According to Marget, Keynes Misrepresents the History of Monetary Theory; Therefore, Progress Involves Escaping the Keynesian “Blind Alley”

Arthur William Marget (1899-1962) was a respected American monetary theorist and scholar who received his doctorate from Harvard in 1926 and taught for the next fifteen years at the University of Minnesota. His best known work, The Theory of Prices (2 vols: 1938, 1942), had three goals. Marget sought to demonstrate that Keynes misrepresented the history of monetary theory, to reveal the shortcomings of Keynes’s own approach, and to show that progress required an escape from the Keynesian “blind alley” and a return to the “high road” of earlier tradition.

The book was either behind its time, ahead of it, or (as I suspect) both. The doctrinal revolution that Marget opposed swept The Theory of Prices aside. Perhaps it was imprudent of him to pursue three ambitious goals at once, for even the book’s supporters found it long and arduous. Nicholas Kaldor, a non-supporter whose review managed to misstate the book’s subtitle, called Prices I “mid-Victorian,” with its “leisurely repetitiousness, elaborate style, pompous exactitude, and . . . exhaustive scholarship,” reminding him “of the bourgeois solidity and spaciousness of that bygone age” (1939, pp. 495-6).²

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²Marget’s response (1942, p. vii): “I, on the contrary, rest my case on the proposition that if the qualities of ‘exactitude,’ ‘solidity,’ and ‘exhaustive scholarship’ are indeed characteristic only of a ‘bygone age,’ that fact constitutes a condemnation of our own age and a commentary on our current needs.”

—John B. Egger, “Arthur Marget in the Austrian Tradition of the Theory of Money,” Review of Austrian Economics 8, no. 2 (1995): 3-4, 4n.

Doubting the Validity of Aggregates and Averages Is a Dagger Aimed Straight at the Heart of Statistical Analysis in Economics

In an interesting, though apparently neglected, aside, Professor Hayek has remarked that “. . . neither aggregates nor averages do act upon one another, and it will never be possible to establish necessary connections of cause and effect between them as we can between individual phenomena, individual prices, etc. I would even go so far as to assert that, from the very nature of economic theory, averages can never form a link in its reasoning. . . .”

Now, any serious doubt concerning the validity of aggregates and averages is a dagger aimed straight at the heart of much current empirical research and statistical analysis in economics. Therefore it deserves close and systematic attention, even if this involves, in the opinion of some dedicated empiricists, an annoying interruption of the “front-line” activity of measurement for the mere purpose of “armchair” discussion of methodological issues. Yet such is our contemporary spirited march on “objective data” that one who begins to suspect that a wrong turn may have been made sometime back almost naturally feels guilty for harboring this traitorous thought, and, if he expresses it at all, must expect to be regarded as a ruminant obstructionist in the company of men of action.

—Louis M. Spadaro, “Averages and Aggregates in Economics,” in On Freedom and Free Enterprise: Essays in Honor Ludwig von Mises, ed. Mary Sennholz (Auburn, AL: Ludwig von Mises Institute, 2008), 140.

For Frank Knight, John Maynard Keynes Succeeded in Carrying Economic Thinking Well Back to the Dark Age

The Keynesian avalanche soon swept away virtually all the competing approaches, ideas, or theories with which to explain the business cycle. Indeed, there was hardly a voice in the mainstream of the economics profession that was willing or able to directly question or challenge the near Keynesian monopolization of economic thinking on problems of economy-wide fluctuations in employment, output, and prices.

When Frank H. Knight declared in his 1951 presidential address before the American Economic Association that in his view “The latest ‘new economics’ and in my opinion rather the worst, for fallacious doctrine and pernicious consequences, is that launched by the late John Maynard (Lord) Keynes, who for a decade succeeded in carrying economic thinking well back to the dark age” (Knight, 1951, p. 2) it must have created shock and disbelief among many who heard these words spoken. Few besides Frank Knight could have been so blunt without permanently risking their reputation and standing in the economics profession of that time.

What was this “dark age” back to which Keynes took economic thinking? At its core, I would suggest, was its focus on macroeconomic aggregate building blocks: Aggregate Demand, Aggregate Supply, Total Output and Employment, and the average Price Level and Wage Level.

