5. Theory of Employment, Money, Interest, and the Capitalist Process: The Misesian Case Against Keynes

It is my goal to reconstruct some basic truths regarding the process of economic development and the role played in it by employment, money, and interest. These truths neither originated with the Austrian School of economics, nor are they an integral part of this tradition of economic thinking alone. In fact, most of them were part and parcel of what is now called classical economics, and it was the recognition of their validity that uniquely distinguished the economist from the crackpot. Yet the Austrian School, in particular Ludwig von Mises and, later, Murray N. Rothbard, has given the clearest and most complete presentation of these truths. ¹ Moreover, they have also presented their most rigorous defense by showing them to be ultimately deducible from basic, incontestable propositions (such as that man acts and knows what it means to act) so as to establish them as truths whose denial would not only be factually incorrect but, much more decisively, would amount to logical-praxeological contradictions and absurdities. ²

First, I will systematically reconstruct this Austrian theory of economic development. Then I will turn to the “new” theory of Keynes, which belongs, as he himself cannot help but acknowledge, to the tradition of “underworld” economics (like Mercantilism) and of economic cranks (like Silvio Gesell). ³ I will show that Keynes’s new economics, too, is cranky: a tissue of logical-praxeological falsehoods reached by means of obscure jargon, shifting definitions, and logical inconsistencies, intent to create an anticapitalist, anti-private-property, and antibourgeois mentality.

I.

1. EMPLOYMENT

“Unemployment in the unhampered market is always voluntary.” ⁴ Man works, because he prefers its anticipated result to the disutility of labor and the psychic income to be derived from leisure. He “stops working at that point, at which he begins to value leisure, the absence of labor’s disutility, more highly than the increment in satisfaction expected from working more.” ⁵ Obviously, then, Robinson Crusoe, the self-sufficient producer, can only be unemployed voluntarily (because he prefers to remain idle and consume present values instead of expending additional labor in the production of future ones).

The result is not different when Friday enters and a private property economy is established based on a initial recognition of each person’s rights of exclusive ownership over those resources which he had recognized as scarce and appropriated (homesteaded) by mixing his labor with them before anyone else had done so, and of all goods produced with their help. In this situation not only exchange ratios—prices—for the purchase or rental of material goods become possible, but also prices (wages) for the rental of labor services. Employment will ensue whenever the offered wage is valued more highly by the laborer than the satisfaction to be derived from self sufficiently working with and/or consuming his own resources (or of appropriating previously submarginal resources). Employment will increase, and wages rise, so long as entrepreneurs perceive existing wages as lower than the marginal value product (discounted by time preference) ⁶ which a corresponding increment in the employment of labor can be expected to bring about. On the other hand, unemployment will result, and increase, so long as a person values the marginal value product attained through self-employment more highly than a wage that reflects his labor services’ marginal productivity.

In this construction there is no logical room for such a thing as involuntary unemployment. As employment is always voluntary, so is unemployment (self-employment). ⁷

Involuntary unemployment is only logically possible once the situation is fundamentally changed and a person or institution is introduced which can successfully exercise control over resources which he has not homesteaded, or acquired through voluntary exchange from homesteaders. Such an extra-market institution, by imposing, for instance, a minimum wage higher than the marginal productivity of labor, can effectively prohibit an exchange between a supplier of labor service and a capitalist which would be preferred by both, if both had unrestricted control over their homesteaded property. The would-be laborer then becomes involuntarily unemployed, and the would-be employer is forced to dislocate complementary factors of production from more into less value productive usages. As a matter of fact, an extra-market institution can in principle create any desired amount of involuntary unemployment. A minimum wage of say, $1 million per hour would, if enforced, involuntarily disemploy practically everyone and would, along this way toward forced self-employment, condemn most of today’s population to death by starvation.

In the absence of an institution exempt from the rules of the market involuntary unemployment is logically impossible, and prosperity instead of impoverishment will result.

