All that Bunk About Deficits and Skyrocketing Interest Rates

It is astounding how long experts can keep repeating the conventional wisdom in the face of -what SHOULD be - overwhelming reality.  The way things work today, the Federal Reserve sets the interest rate.  Additionally, inflation is determined primarily by aggregate demand.  We have nearly 5 years of data backing this stuff up.  Yet, the conventional wisdom marches on.

The federal reserve very plainly sets the (short-term) interest rate.  That is what they do.  It's called an Open Market Operation. When they want interests to go down they buy U.S. bonds.  That puts cash in the system and lowers interest rates.  When the Fed wants interest rates to go up, they sell their stock of U.S. bonds and remove cash from the system.  In this way the federal reserve sets the interest rate on U.S. bonds which then in turn influence other interest rates(like mortgages and car loans).  This isn't a secret.  They explain it on their website.

Despite this, we have deficit terrorists running around telling us that we need to cut social security and gut medicare right now! This very instant!  Because if we don't, interest rates will spike.  We'll have to start paying 150 bazillian% (Note:  not a real number) on the federal debt and our mortgages.  Pete Peterson, the stereotypical deficit terrorist, states the conventional wisdom very plainly.

I see two potential crises in the future: a near-term financial crisis rooted in declining investor confidence that leads to sharp rises in interest rates and forces sudden, draconian changes in the federal budget; and a longer-term economic crisis that would result from diverting more and more of our national resources to servicing debt instead of investing in areas that are essential to long-term growth. These crises are made all the more likely by the fact that growing debts aren’t just an American problem. Projections show that, by 2035, the world’s advanced economies could face debts approaching 200% of their GDP. With countries competing for scarce capital, interest rates are almost sure to rise steeply.
(emphasis added)

We are now on fiscal year 5 of approx trillion-dollar budget deficits.  I'm still waiting on those mythical bond vigilantes to spike our interest rates.

With that in mind, I found two news stories that are oh-so interesting.  The first is that Mortgage rates hit a new record low last week.  So much for worrying about skyrocketing interest rates...  But what about U.S. bonds?   Maybe those are skyrocketing?  They are still insanely low.  On top of that, there was a bond auction this week where, for every 1$ in U.S. treasuries being sold, 3.16$ was bidding to buy them.  That is a record high amount of bids.  So despite low interest rates and high budget deficits, bond holders are not only sticking with U.S. bonds, but are flocking towards them in record numbers.

In both cases, it is because the federal reserve is purposely keeping the interest rates low.  They always keep it low when they want it low and always keep it high when they want it high.  At this point, I expect someone who is well-versed in the conventional wisdom to grab his or her hair and shout, "Fed keeping interest rates low?  zOMG!  Hyperinflation!  Weimer!  Printing Press!", and then their head explodes(Note:  I cannot be held liable for exploding heads).  All I have to say is that I am still waiting on that hyperinflation.

The small, but growing community of Modern Monetary Theory(MMT) economists can explain this phenomenon better than conventional economists.  They understand how Modern money works.  How Inflation an interest rates are really set.  Unfortunately, the conventional wisdom doesn't want to hear it.  Instead, we continue to have both presidential nominees talk about budget deficits without anyone asking to explain the supposed problem.

The 401k is a Government Subsidy for Wall Street

Wall Street apologists often try to defend Wall Street by pretending that it is somehow the last bastion of laissez-faire capitalism.  Even more comical, some wall street traders have even taken to call themselves defenders of free enterprise.  The truthais, the big bank bailouts in 2008 was the continuation of a long history of government sending our money to Wall Street.  There are several ways that the government subtly helps Wall Street fund it's addiction to speculation and stock market gambling.  One of the ways it does that is through the 401k tax provision.

It shouldn't surprise us that the 401K, marketed to us as a retirement plan, is just a cash cow for Wall Street. After all, the 401k started as a tax loophole for executive pay. So why do i call the retirement "plan" of millions a "Wall Street subsidy"? Well, let's see how it works.

