Keynesianism, Monetarism and Complexity
The debate between Keynesianism and Monetarism is over; they both won. Obama’s approach to the crisis is breathtakingly simple – print money and spend it fast. For Keynesians, stimulus substitutes for private demand until the latter is jump started and stimulus can be reversed. For Monetarists, the logic is equally simple – increase the monetary base to expand GDP. Don’t worry about inflation until you see the whites of its eyes. Then withdraw the money after the job is done. Easy.
But what if Keynesianism and Monetarism are both fatally flawed? The evidence for a Keynesian multiplier is that there isn’t one. At best it’s fractional, maybe 60 cents for each dollar spent. Intuitively its hard to see how taking a dollar from the private sector and washing it through government creates any growth at all; experience says that part of the dollar is wasted; evidence bears that out. For Monetarists, the relationships among money, prices and GDP break down once velocity is considered. Targeting money against potential 3% real GDP growth is child’s play if velocity is constant. When velocity drops in hard to measure ways, central banks are driving blind.
Apart from these flaws, Keynesians and Monetarists are wedded to the linearity of stocks and flows. The idea is that some stock, such as money or deficit spending, can be dialed-up to create some flow, such as GDP growth in predictable ways. But markets are complex nonlinear systems; inputs and outputs bear no predictable relationship except in sub-critical states. The key question for policy is whether the financial system is in the critical state, i.e. dynamically unstable. This is impossible to answer because the computational complexity defies analysis. But it is possible to say with certainty that we are closer to the critical state than ever because of globalization, derivatives and leverage. As scale increases parametrically, complexity and risk increase exponentially. Critical thresholds at which diverse actors reject dollars in a cascading collapse are too near for comfort. Pushing the system by money printing and deficit spending are not reversible probes but lethal catalysts which may ruin the U.S. dollar and federal finance.
What is needed is what has always worked: sound money, low taxes and light regulation. This means raising interest rates and all that implies for valuations and bank collapses. Lower taxes means higher deficits but there is a world of difference between deficits caused by spending and those caused by lower taxes; the former crushes creativity while the latter frees animal spirits. Light regulation does not mean no regulation. Reinstating Glass-Steagall and separating deposit taking from gambling would be a good start. If this medicine causes hardship, use spending to mitigate that with unemployment benefits, food stamps, rental assistance and education, rather than profligate spending on inefficient technology and state jobs.
Keynesian and Monetarist approaches are not merely based on flawed assumptions about multipliers and velocity. They are dangerous in a complex nonlinear world. Classic sound policy and a dose of humility are needed now.
James G. Rickards is a writer, lawyer and economist. Twitter.com/JamesGRickards.