Brains Not Included

Cracked Up, Whacked Out and Completely Out of Control

Keynesian Kooks – Why Keynesian Theory Doesn’t Work

KeynesianWhose Theory is This?

Keynesian Theory was developed by John Maynard Keynes, a man who would eventually have the royal title of Duke bestowed upon him in England.  Born in 1883, he came to prominence as an economist and philosopher around the time of The Great Depression. 

 His theories were adopted by the government in England in the late 1930’s and were eventually adopted by the Americans towards the end of World War II.  Essentially he believed that government could and should control capital in order to abate the swings in unemployment that can be typical in capitalist economic systems.

His theory basically states that high rates of savings by the population should be discouraged because those rates of savings hamper growth.  He also believed that supply drove demand not the other way around.

One of his largest critics was Milton Friedman who believed there were some basic flaws in Keynes theory.  One of the things that bothered Friedman the most was that much of Keynes economic themes were based on his feelings or his philosophy and had very little to do with actual mathimatical formulaic proof.

Friedman actually disproved Keynes theory that supply created demand and proved mathematically the opposite was in fact true.

What is the Keynesian Theory of Economics?

Simply put, Keynesian theory states that government can place capital more efficiently than the private sector.  When government controls capital and directs its placement through taxation and heavy regulation or through deficit spending, then swings in economic cycles are flattened and full employment is brought into equilibrium for long periods of time.

It further hypothesizes that high savings rates are unsafe and destabilize the economy and that only low savings rates and high rates of spending by the population can sustain growth and fuel stable economic cycles. 

Therefore, when the public is saving in large numbers, the government must encourage spending through regulation and if government cannot encourage spending then it should tax heavily in order to put the saved money to work in the economy.

Why Keynesian Theory is Still a Theory

Keynesian Theory is still a theory because it’s never been proven to work.  While America embraced Keynesian Theory in the lat 70’s under Nixon and Carter, the British were quickly squeezing the vestiges of this failed theory out of their government.

Theories remain theories until they are proven at which time they receive the title of Rule or Law.  We don’t call it a law because the theory’s concepts have failed time and again.  If it worked we would call it a Keynesian’s Law or the Keynesian Rule.

Milton FriedmanCommon Sense Shows Us the Way

Think about the two basic tenants of Keynesian Theory.  1.)  That saving is bad and; 2. )  That capital in the hands of a few (the government) is better than the profit motive of capital in the hands of many.

Instinctively we know that having savings is good.  ‘Save for a rainy day’… ‘Neither a beggar or a borrower be’…  ‘Waste not, want not’…  All of these wise old sayings are telling us something.  SAVE FOR A RAINY DAY!  Saving is a good thing.

Next lets take a look at human nature.  How good would a person have to be if you put millions, billions or even trillions of dollars in their hands and said, this doesn’t belong to you but you have complete control over it? 

Now the rules say this person can’t use their emotions in deciding what to do with the money and they can’t let their personal opinions play on their decisions, but…  How does this person or these few people in control that kind of money keep their own human nature in check? 

They don’t, just look at the Marxist utopia that should have bloomed from the Bolshevik revolution.  Instead of Utopia we got the USSR.  Socialism and Communism are the end result of basic Keynesian Theory.

Friedman Got It Right

Milton Friedman used mathematics to prove his economic theories and to disprove Keynesian Theory.  While Keynesian approached economics from the viewpoint of philosophy first and mathematics second, Friedman comes at from the other side.

While the Keynesian experiment was all the rage in Europe and was being put into practice in the U.S.A., Friedman was being decried by his piers for his opposition to this ‘enlightened’ economic theory. 

But, armed with the mathematical facts and penchant for philosophy himself, Friedman was able to write one of the greatest books of all times.  Capitalism and Freedom is a must read for anyone that wants to understand why Capitalism works and how it creates freedom.

We can try Keynes ideas one more time, but doesn’t make more since to turn to the logical rules that are proven and documented for us by Friedman?  Capitalism may give us some ups and downs in our economy, but it is still the worlds last best chance for strong free societies where people have an opportunity to live free from tyranny and where people are free to live their lives as they see fit!

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When the Roof Leaks Put a TARP On It

The night was stormy.  The wind was trashing and thunder was crashing and trees were falling all around us.  It was a horrible storm.  The rain was coming down in sheets and water flowed through a gash in the roof filling bucket after bucket with water.

The next day we surveyed the damage.  After pulling a huge tree limb out of the roof it revealed a gaping hole.  Something had to be done so a huge blue tarp was strung across the house.  It was a temporary fix but it worked until the roof could be repaired and all could be made right again.

In a way, this is what has happened to our economic system and isn’t it appropriate that the government would name the portion of HR 1424 Emergency Economic Stabilization Act that is designed to stabilize home ownership T.A.R.P. (Troubled Asset Relief Program)

Many people ask me what this bill is all about and the answer is complex.  You see the bill is about a lot of things.  Some of what is in the bill is important, however I am sad to say that there is a lot in the bill that is not.  So let’s focus on what is important in the bill and for the time being, leave the pontification of what should not be there to the pundits.

One of the most important parts of this bill is the TARP (Troubled Asset Relief Program).  The TARP is the portion of the bill that gives the Secretary of the Treasury the authority to purchase non-performing and under-performing loan assets from banks.  This huge fund should start to get all of the bad loans out of the credit system so that the real value of the loan pools that are performing can be determined.

The American economy, our financial house, has just been through a really bad storm.  The TARP is there to temporarily cover the hole in the rough until it can be fixed properly.  It is truly and temporary fix.

However, don’t fret, there is a portion of this bill that is designed to permanently fix the hole and put our economic house in order.  After the Sec. Tres. buys these troubled assets he has several tools he can use to transform the troubled assets from worthless pieces of paper into valuable streams of income.

  • First, the bill gives the Secretary the ability to adjust non-performing loans.  The secretary can lower the interest rate, lower the loan balance or reset the loan to a 30 year fixed.  He can do one or all of these things to help the borrower stay in their home and to make the home affordable based on the current income of the homeowner.  This should allow the homeowner to start making their payments on time and should turn a non-performing asset with no value into a performing asset that can be sold for a profit.
  • Second, the Secretary has the authority to insure the payments on the new loan.  If the secretary feels that the new loan would sell faster and for more money in the tertiary market if it were insured, the secretary can add a premium to the payment.  This premium would insure the loan for up to 100% of it’s payment if it went into default.  Essentially this means that anyone purchasing the loan as an investment would have no downside risk.

As I said, there is much more in this bill that can be discussed.  Much of it has to do with technical issues relating to how banks lend to each other and how they borrower from the Fed.  The bottom line is that the TARP is the major portion of the bill that will help homeowners and that will stabilize the real estate markets.

So we’ve decided to do something about the hole in the roof caused by the storm.  We’ve put a TARP over it to stop the damage.  Now let’s hope our politicians have the knowledge and foresight to take the next steps to do the hard work to remove the TARP as quickly as possible and truly fix the gaping hole in our economic house.

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