A 401k retirement "account" allows one to make money on financial income without being taxed on it until later. For instance, if, one year, you put 100$ in your 401k, the income tax you would've paid on it is suspended.  Not until after you've retired and pull out that money will you pay income taxes on it - long after you've made interest, dividends, and other money with your untaxed money.

On top of that, your employer will get certain tax deductions and credits for setting up and directly contributing to an employee 401k plan.  When an employer sets up a 401k, a wall street firm will charge them a certain fee.  But lo and behold, the government gives the employer a tax credit to cover some or part of the fee.  This is essentially the federal government subsidizing 401k Management firms.  Funny how we hear the financial elite complain about healthcare subsidies, but not complain about this subsidy.

The worse part is the tax-free income of the 401k.  All money made in a 401k can get reinvested and doesn't get taxed until you want to spend it.  That might make sense for business taxes that pay only on profits, but not for personal taxes.  Personal income taxes, you pay on all income.  I don't get an exemption for investing in a car that can get me to my job faster, why do I get an exemption for buying Dow Chemical stock?

A 401k locks you into handing your money to Wall Street firms by specifying what you can't do with a 401k.  You can't use your 401k savings to invest in your friend's small business(You can take out a loan against your 401k, but still have to pay it back to wall street - with Interest!).  Unless that small business is listed on the New York stock exchange or some other stock exchange(that isn't a cheap(pdf) or easy task) and there is a mutual fund that invests in it(very unlikely).  Once Wall Street has your money via your 401k, they have it until you retire (unless you're willing to pay a huge fee, of course).

Some might think the answer is to boycott funding our 401ks.  Something akin to the Move Your Money campaign.  That campaign was trying to defund Wall Street by moving our money from the large commercial banks to local banks or credit unions.  But that won't work as well.  Moving to a local bank or credit union didn't involve losing much money.  In fact, it often means gaining money because credit unions often have better interest rates.  With a 401k, boycotting it means "leaving money on the table".

Because the government incentives employers to have as many employees to participate as possible, they offer matching funds(which are tax-deductible) that employees wouldn't get if they don't participate in the 401k.  If an individual employee doesn't participate he is losing money because of the government subsidies.

So what does this all amount to?  The federal government pays employers to setup 401k "retirement" funds that can only invest in financial assets that Wall Street firms control, pays employers to get as many people to participate as possible, and then gives employees tax breaks to go along with it.  The "defenders of free enterprise" are suspiciously quiet on this racket.

You might think I'm exaggerating the importance of the 401k in directing money to Wall Street.  So let's look at the numbers.  The 401k law went into effect in 1980.  In that year, the percentage of people who owned stock was 13%.  A slight dip from 15% in 1970.  By 1989, the number was 32% - More than double 9 years earlier.  By 1998 over half of the country owned stock(source for numbers here).  There is significant financial wealth to be had with 401ks.  Nearly 3 trillion dollars worth.  That is a lot of money to be sloshing around in Wall Street's computer banks.  As you can imagine that 3 trillion dollars means a lot fees for managing all that wealth.

I have no problem with people entering the wall street casino willingly.  But now we incentivise people to enter it.  Requiring people to enter it to make sure they get all the tax breaks they wouldn't receive otherwise.  This requirement means that people who are not qualified to manage their own investments are forced into it.  The power elite know this.

I used to ask the CEO, CFO of my major clients, ... often in a conference room [after] some young employee would bring in coffee, and as they would be leaving, I would ask the CEO, "Would you allow that employee to direct the investment of your account in the 401(k) plan?" They always thought I was some kind of idiot: "Of course not. I wouldn't let them touch my account with a 10-foot pole." And I said, "But you force them to manage their own!" And they are running their money into the ground.

