
Masses, because the Capitalists per capita would not be tak-
ing any more out of the consumption cake per capita than
the Workers would. The surplus income of the Capitalists,
instead of going for ostentation and wasteful sybaritic liv-
ing, would be going into investment to increase the produc-
tion, reduce the cost, and improve the quality of consump-
tion goods for the Masses.

Incidentally, envy and hatred, which play such a large
role behind the schemes of revolutionary economic reform-
ers, would be minimized under such behavior by the Cap-
italists; for though there would be inequality of income
there would be equality of consumption. Ostentatious and
sybaritic living on the part of the rich, accompanied by
Veblen's "conspicuous waste," which is recommended by
implication by the Keynesians, is precisely the course most
calculated to inflame envy and resentment and social dis-

12 For an analysis of the respective effects of extravagance and thrift by the
rich on the condition of the relatively poor, see Hartley Withers, Poverty and
1914, an excellent but neglected volume. Before World War I revived
statism and inflationism, economists still dared to defend frugality. I cannot re-
frain quoting at this point, for example, from a little book by S. J. Chapman,



This is the conclusion that we get even when we make
the extreme assumption o£ two income classes in which the
higher income class saves the whole o£ its per capita excess
of income above that o£ the lower income class. We can
generalize this assumption, and bring it closer to reality,
first by assuming n different income classes, instead o£ only
two, with the poorest class having a mere subsistence per-
capita income o£ x, the next worst off class an income o£
x + 2,y, the third class from the botton an income of x + Ay,
the fourth an income of x + 6y, etc. And instead of assum-
ing that those with incomes above the minimum save the
whole excess, we can assume that they save only half of it,
and spend, respectively, x + y, x -\- 2y, x + %y, etc. Or we
can state our assumptions regarding saving and spending in
the form of a continuous function, in which those with
higher incomes not only save a continuously greater abso-
lute amount than those with lower incomes, but a continu-
ously greater percentage of their incomes. If there is no
reason to fear an insufficiency of investment opportunities
or "outlets" even under our preceding extreme assumption,
there is of course still less reason to fear such an insufficiency
under these more moderate and realistic assumptions.

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