2. MONEY

Man participates in an exchange economy (instead of remaining in self-sufficient isolation) insofar as he is capable of recognizing the higher productivity of a system of the division of labor and he prefers more goods over less. Out of his market participation arises in turn his desire for a medium of exchange (money). Indeed, only if one were to assume the humanly impossible (that man had perfect foresight regarding the future), would there be no purpose for him to have money. For with all uncertainties removed, in the never-never land of equilibrium one would know precisely the terms, times, and locations of all future exchanges, and everything could be prearranged accordingly and would take on the form of direct rather than indirect exchanges. ⁸ Under the inescapable human condition of uncertainty, however, when all this is not known and action must by nature be speculative, man will begin to demand goods no longer exclusively because of their use-value, but also because of their value as media of exchange.

Faced with a situation where his reservation demand for some supplied goods or services is low or nonexistent, and where a directly satisfying exchange, due to the absence of double coincidences of wants, is out of the question, he will also consider trading whenever the goods to be acquired are more marketable than those to be surrendered, such that their possession would then facilitate the acquisition of directly serviceable goods and services at not yet known future dates.

Moreover, since it is the very function of a medium of exchange to facilitate future purchases of directly serviceable goods, man will naturally prefer the acquisition of a more marketable and, at the limit, universally marketable medium of exchange to that of a less or nonuniversally marketable one so that

there would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money. ⁹

On the way toward this ultimate goal, by selecting monies that are increasingly more widely used, the division of labor is extended and productivity increased.

However, once a commodity has been established as a universal medium of exchange, and the prices of all directly serviceable exchange goods are expressed in terms of units of this money (while the price of the money unit is its power to purchase an array of nonmoney goods), money no longer exercises any systematic influence on the division of labor, employment, and produced income. Once established, any amount of money is compatible with any amount of employment and income. ¹⁰ Indeed, as explained above, in the nevernever land of equilibrium there would be no money, but there would still be employment and income. This demonstrates that money on the one hand and employment and income on the other must be regarded as logically-praxeologically independent and unrelated concepts. For instance, should the supply of money increase, other things being equal, this would surely have redistributive effects, depending on where and how the additional money entered the economy; but it would just as surely have no systematic effect on the amount of employment and the size of the social product. Prices and wages generally would go up, and the purchasing power of the money unit would go down. However, nothing would follow with regard to employment and social product. They may be different, or they may be the same. The same is true of changes in the demand for money. An increase in the demand for money (i.e., a higher relative value attached to additional cash as compared to additional nonmoney), would certainly change relative prices; yet it would not imply anything as far as employment and social product is concerned. In equilibrating an increased demand for money with a given stock of money, the general level of prices and wages must fall, and the purchasing power of the money unit must rise, mutatis mutandis. But there is no reason to suppose that this should have any impact on employment or income. Money wages fall, but simultaneously the purchasing power of money increases, leaving real wages and real social product entirely unaffected.

The result is no different if changes on the nonmoney side are considered. Other things being equal, an increase in the supply of goods and services, for instance, brings about an increase in the purchasing power of money; money prices fall. This reduces the quantity of money demanded (the demand schedule for money being given), because the cost of holding onto money instead of spending it on non-money has risen; and this lowered demand for cash implies in turn a reverse tendency toward rising prices and a reduced purchasing power of money. Nothing concerning employment and social product follows. Nor does the picture change when expectations are explicitly taken into account. Inflationary (deflationary) expectations reduce (increase) the demand for money immediately and thus speed up the adjustment toward whatever has been anticipated; and if something wrong has been anticipated (i.e., something out of line with the underlying reality), then the process of self-corrective adjustments is sped up through the workings of expectations. But none of these monetary phenomena has any systematic praxeological connection with employment and social product, which may well remain the same throughout all monetary changes.

Invariably, money is “neutral” to employment and social product.

3. INTEREST

Money is “neutral” also to interest. However, interest, unlike money, is praxeologically related to employment and social product.