—Richard M. Ebeling, “The Misdirection of Keynesian Aggregates for Understanding Monetary and Cyclical Processes,” in What’s Wrong with Keynesian Economic Theory? ed. Steven Kates (Cheltenham, UK: Edward Elgar Publishing, 2016), 79.

If We Want to Recover from a Depression, We Need to Restore Genuine Profits, NOT the Phony Profits of a Bubble

Keynesian analysis tells us that what is lacking during a depression is demand. Since private savings (in this view) will lie fallow, will not be invested, the only effective demand comes from consumer or government spending. But what really drives an economy is not demand; it is production. And what really drives production is profits. If we want to restore the economy, we need to restore profits, genuine profits, not the phony profits of a bubble.

A collapse of profits tells us that the price and profit system of the market has been damaged, usually by government interventions to reduce interest rates, increase wages, increase consumption, subsidize some sectors and enforce cartels in others. It is not the savers who have wrecked the economy, it is government interventions that have penalized savers and ultimately destroyed profits.

Even Keynes must have known how important profits are. In his Treatise on Money, he acknowledged that

the engine which drives enterprise is . . . profit.

By the time he wrote The General Theory, Keynes often used jargonish circumlocutions to sidestep the word profit, terms such as “the marginal efficiency of capital.” But the inescapable truth is that profit is the key to prosperity. And the way to rebuild genuine profit is to allow all prices, including interest rates and currencies, to tell the truth about the economy. In an environment of free prices, hard work, production, and saving will do all that is required, just as John Stuart Mill said they would almost two hundred years ago.

—Hunter Lewis, Where Keynes Went Wrong: And Why World Governments Keep Creating Inflation, Bubbles, and Bust (Edinburg, VA: Axios Press, 2011), Kindle e-book.

Keynes Tells Us to Praise the Mercantilist “Army of Heretics and Cranks” Who Argued for Lower Interest Rates

We should pay our respects to the “army of heretics and cranks” who in earlier periods argued for lower interest rates.

In The General Theory, Keynes acknowledged that he was refurbishing and updating

sixteenth and seventeenth century . . . [economic writers generally known as] Mercantilists.

This was ironic, because Keynes’s teachers in Britain, and Keynes himself early in his career, had regarded Mercantilist thought as a “fallacy” long since exploded.

Now Keynes saw an

element of scientific truth in Mercantilist doctrine, [especially in their view] that an unduly high rate of interest was the main obstacle to the growth of wealth [and in their] preoccupation . . . [to] increase . . . the quantity of money [in order to] . . . diminish the rate of interest.

In addition to the Mercantilists, Keynes acknowledged his debt to the economist Thomas Malthus (1766–1834), a few other economists, and even some 20th century figures, Sylvio Gesell and Major C. H. Douglas, whom he had previously dismissed as

no better than . . . crank[s].

In The General Theory, he described Gesell, best known for advocating stamped money whose value would expire if not spent by a certain date, as

an unduly neglected prophet . . . [with] flashes of deep insight.

Douglas, another proponent of what is sometimes called easy money, he somewhat backhandedly praised as

at least . . . not wholly oblivious of the outstanding problem of our economic system.

These people together Keynes called his

brave army of heretics

in which classification he happily included himself.

—Hunter Lewis, Where Keynes Went Wrong: And Why World Governments Keep Creating Inflation, Bubbles, and Bust (Edinburg, VA: Axios Press, 2011), Kindle e-book. 

Keynes’s First Claim: The Free Market’s Chronic State of Depression Is Caused by Too Much Saving and Not Enough Consumption and/or Investment

To Keynes, a state of high unemployment is a part of the normal conditions of a free market. He claims, “the evidence indicates that full, or even approximately full, employment is of rare and short-lived occurrence.” He also says, “it [the economic system] seems capable of remaining in a chronic condition of sub-normal activity for a considerable period.” To understand what Keynes means by a “condition of sub-normal activity,” one must keep in mind that he wrote The General Theory when economies were still recovering from the Great Depression and he was referring to an economy that was in a state of depression.

This chronic state of “sub-normal activity,” according to Keynes, is caused by too much saving and not enough consumption and/or investment. In Keynes’s words, “If the propensity to consume and the rate of new investment result in a deficient effective demand, the actual level of employment will fall short of the supply of labour potentially available.” . . . 

