Monday, January 24, 2011

Keynes - The General Theory - Chapter XII

Since this chapter, The State of Long-Term Expectation, has little to do with economics, Keynes's writing is clearer than usual. Unfortunately, this clarity is devoted to little more than an ad hominem attack on the free market.

Section I: Keynes notes that the entrepreneur must concern himself with "future events which can only be forecasted with more or less confidence." Long-term expectation is then defined as "the state of psychological expectation which covers" these future events.

Section II: After noting that future events are uncertain, he explains that the state of confidence is very important in bringing these about. "But economists have not analysed it carefully and have been content, as a rule, to discuss it in general terms." This is attempt at profundity is typical of Keynes; the reason economists deal with it so little is not that is if of no importance, but that it cannot be measured. Indeed, while the American "state of confidence" is probably very weak presently, this hasn't hurt the sale of gold--or iPads. Keynes is once again guilty of aggregating disparate things.

He also points out: "There are not two separate factors affecting the rate of investment, namely, the schedule of the marginal efficiency of capital and the state of confidence. The state of confidence is relevant because it is one of the major factors determining the former, which is the same thing as the investment demand-schedule."

Section III: Keynes rhetoric is very revealing. For instance, he categorizes successful entrepreneurship as a lottery. Certainly luck plays a role, but an entrepreneur anticipates and responds to consumer demand. It is uncharitable to pretend that his only role is to be blessed by fortune.

Section IV: This can be skipped over without loss.

Section V: Keynes, looking back at The Great Depression, lampoons the role of "speculators" on the stock market. He gives five reasons why the stock market is especially precarious.

He devotes most of his space to the fourth reason. The speculators have ruined things for everyone: "It might have been supposed that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, would correct the vagaries of the ignorant individual left to himself. It happens, however, that the energies and skill of the professional investor and speculator are mainly occupied otherwise."

This focus on short-term expectation is somehow believed to foil long-term expectations. The former lack, apparently, a basis in reality, to which the latter are preferable. Yet the greater the liquidity, the less likely that the market will over value a particular stock--though, especially in the case of overt fraud, this will still happen from time to time. Keynes insisted that his was a general theory, but his concerns about speculation were devoted purely to the realm of the most recent bubble, namely, the stock market.

Section VI: Keynes writes: "If I may be allowed to appropriate the term speculation for the activity of forecasting the psychology of the market, and the term enterprise for the activity of forecasting the prospective yield of assets over their whole life, it is by no means always the case that speculation predominates over enterprise." Again, notice the rhetoric. Certain trading is bad, while other trading is good; we are not given a reason for this.

Most illuminating is Keynes insistence that the people, who obviously have no idea what they are doing, be prevented from using their money as they see fit: "The only radical cure for the crises of confidence which afflict the economic life of the modern world would be to allow the individual no choice between consuming his income and ordering the production of the specific capital-asset which, even though it be on precarious evidence, impresses him as the most promising investment available to him."

Earlier, Keynes had written: "That the sins of the London Stock Exchange are less than those of Wall Street may be due, not so much to differences in national character, as to the fact that to the average Englishman Throgmorton Street is, compared with Wall Street to the average American, inaccessible and very expensive." So the problem is not merely with speculators so much as it is with, well, poor people. Keynes has much less of a problem with allowing the rich to invest their money.

Section VII: Here we come to Keynes's famous "animal spirits":

"Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits — of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die; — though fears of loss may have a basis no more reasonable than hopes of profit had before.

This comes in a chapter diametrically opposed to any notion of rationality in the markets. Since it is all a game, it is important that the confidence of man be stimulated so as to keep the charade going. Obscured is an economic reality, which can be recognized by man.

Moreover, an irrational optimism is more dangerous than pessimism. If people are overly optimistic, they will, for instance, build houses where none are needed; this wastes scarce resources. On the other hand, if the government refrains from distorting the market, a fall in prices will eventually bring forth investment. Since man must consume in order to live, the animal spirits must eventually revive.

Section VIII: Having demonstrated his lack of faith in the ability of people to handle their own economic affairs, Keynes turns to omnipotent government to save us from ourselves:

"I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organising investment; since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital, calculated on the principles I have described above, will be too great to be offset by any practicable changes in the rate of interest." Coming at the end of this chapter, I can only call this implicit approval.

Surely the government, investing other people's money, will only do so with the most perfect of intentions. Even bridges to nowhere are evidence of the brilliance of our masters, who would never focus on the next election at the expense of the long-term. Keynesianism is often seen as a moderate path between capitalism and socialism, but we see here that it was far closer to the latter.

UPDATE: One of the recent Planet Money podcasts dealt with one of the examples from this section of the book. Interested parties ought to check it out.

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