Having recently reread Richard Heilbroner's hoary old monograph, "The Worldly Philosphers", I come armed with wisdom for these bleak economic times, not unlike Don Quixote, astride his faithful Rocinante.
Perhaps at the end of the day, historians of economics will come to view John Maynard Keynes as the Einstein to Adam Smith's Newton. Undoubtedly Smith's law of supply and demand will always enjoy the central stage of economics, just as Newton's laws of motion do for physics. But might I gently remind the dear reader that Newton's laws are wrong (however undetectable that may be for human speeds and masses). So too, Keynes found major flaws in the optimistic dynamics and equilibrium implied by Smith, and hence could be the most important and consequential economist since.
Perhaps the key to his work lies in the re-conception of savings. For a long time, the saving of money was considered an unmitigated private and public virtue; a habit that redounds multipliers on the foresighted family or state, without a doubt.
Not so for Keynes! The act of saving, removes wealth from circulation. That money under the mattress is no longer spent on goods and services that contribute to someone else's income. That someone else, too has less income to spend, so the effect multiplies. If everybody stashes too much of their earnings, the national income plummets and a depression sets in.
"Wait wait," you say, "Now just how does depression settle in so comfortably and uninvited?" Well I ask you to consider the lowly widget factory: The widget factory sees a drop in demand, because people have decided to save their money rather than spending it on widgets. So the factory is forced to lay off some of its employees and cut the pay of still others. Moreover, in order to make ends meet, the CEO decides it is necessary to reduce investment in promising new widget technologies, especially considering that it is unkown how long this savings binge will last. This contributes to a general decline in investment which throws the investment-savings differential still further out of whack and the wheels come off of the economy as it loses its unplanned Smithian efficiency. Prices and inflation rise and all hell breaks loose, in the academic vernacular.
Hence we come to the Bush Administration's much maligned encouragements after 9/11 to go out and spend money. Perhaps this was a strange thing to say at the time, but it was rooted in a belief in Keynesian economics: that a sudden clenching of the pocketbook might lead to depression.
So stashing money under the mattress is a surprisingly bad thing indeed. Tisk tisk! But not quite as bad as all that, is putting it in the bank. The bank takes your money quite happily and lends it out as new investment capital, with interest. Thus, your money finds its way back into circulation, and joins the happy cycle of income to income, and all is well with the world.
Or is it? What happens when there is too much money in the bank? There are simply not enough investors applying for loans. What if the differential between investment and savings is huge and sudden? Pop! The bubble bursts. National income plummets and depression sets in. So even with the cool invention of banks, trouble can be had under the right circumstances.
"Okay, but could this actually happen?" says my imaginary reader; the one who, for some strange reason, has not yet wandered over to her Google, Facebook or Twitter account. Well Keynes says it can and does happen. Growth happens in spurts as new markets rapidly mature and saturate. Take the internet for example. The bubble burst in the late 90's as there was an over-investment in fiberoptic cable and the market saturated. Investment dropped precipitously as there was no longer any reason to lay new cable. This is a repetition of what happened with railroads, autos, and other markets.
So what is to be done? Are we fated to suffer the indignities of boom and bust? Besides not having a clue, this post is getting long in the tooth, so lets save it for the sequel. Anyways Rocinante is getting thirsty.
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