The irony here is dripping.  First, we are assumed to be too stupid to properly save for our retirement, so we have to have tax breaks that incentivize us to give money to Wall Street to save for retirement.  But once we make the decision to hand our money over, then suddenly we are magically smart enough to manage our own stock portfolio.  As you can imagine, most aren't educated nor have enough time to make informed decisions.  This disparity reflects poorly on those who most need a retirement plan.  Only the highest educated and most familiar regularly beat the system and maximize their gains.

I think what should happen is that this 401k tax loop-hole should be closed and in exchange we all get a general income tax cut(starting at the bottom bracket).  If we are all taxed less on our work and labor, we will have more money to save.  Then we can all decide on how best to save for retirement beyond Social Security.  Some might still enter the wall street casino that are knowledgeable enough, others might choose other routes like paying off mortgages early, or others still might try to build a small business.

The point is, we shouldn't let Wall Street use the tax code to force us all into the same option.  That would be a real "free market" principle.  You would think all those big bankers would be all for that.  Unfortunately, they rarely speak up when a free market principle would actually take away one of their cash cows.  People like Peter Schiff will go in front of congress and demand eliminating the minimum wage, unemployment benefits, and anti-discrimination laws, but not once has he ever suggested eliminating the 401k or any of the other canards that direct money to investment firms like the one he owns.  So much for our "defenders of free enterprise".

General Theory Study Guide: Chapter 2, Sections VI and VII

In Section VI, Keynes gives "Classical Economics" a final blow.  He starts to build his case that Money has an effect on the way an economy works.  The thought that the principles of a barter economy can be applied to a monetized economy was strong.  In fact, it is still strongly believed by Austrian Economics that barter is a useful model for monetized economies.

Keynes starts off section IV by quoting John Stuart Mill and Alfred Marshall.  This is to demonstrate the current thought which is that "supply creates it's own demand" as presumed by Mill.  The Marshall quote goes to show that the belief really is that if a person abstains from spending his income, it somehow automatically triggers a corresponding investment by himself or others.  Keynes claims this is incorrect because the two are using a false analogy between the world in which we live(a monetized economy) and a Robinson Crusoe economy of pure barter.

Keynes makes  a couple guesses as to why people have made this mistake.  The first is the strong case of Says law.  He agrees with the premise that the "income"(things it gets) of an entire community is exactly equal to it's "output"(things it makes).  This concept is confused with a (what Keynes calls a "similar-looking") proposition: "the costs of output are always covered in the aggregate by the sale-proceeds resulting from demand".  So what does that mean?  I found someone who explained it simply:

That is, I do not decide how many ipods will be made this year, but I do decide whether I want to buy one. Apple has to guess whether or not I will buy.

His other guess as to why people make this mistake is that those who believe Say's laws are basing it on individuals.  If an individual "saves" he is richer.  If every individual in the community "saves" then shouldn't the whole community be richer?  Keynes doesn't think so since.  This is his first hint at his fallacy of composition argument.

The two most important concepts from this section are:

1. Money matters.  It changes the way an economy works.  Money is not a "thing veneer" over a pure barter economy.

2.  The "classicals" are "fallaciously supposing that there is a nexus which unites decisions to abstain from present consumption with decisions to provide for future consumption."

This leads Keynes to declare that many theories of "the classicals" need to be re-examined.

Section VII

Section VII is a summary of the rest of the chapter.  Keynes summarizes the 3 biggest ideas of the classical economists(seen below) that he believes are flat out wrong.  The following ideas must all be true, or all not true.

1. The real wage is equal to the marginal disutility of the existing employment;
2. There is no such thing as strictly involuntary unemployment;
3. supply creates its own demand

Henry George, The First Progressive

Henry George(1839 - 1897) is a progressive hero that has been largely forgotten by time.  In his heyday, he was one of the most famous living Americans in the World.  Surpassed by only Thomas Edison and Mark Twain.  His most famous book was translated into dozens of languages and sold 3 million copies in his lifetime.  He was invited to speak and lecture all over the country and world, and his writings appeared in newspapers across the nation.  At his funeral in 1897, 200,000 paid their respects by filing past his casket(as a comparison, when President McKinley was assassinated 4 years later, only about 100,000 people filed past his casket.  So how did a 19th century printer, living in San Francisco , with no more than a 7th grade education become so famous?  And why was he forgotten?