As money is the result of uncertainty, so interest results from time preference, which is as essential to action as uncertainty (and in a sense to be explained shortly even more so). In acting, an actor not only invariably aims to substitute a more for a less satisfactory state of affairs and so demonstrates a preference for more rather than less goods; he must invariably also consider when in the future his goals will be reached (i.e., the time necessary to accomplish them) as well as a good’s duration of serviceability, and every action thus also demonstrates a universal preference for earlier over later goods and of more over less durable ones. Every action requires some time to attain its goal; since man must consume something sometimes and cannot stop consuming entirely, time is always scarce. Thus, ceteris paribus, present or earlier goods are, and must invariably be, valued more highly than future or later ones. ¹¹ In fact, if man were not constrained by time preference and the only constraint operating were that of preferring more over less, he would invariably choose those production processes that would yield the largest output per input, regardless of the length of time needed for these methods to bear fruit. For instance, instead of building a fishing net first, Crusoe would immediately begin constructing a fishing trawler, as the economically most efficient method for catching fish. That no one, including Crusoe, acts in this way makes it evident that man cannot but “value fractions of time of the same length in a different way according as they are nearer or remoter from the instant of the actor’s decision.” ¹²

Thus, constrained by time preference, man will only exchange a present good against a future one if he anticipates thereby increasing his amount of future goods. The rate of time preference, which can be different from person to person and from one point in time to the next, but which can never be anything but positive for everyone, simultaneously determines the height of the premium which present goods command over future ones as well as the amount of savings and investment. The market rate of interest is the aggregate sum of all individual time preference rates, reflecting, so to say, the social rate of time preference, and equilibrating social savings (i.e., the supply of present goods offered for exchange against future goods) and social investment (i.e., the demand for present goods capable of yielding future returns).

No supply of loanable funds could exist without previous savings, i.e., without the abstention from some possible consumption of present goods. Furthermore, no demand for loanable funds would exist if no one were to perceive any opportunity to employ present goods productively (i.e., to invest them so as to produce a future output that would exceed current input). Indeed, if all present goods were consumed and none invested in time-consuming production processes, there would be no interest or time preference rate, or rather, the interest rate would be infinitely high, which outside of the Garden of Eden, would be tantamount to eking out a primitive subsistence living by encountering reality with nothing but one’s bare hands and with nothing but a desire for instantaneous gratification.

A supply of and a demand for loanable funds only arises—and this is the human condition—once it is recognized that indirect, more roundabout, lengthier production processes can yield a larger or better output per input than direct and short ones; ¹³ and it is possible, by means of savings, to accumulate the amount of present goods needed to provide for all those wants whose satisfaction during the prolonged waiting time is deemed more urgent than the increment in future well-being expected from the adoption of a more time-consuming production process. ¹⁴

So long as this is the case, capital formation and accumulation will set in and continue. Instead of being supported by and engaged in instantaneously gratifying production processes, the originary factors of production, land and labor, are supported by an excess of production over consumption and employed in the production of capital goods. These have no value except as intermediate products in the process of turning out final (consumer) goods. In other words, their value lies in the fact that whoever possesses them can use them to produce other capital goods more efficiently. The excess in value (price) of a capital good over the sum expended on the complementary originary factors required for its production is due to this time difference and the universal fact of time preference. It is the price paid for buying time; for moving closer to the completion of one’s ultimate goal rather than having to start at the very beginning. Because of time preference, the value of the final output must exceed the sum spent on its factors of production (the price paid for the capital good and all complementary labor services).

The lower the time preference rate, then, the earlier the process of capital formation will set in, and the faster it will lengthen the roundabout structure of production. Any increase in the accumulation of capital goods and in the roundaboutness of the production structure in turn raises the marginal productivity of labor. This leads to either increased employment and/or wage rates, and, in any case (even if the labor supply curve should become backward sloping with increased wages), to a higher wage total. ¹⁵ Supplied with an increased amount of capital goods then, a better paid population of wage earners will produce an overall increased—future—social product, raising at last, after that of the employees, also the real incomes of the owners of capital and land. While interest (time preference) thus has a direct praxeological relation to employment and social income, it has nothing whatsoever to do with money. To be sure, in a money economy there also exists a monetary expression for the social rate of time preference. Yet this does not change the fact that interest and money are systematically independent and unrelated, and interest is a “real,” not a monetary phenomenon. In fact, in the never-never land of equilibrium there would be no place for money because the future by definition would be certain and with all uncertainty removed no one would have any need for cash holdings (whose sole purpose it is, cash being neither productive nor consumable, to have one prepared for not yet known purchases at not yet known dates). Time preference and interest, however, cannot be conceived of as disappearing even then. For even in equilibrium the existing capital structure needs to be constantly maintained over time (so as to prevent it from gradually becoming consumed in the even course of an endlessly repeated pattern of productive operations). There can be no such maintenance, however, without ongoing savings and reinvestments: and there can be no such things as these without the expectation of a positive rate of interest. (Indeed, if the rate of interest paid were zero, capital consumption would result, and one would move out of equilibrium.) ¹⁶