The problem of too much saving and the chronic state of depression is especially true for a wealthy society, according to Keynes. He states:

The richer the community, the wider will tend to be the gap between its actual and its potential production. . . . [A] poor community will be prone to consume by far the greater part of its output, so that a very modest measure of investment will be sufficient to provide full employment.

—Brian P. Simpson, Remedies and Alternative Theories, vol. 2 of Money, Banking, and the Business Cycle (New York: Palgrave Macmillan, 2014), 18-19.

The Problem Is Not One of “Aggregate Demand” Or “Overproduction” But Rather One of Cost-Price Differentials

But, these theorists may object, “we do not claim that all desires have ceased. They still exist, but the people lack the money to exercise their demands.” But some money still exists, even in the steepest deflation. Why can’t this money be used to buy these “overproduced” goods? There is no reason why prices cannot fall low enough, in a free market, to clear the market and sell all the goods available. If businessmen choose to keep prices up, they are simply speculating on an imminent rise in market prices; they are, in short, voluntarily investing in inventory. If they wish to sell their “surplus” stock, they need only cut their prices low enough to sell all of their product. But won’t they then suffer losses? Of course, but now the discussion has shifted to a different plane. We find no overproduction, we find now that the selling prices of products are below their cost of production. But since costs are determined by expected future selling prices, this means that costs were previously bid too high by entrepreneurs. The problem, then, is not one of “aggregate demand” or “overproduction,” but one of cost–price differentials. Why did entrepreneurs make the mistake of bidding costs higher than the selling prices turned out to warrant? The Austrian theory explains this cluster of error and the excessive bidding up of costs; the “overproduction” theory does not. In fact, there was overproduction of specific, not general, goods. The malinvestment caused by credit expansion diverted production into lines that turned out to be unprofitable (i.e., where selling prices were lower than costs) and away from lines where it would have been profitable. So there was overproduction of specific goods relative to consumer desires, and underproduction of other specific goods.

—Murray N. Rothbard, America's Great Depression, 5th ed. (Auburn, AL: Ludwig von Mises Institute, 2000), 56-57.

Short of the Garden of Eden, There Is No Such Thing As General “Overproduction”

“Overproduction” is one of the favorite explanations of depressions. It is based on the common-sense observation that the crisis is marked by unsold stocks of goods, excess capacity of plant, and unemployment of labor. Doesn’t this mean that the “capitalist system” produces “too much” in the boom, until finally the giant productive plant outruns itself? Isn’t the depression the period of rest, which permits the swollen industrial apparatus to wait until reduced business activity clears away the excess production and works off its excess inventory?

This explanation, popular or no, is arrant nonsense. Short of the Garden of Eden, there is no such thing as general “overproduction.” As long as any “economic” desires remain unsatisfied, so long will production be needed and demanded. Certainly, this impossible point of universal satiation had not been reached in 1929.

—Murray N. Rothbard, America's Great Depression, 5th ed. (Auburn, AL: Ludwig von Mises Institute, 2000), 56.

To Most of the Classical Economists, the Theory of General Over-production Was a Heresy

It is one thing to deny the existence of demand deficiency and another to provide a theory of the cycle. Classical economists, because of their acceptance of the law of markets, had to do both. Those who accepted the validity of the law of markets had to explain the fact of recession without reference to demand deficiency or over-production. This was done by explaining recessions as resulting from misdirected production or other factors which drove demand and supply out of alignment.¹ This theory of recession must be seen as an integral part of the matrix of ideas associated with the law of markets since it was this which explained the existence of recession while denying the possibility of deficient demand or overproduction. The two concepts, in fact, evolved together and are part of a unified conception of the operation of an economy.

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¹ Cf. Wesley Mitchell (1927: 8) who wrote, ‘to most of the classical economists, the theory of general over-production was a heresy, which they sought to extirpate by demonstrating that the supply of goods of one sort necessarily constitutes demand for goods of other sorts. But maladjusted production they allowed to be possible, and their brief references to crises usually aimed to show how production becomes maladjusted through the sinking of capital in unremunerative investments.’

—Steven Kates, Say's Law and the Keynesian Revolution: How Macroeconomic Theory Lost its Way (Cheltenham, UK: Edward Elgar Publishing, 2009), 75, 75n.