Henry George went on a quest to find out why there is poverty among so much progress and wealth.  The result of his quest was a book called Progress and Poverty.  He started writing in 125 years this month.  Except for some anachronisms, the book could be mistaken for being written in any decade between then and now.  If you read it today, you could easily think it was written last year .  All the problems he describes are still problems today.  All the excuses that he debunks as causes for these problems are still repeated today.  Here is the opening of Progress and Poverty.

THE NINETEENTH CENTURY saw an enormous increase in the ability to produce wealth. Steam and electricity, mechanization, specialization, and new business methods greatly increased the power of labor.
Who could have foreseen the steamship, the railroad, the tractor? Or factories weaving cloth faster than hundreds of weavers? Who could have heard the throb of engines more powerful than all the beasts of burden combined? Or envisioned the immense effort saved by improvements in transportation, communication, and commerce?...
[snip]
...Yet we must now face facts we cannot mistake. All over the world, we hear complaints of industrial depression: labor condemned to involuntary idleness; capital going to waste; fear and hardship haunting workers. All this dull, deadening pain, this keen, maddening anguish, is summed up in the familiar phrase "hard times."

Does that not sound like it could've been written last year?  Change the century and replace the inventions with more recent inventions like robotics and computers, and this could be an Op-Ed in yesterday's New York Times.

Henry George described the conditions of the poor as, in many ways, worse than ancient man.

Nevertheless, no one who faces the facts can avoid the conclusion that -- in the heart of our civilization -- there are large classes that even the sorriest savage would not want to trade places with. Given the choice of being born an Australian aborigine, an arctic Eskimo, or among the lowest classes in a highly civilized country such as Great Britain, one would make an infinitely better choice in selecting the lot of the savage.
Those condemned to want in the midst of wealth suffer all the hardships of savages, without the sense of personal freedom. If their horizon is wider, it is only to see the blessings they cannot enjoy. I challenge anyone to produce an authentic account of primitive life citing the degradation we find in official documents regarding the condition of the working poor in highly civilized countries.

Today, conservatives berate the poor for having cell phones and TVs.  They use it as evidence that poverty is not a problem in America.  Henry George had an insightful response that is still relevant to this day.

Yes, in certain ways, the poorest now enjoy what the richest could not a century ago. But this does not demonstrate an improvement -- not so long as the ability to obtain the necessities of life has not increased. A beggar in the city may enjoy many things that a backwoods farmer cannot. But the condition of the beggar is not better than that of an independent farmer. What we call progress does not improve the condition of the lowest class in the essentials of healthy, happy human life. In fact, it tends to depress their condition even more.

Henry George was very progressive when it came to other cultures.  At the time, it was common to blame poverty on nature or racism.  For instance, the Irish were too dumb when they depended so heavily on potatoes, India and China were overpopulated.  These were popular myths for why these countries were or had so many poor.  Henry George demolished all of them.  All he had to do was point out how well off the elites were in each of these countries.

Another popular explanation of why the poor were poor, was based on good old fashioned classism.  That is, the poor are poor because they are lazy, criminally inclined, or just generally rude(sound familiar?).  Henry George had a great retort for these people too.

In society as presently constituted, people are greedy for wealth because the conditions of distribution are so unjust. Instead of each being sure of enough, many are condemned to poverty. This is what causes the rat race and the scramble for wealth. An equitable distribution of wealth would exempt everyone from this fear. It would destroy greed for wealth, as greed for food is destroyed in polite society. 

On crowded steamers, manners often differed between cabin and steerage, illustrating this principle of human nature. Both had enough food. However, steerage had no regulations to insure efficient service, so meals became a scramble. In cabin, on the contrary, each was assigned a place, and there was no fear of not getting enough to eat. There was no scrambling and no waste. The difference was not in the character of the people, but simply in the arrangements. A cabin passenger transferred to steerage would participate in the greedy rush; a steerage passenger transferred to cabin would become respectful and polite.