Matters become somewhat more complex under conditions of uncertainty, with money actually in use, but the praxeological independence of money and interest remains fully intact. Under these conditions, man invariably has three instead of two alternatives as to how to allocate his current income. He must not only decide how much to allocate to the purchase of present goods and how much to future goods (i.e., how much to consume and how much to invest), but also how much to keep in cash. There are no other alternatives. Yet while man must at all times make adjustments concerning three margins at once, invariably the outcome is determined by two distinct and praxeologically unrelated factors. The consumption/investment proportion is determined by time preference. The source of the demand for cash, on the other hand, is the utility attached to money (i.e., its usefulness in allowing immediate purchases of directly serviceable goods at uncertain future dates). Both factors can vary, independent of one another.

If the supply of money changes, or if the demand for money changes with a given social stock of money, the purchasing power of money will also change. However, aside from causing changes in relative incomes, no such changes in a money unit’s purchasing power would have any effect on overall real income. Incomes in terms of money increase or decrease, yet the purchasing power of money correspondingly falls or rises, leaving real income unchanged. Or, with money incomes unchanged, more or less of it will be held in cash (hoarded), but then the purchasing power of money correspondingly rises or falls, once again leaving the real income purchased with a smaller or larger sum of money unaltered. It is this real income, however, not money as such, to which a man’s time preference schedule is related, and in light of which his effective rate of time preference is determined. Since real income does not change through all these monetary changes, there is no reason to suppose that the rate of time preference will. If, for instance, the Keynesian nightmare of increased hoarding becomes reality and prices generally fall while the purchasing power of money correspondingly rises, this will leave the real investment/consumption proportion entirely unaffected. Unless the time preference schedule is assumed to have changed at the same time, the additional hoards will be drawn from funds that formerly were spent on consumption and from funds that formerly went into investment in the same pre-established proportion, so as to leave real consumption and real investment at precisely their old levels. However, if time-preference is assumed to change concomitantly, then everything is possible. Indeed, if the additional hoards come exclusively from previous consumption spending, an increased demand for money can go hand in hand even with a fall in the rate of interest and increased investment. Yet this is due not to changes in the demand for money but exclusively to a change (a fall) in the time preference schedule. ¹⁷

4. THE CAPITALIST PROCESS

With the division of labor established and extended to its ultimate limit via the development of a universal medium of exchange, the process of economic development is essentially determined by time preference.

To be sure, there are other factors that are important: the quality and quantity of the population, the endowment with nature-given resources, and the state of technology. Yet of these, the quality of a people is largely beyond anyone’s control and must be taken as a given: the quantity of a population may or may not advance economic development, depending on whether the population is below or above its optimum size for a given-sized territory: and nature-given resources or technological know-how can only have an economic impact if discovered and utilized. To do this, though, there must be prior savings and investment. It is not the availability of resources and technical or scientific knowledge that imposes limits on economic advancement: rather, it is time preference that imposes limits on the exploitation of actually available resources as well as on the utilization of existing knowledge (and also on scientific progress for that matter, insofar as research activities, too, must be supported by saved-up funds).

Thus, the only viable path toward economic growth is through savings and investment, governed as they are by time preference. Ultimately there is no way toward prosperity except through an increase in the per capita quota of invested capital. This is the only way to increase the marginal productivity of labor and only if this is done can future income rise in turn. With real incomes rising, the effective rate of time preference falls (without, however, ever reaching zero or even becoming negative), adding still further increased doses of investment, and setting in motion an upward spiraling process of economic development.