In other words, the negative behavior attributed to the poor is not the reason they are poor.  Rather, the behavior is a result of being poor.  This argument, and all other arguments boiled down to a refutation of Social Darwinism.  The crude theory that the poor are poor because they suck, and the rich are rich because they are awesome.  Henry George expertly busted this mythology that the elite told themselves.

Finally, the reason I call Henry George the "First Progressive" isn't just because he argued against Social Darwinism.  The reason is because he was the first popular figure to do so, that didn't blame capitalism and turn to a marxist solution to solve the problem.  From his preface to the fourth edition to Progress and Poverty.

What I have done in this book is to unite the truth perceived by Smith and Ricardo with the truth perceived by Proudhon and Lassalle.  I have shown that laissez faire—in its full, true meaning—opens the way for us to realize the noble dreams of socialism.

He blamed what he called the "Land Monopoly".  The details, and his solution, to the problem are too long for this already long post.  Just to give you an idea, he redefined the class fight from being capitalists VS. workers as Marx did, to Land(and other) Monopolists VS.  "real capitalists"workers.  His book is an easy read and is free on the web and as a pdf.  I think you'll enjoy it if you give it a chance.(my only recommendation is to skip chapter 5 in book III - it's a little convoluted)

As for why he has been largely forgotten, I can only speculate.  Maybe because he billed himself as an "economist" yet he expounded on classic political economy.  At the time of his writing, the world of economics was moving onto the "neoclassical" economics that we are more familiar with today.  Maybe the elite wanted us to forget about him.  Unlike figures like Adam Smith and Thomas Jefferson, they couldn't "rehabilitate" his legacy to make him appear as a conservative.  Perhaps it is as innocent as later economic figures like John Maynard Keynes over shadowing his legacy.

Whatever the reason for Henry George being forgotten, it certainly isn't because his work is no longer relevant, nor is it because his proposed solution was a bad idea(ever city, state, or province that has tried it has had enormous growth).    Here's to remembering a man that deserves to be remembered.

General Theory Study Guide: Chapter 2, Sections III, IV and V

In these sections, Keynes finishes demolishing the classical understanding of unemployment that he started in section II.  By the end of section V, his theory of employment should start(START!) coming into focus.  If by the end of section V, you don't understand his argument of why there is involuntary unemployment in a money economy, I would reread sections II through V over and over until you do before moving on.

Section III

Section III starts off by repeating that workers have no mechanism to lower their own REAL wages across the economy.  This is such an important point, Keynes can be forgiven if he repeats it a couple (or even a hundred) times.  Workers can only cut their dollar-wages, but that doesn't necessarily lower their REAL wage. Understanding this is critical to Keynesian economics.  From Section III

In other words, the struggle about money-wages primarily affects the distribution of the aggregate real wage between different labour-groups, and not its average amount per unit of employment, which depends, as we shall see, on a different set of forces. The effect of combination on the part of a group of workers is to protect their relative real wage. The general level of real wages depends on the other forces of the economic system.

I cannot over stress the criticality of understanding this.  Keynes is pointing out that because people make their deals in money-terms and not REAL-wage terms, there is no way for workers to increase the general level of employment by accepting wage cuts.  Even if workers start a cycle of slashing their wage demands, all that will happen is either the price of what they're making is slashed or their wages will be redistributed to other groups.  If all workers lower their dollar-wage, it redistributes wages to capital or land in the form of interest and rent.

More detail on how and why this is will be explained later and throughout the book.  For now, just understand that Keynes rejects the notion of obstinate workers as an explanation for involuntary unemployment.

Keynes also points out now why it is actually logical(remember how the Classicals thought it illogical) for workers to resist reduction in dollar-pay, but not resist loss of REAL wages from a sudden increase in the cost of living.  A rise in cost-of-living affects all industries equally and happen so often that resisting them is impractical.  Of course, Keynes, being thorough, does point out that there are exceptions when things go to the extreme(i.e. A very high increase in cost of living).

Section IV
Section IV is where Keynes takes up the task of defining involuntary unemployment.  He makes some obvious caveats about his definition and existing definitions first(you shouldn't have a problem with theses).  Then he gets to his definition.  It is a complicated definition:

Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment

Fortunately, if you have a hard time deciphering this "an alternative definition, which amounts to the same thing, will be given in the next chapter".  What he's saying here is if the cost of living rises, but dollar-wages stay about the same, and more people are working after the rise than before the rise, then there was some involuntary unemployment.

Keynes in this section then reiterates that his problem with "the classicals" isn't their reasoning, it is their assumptions.  They have assumed, whether they realize it or not, that "Full Employment" already exists.

Section V
In this section Keynes comes puts and explicitly states that he does believe a reduction in REAL wages will in fact increase employment(assuming land and capital remains even).  He is not disputing this.  Only thing he is disputing is the ability for workers to cut their REAL wages.  At the end of the section he states, "The theory of wages in relation to employment... cannot be fully elucidated, however, until Chapter 19 and its Appendix have been reached."

General Theory Study Guide: Book 1, Chapter 2, Sections I and II

To start off Chapter 2 of "The General Theory of Employment, Interest, and Money", Keynes makes a keen observation of the economics profession.  That there is a tendency to talk more about how an economy distributes its wealth, and not how to produce more wealth as well as what determines the employment of the available resources.  He attributes this to be because classic political economists believe that the answer is so simple and obvious it is barely worth mentioning.   However, since Keynes is planning on refuting much of it, he'll prove that he understands the "classical" position by restating it.  In Section 1,  Keynes restates the classical position on several economic items, including: What determines wages, the "types" of unemployment, and how to reduce unemployment.  In section II, Keynes starts to refute some of these by implying that there is the possibility that there is another type of unemployment.

Section 1 is just a restatement of the "classical" view of wages and unemployment. Keynes uses Professor Pigou's writings as representative of the mainstream understanding of economics.  The reason is that Pigou was, at the time, the head of the world renown school of economics at University of Cambridge.  He studied under Alfred Marshall.  I would probably compare Pigou to Larry Summers or Greg Mankiw.  A well-known, influential economist who mostly adheres to conventional wisdom.

The classical view of wages is the typical supply vs. demand curve, like the one below, that we're all used to seeing.  The value of the worker to the company sets the demand line.  The willingness of workers to give up their time sets the supply line.

The classic postulate allows for only two types of unemployment.  The first is "frictional" That's a fancy way of saying someone is literally "between" jobs for various reasons.  For instance, was just laid-off and is looking for another job.  The other type is 'voluntary' unemployment.  And I purposely use quotes around voluntary.  This is unemployment where a person or persons either doesn't want a job, or is holding out for more pay.

From this, Keynes lists the 4 logical ways to increase employment according to the Classic economists:(I'm paraphrasing)

A)  Better policies to make "frictional" unemployment end quicker.

B)  Make workers more willing to give up their time(to eliminate so-called "voluntary" unemployment)

C) Make workers more productive so that companies are willing to hire more at the current wage

D) All Labor becomes cheaper as compared to everything else a company(or "firm") needs to make its products

Before going to Section two let's look at the two categories of unemployment the classic economists recognize vs. those that we recognize today.  Today, economists recognize "frictional" unemployment, just like pre-Keynes's classic economists.  Today, we also recognize "structural" unemployment.  Since structural unemployment just means workers don't have the skills or knowledge to do the jobs that are available, we could categorize that as long-term frictional unemployment that the classics recognize.  That means the only point of contention between classics and today is Voluntary and "Cyclical".    "Voluntary" unemployment isn't even considered a "type" of unemployment these days.  The other category we have today, "cyclical" is what Keynes is introducing to the world.  It is appropriate that these are the types that the others don't recognize.  Because, in section II, Keynes will introduce what people will one day call "cyclical" unemployment.  However, what we call cyclical unemployment today, classical economists would call "voluntary".