There is no reason to suppose that this process should come to a halt short of reaching the Garden of Eden where all scarcity has disappeared—unless people deliberately choose otherwise and begin to value additional leisure more highly than any further increase in real incomes. Nor is there any reason to suppose that the process of capitalist development would be anything but smooth and that the economy would flexibly adjust not only to all monetary changes but to all changes in the social rate of time preference as well. Of course, so long as the future is uncertain, there will be entrepreneurial errors, losses, and bankruptcies. But no systematic reason exists why this should cause more than temporary disruptions, or why these disruptions should exceed, or drastically fluctuate around, a “natural rate” of business failures. ¹⁸

Matters become different only if an extra-market institution such as government is introduced. It not only makes involuntary unemployment possible, as explained above: the very existence of an agency that can effectively claim ownership over resources which it has neither homesteaded, produced, nor contractually acquired, also raises the social rate of time preference for homesteaders, producers, and contractors, and hence creates involuntary impoverishment, stagnation, or even regression. It is only through government that mankind can be stopped on its natural course toward a gradual emancipation from scarcity long before ever reaching the point of a voluntarily chosen zero-growth. ¹⁹ And it is in the presence alone of a government, that the capitalist process can possibly take on a cyclical (rather than a smooth) pattern, with busts following booms. Exempt from the rules of private property acquisition and transfer, government naturally desires a monopoly over money and banking and wants nothing better than to engage in fractional reserve (deposit) banking—in nontechnical terms: monopolistic counterfeiting—so as to enrich itself at the expense of others through the much less conspicuous means of fraud rather than through outright confiscation. ²⁰ Boom and bust cycles are the outcome of fraudulent fractional reserve banking. If and insofar as the newly created counterfeit money enters the economy as additional supplies on the credit market, the rate of interest will have to fall below what it otherwise would have been. Credit must become cheaper. Yet at a lower price more credit is taken, and more resources then are invested in the production of future goods (instead of being used for present consumption) than otherwise would have been. The roundaboutness of the entire production structure is lengthened. In order to complete all investment projects that now are underway, more time is needed than that required to complete those begun before the credit expansion. All the goods which would have been created without credit expansion must be produced; plus those that are newly added. For this to be possible, however, more capital is required. The larger amount of future goods can only be produced successfully if additional savings provide for a fund of means of sustenance sufficiently large to bridge, and carry workers through, the longer waiting time. But, by assumption, no such increase in savings has taken place. The lower interest rate is not the result of a larger supply of capital goods. The social rate of time preference has not changed at all. It is solely the result of counterfeit money entering the economy through the credit market. It follows logically that it must be considered impossible to successfully complete all investment projects underway after a credit expansion due to a systematic lack of real capital. Projects will have to be liquidated so as to shorten the overall production structure and to readjust it to an unchanged rate of social time preference and the corresponding real investment-consumption proportion. ²¹

These cyclical movements can neither be avoided by expecting them (according to the motto “a cycle anticipated is a cycle avoided”): They are the praxeologically necessary consequence of additional counterfeit credit being successfully placed. Once this is the case, a boom-bust cycle is inevitable, regardless of what actors correctly or incorrectly believe or expect. The cycle is induced by a monetary change, but it takes effect in the realm of “real” phenomena and will be a “real” cycle no matter what beliefs people happen to hold. ²²

Nor can it be realistically expected that the inevitable cyclical movements resulting from an expansion of credit will ever come to a halt: So long as an extra-market institution like government is in control of money, a permanent series of cyclical movements will mark the process of economic development. For through the creation of fraudulent credit, a government can engender a smooth and highly inconspicuous income and wealth redistribution in its own favor. There is no reason (short of angelic assumptions) to suppose that it would ever deliberately stop using this magic wand merely because credit expansion has the “unfortunate” side-effect of business cycles.

II.

After this reconstruction of the classical, and especially the Austrian theory of employment, money, interest, and the capitalist process, I will now turn to Keynes and his “new” theory. Before the backdrop of our explanation of the old one it shall be easy to recognize Keynes’s “new” General Theory of Employment, Interest, and Money as fundamentally flawed and the Keynesian revolution as one of the twentieth century’s foremost intellectual scandals. ²³

1. EMPLOYMENT

Keynes sets out with a false theory of employment. Contrary to the classical view, he claims that there can be involuntary unemployment on the free market; and, further, that a market can reach a stable equilibrium with persistent involuntary unemployment. And in claiming such market failures to be possible he contends to have uncovered the ultimate economic rationale for interfering in the operations of markets by extra-market forces.