Section II

In this section, Keynes is calling "Bullshit!" on the classical theory as he describes in section I.  the mainstream view of the time was that if unemployed workers would just quit being so obstinate and agree to a decrease in wages, then they could get a job and end mass unemployment.  Therefore, mainstream economists believed that massive "cyclical" unemployment was really just a type of 'voluntary unemployment'.  Keynes takes 2 issues with this.  The first issue is covered in this section and is only a minor issue.  The second issue is the "fundamental" issue and will be described in this book.

To start off explaining his first issue, Keynes again demonstrates his understanding of classic economics.  In classic economics, economists always assume that the money(or dollar) wages workers agree to are always the same as the REAL wage(i.e. adjusted for inflation) that they would work for.  Logically, if a worker would quit if an employer cut his salary by 10%, then a worker would also quit if prices of products rose 10%.  This seems logical because in both scenario's workers are getting 10% less stuff in the end.  Classical economists agree with this logic.

Keynes points out that this doesn't happen in the real world.  Workers will not resist short term REAL wage cuts that come in the form of rising prices, but do resist short term dollar cuts in wages.  As Keynes puts it, "whether logical or illogical, experience shows that this is how labor in fact behaves."  Keynes claims that the  Classical economists actually acknowledge that a short term drop in REAL wages won't lead to workers quitting - but they assume that. since it's a short term thing, it isn't a significant departure from their theory. Keynes disagrees. If dollar-wages aren't solely dependent on REAL wages then the whole classical theory of employment falls apart.

The second issue is the more fundamental issue to Keynes. Wage workers have no way to lower their own REAL wages as a group, they have only the ability to redistribute REAL wages.  Here is what I think Keynes is getting at:  An individual can always agree to lower his or her own wages to get a job.  However, that act alone will not increase employment, instead what will happen is that someone else becomes unemployed.  If labor as a group lowers it's REAL wages as a group, the number of workers won't increase, instead, the income will only be redistributed to non-labor input.  He doesn't say what that input is, but I assume he means capital and land.  Explaining how and why this all happens is the purpose of this book.

Happy B-day to 2 Misunderstood Men: Adam Smith & J.M. Keynes

It is a fun fact that both the "founder" of economics, Adam Smith, and "founder" of macro economics, John Maynard Keynes, share the same birthday.  It is a not so fun fact that both men and their theories are so misunderstood by, not just the general public, but by other economists as well.  I realize I'm a day late on wishing them a happy birthday, but I'd like to give them both a belated present:  Clearing up some common misconceptions of their work.

Adam Smith was a compassionate person who cared greatly about morality, the well-being of humanity, and the poor.  Before publishing his famous economic Treatise, The Wealth of Nations, he published The Theory of Moral Sentiments.  A book that starts out with (bold emphasis mine)

How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortunes of others, and render their happiness necessary to him, though he derives nothing from it, except the pleasure of seeing it... a matter of fact too obvious to require any instances to prove it

Smith was certainly no "let the poor fend for themselves or die" Ayn Rand disciple.  Despite this, the right wing in this country attempts to portray Smith as their mascot.  Even to the point of naming right-wing institutes after him.  So let's take a look at some of his views that would get him drummed right out of the republican party, tea party, and the general conservative movement.

Adam Smith recognized "the rich" taking advantage of the poor.  This excerpt is from From Book I, chapter 11 of the Wealth of Nations. (bold emphasis mine)

Rent, considered as the price paid for the use of land, is naturally the highest which the tenant can afford to pay in the actual circumstances of the land. In adjusting the terms of the lease, the landlord endeavours to leave him no greater share of the produce than what is sufficient to keep up the stock from which he furnishes the seed, pays the labour, and purchases and maintains the cattle and other instruments of husbandry, together with the ordinary profits of farming stock in the neighbourhood. This is evidently the smallest share with which the tenant can content himself, without being a loser, and the landlord seldom means to leave him any more.

In his day, Smith didn't use the term 'the rich' or the '1%' to describe wealthy people living off of the working class.  In his day they were called land lords and he didn't particularly care for them.  In this day and age he'd be accused of "envy" and "class warfare".  The excerpt above is just one of many that paints a negative view of landlords.

One last thing on Adam Smith.  If you were to claim Adam Smith's principles of taxation as your own, your right-wing friends and relatives would label you a socialist. It's really that first principle that would get smith labeled a socialist and thrown out of the tea party. From Book 5, Chapter 2, part 2. (bold emphasis mine)

1. The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state...
2. The tax which each individual is bound to pay, ought to be certain and not arbitrary...
3.  Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenient for the contributor to pay it...
4. Every tax ought to be so contrived, as both to take out and to keep out of the pockets of the people as little as possible, over and above what it brings into the public treasury of the state...

I'm not saying Smith would be a liberal or a democrat if he were alive today.  But I am saying he'd be a lot closer to one than he would be to modern conservatives.

Now let's move on to Keynes.  John Maynard Keynes was a pro-capitalist, anti-communist British economist.  His biggest contribution to economics was a coherent theory showing that when it comes to analyzing a modern economy, money matters.  Up to that point, many thought that one could apply the principles of a barter economy to a monetary economy.

The common perception is that Keynes's big contribution to economics was that "demand creates its own supply" as opposed to "Say's law" which stated "supply creates its own demand".  If that was the only thrust of his argument, people wouldn't still be talking about him.  Economists had been making that argument since the time Say made his law.  It was the underlying theory behind his conclusion that made him famous.  Keynes arrived at his  "demand creates its own supply" conclusion based on his analysis of money and it's effect.  There was a reason his major book was called "The General Theory of Employment, Interest, and Money" not "The General Theory of Employment, Interest, and demand".  There was a reason that the prequel to "The General Theory" was called "A treatise on Money" and not "A Treatise on aggregate demand".  If you still don't believe me, read this excerpt from the Preface to "The General Theory".

When I began to write my Treatise on Money I was still moving along the traditional lines of regarding the influence of money as something so to speak separate from the general theory of supply and demand. When I finished it, I had made some progress towards pushing monetary theory back to becoming a theory of output as a whole.
[snip]
This book, on the other hand, has evolved into what is primarily a study of the forces which determine changes in the scale of output and employment as a whole; and, whilst it is found that money enters into the economic scheme in an essential and peculiar manner, technical monetary detail falls into the background. A monetary economy, we shall find, is essentially one in which changing views about the future are capable of influencing the quantity of employment and not merely its direction.

There is something else about Keynes.  He shows that, because of money, the state must play a role in the economy to maintain full employment.  This has spawned two common misconceptions:  One is that conservatives demonize Keynes as the second-coming of Karl Marx.  The other is that in a recession, the government should spend money all willy-nilly until the recession is over.

For the first misconception, Keynes seemed ready for the attack.  In the last chapter of "The General Theory" he states several times he is no socialist and does not advocate it.

But beyond this, no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community.
[snip]
To put the point concretely, I see no reason to suppose that the existing system seriously misemploys the factors of production which are in use.  There are, of course, errors of foresight; but these would not be avoided by centralizing decisions.
[snip]
But there will still remain a wide field of the exercise of private initiative and responsibility.  Within this field the traditional advantages of individualism will still hold good.

Finally, if your only understanding of Keynes is, "use government stimulus to get out of recessions", you haven't fully understood him.  Keynes made clear that in a monetary economy, there is chronic under-consumption and under-utilization of resources.  Even during expansions there is a need for "social investment" (though not necessarily as much).  If the government can always guarantee full employment levels of spending, the private sector will respond by making their own investments and thereby cut the amount government needs to make.  There's much more to Keynes than just his conclusion of demand management.  But they'll have to wait as this post is too long already.  They'll have to wait until next year.