Since the free market is defined in terms of homesteaded or produced private property and the voluntariness of all interactions between private property owners, it should be clear that what Keynes claims to show is roughly equivalent to a squaring of the circle.

Keynes begins with the false statement that the classical theory assumed “that there is no such thing as involuntary unemployment in the strict sense.” ²⁴ In fact, it assumed no such thing. Classical theory assumed that involuntary unemployment is logically-praxeologically impossible so long as a free market is in operation. That involuntary unemployment, indeed any amount of it, can exist in the presence of an extra-market institution, minimum wage laws, etc., has never been seriously doubted.

After this falsehood, Keynes then proceeds to give his definition of involuntary unemployment:

Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods [i.e., consumer goods] relative to the money wage, both the aggregate supply of labor 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. ²⁵

Translated into plain English, what Keynes is saying in his typical obfuscating way is that men are involuntarily unemployed if an increase in prices relative to wage rates leads to more employment. ²⁶ Yet such a change in relative prices is logically equivalent to a fall in real wage rates; and a fall in real wages can be brought about on the unhampered market by wage earners at any time they so desire, simply by accepting lower nominal wage rates with commodity prices remaining where they are. If laborers decide not to do this, there is nothing involuntary in all this. Given their reservation demand for labor, they choose to supply that amount of labor which is actually supplied. Nor would the classification of this as voluntary unemployment-employment change a bit, if at another point in time with lower real wage rates the amount of employment were to increase. By virtue of logic, such an outcome can only be brought about if in the meantime laborers have increased their relative evaluation of a given wage rate versus their labor reservation demand (otherwise, if no such change had occurred, employment would decrease instead of increasing). The fact, however, that one can change one’s mind from one point in time to the next hardly implies that one’s earlier choice was involuntary, as Keynes would have it. Of course, one can define one’s terms any way one wishes, and in a truly Orwellian fashion one may even choose to call voluntary involuntary and involuntary voluntary. Yet through this method anything under the sun can be “proven,” while in fact nothing of substance whatsoever is shown. Keynes’s way of demonstrating the possibility of involuntary unemployment is a verbal nonsense proof which leaves entirely unaffected the fact that no such thing as involuntary employment, in the usual sense of this term, can ever exist on the unhampered market.

As if this were not enough, Keynes tops it off by claiming that involuntary unemployment is conceivable even in the never-never land of equilibrium. Indeed, he criticizes his earlier Treatise on Money by saying, “I had not then understood that, in certain conditions, the system could be in equilibrium with less than full employment.” ²⁷ Yet equilibrium is defined as a situation in which changes in values, technology, and resources no longer occur where all actions are completely adjusted to a final constellation of data; and where all factors of production then, including labor, are employed to the fullest extent possible (given these unchanging data) and are repeatedly and endlessly employed in the same constant production pattern. Hence, as H. Hazlitt has remarked, the discovery of an unemployment equilibrium by Keynes, in his General Theory, is like the discovery of a triangular circle—a contradiction in terms. ²⁸

2. MONEY

Having thrown out logic in his treatment of employment and unemployment, Keynes, in his discussion of money, then throws out economic reasoning by advancing the claim that money and monetary changes (can) have a systematic effect on employment income, and interest.

Given the fact that “money” appears in the title of the General Theory, Keynes’s positive theory of money is amazingly brief and undeveloped. Brevity, of course, can be a virtue. In the case of Keynes, it offers the opportunity to pinpoint rather easily his elementary mistakes. For Keynes, “the importance of money essentially flows from its being a link between the present and the future.” ²⁹ “Money in its significant attributes is, above all, a subtle device for linking the present and the future.” ³⁰ That this is false follows from the fact that in the never-never land of equilibrium no money would exist, ³¹ yet even under equilibrium conditions there would still be a present and a future, and both would still be linked. Rather than functioning as a link to the future, money serves as a medium of exchange; a role that is inextricably tied to the uncertainty of the future. ³² Action, which invariably begins in the present and is aimed at some future goal, more or less distant in time from the point of beginning, constitutes the real link between the present and the future. And it is time preference as a universal category of action that gives this link between the present and the future its specific shape. Money, contrary to interest, no more relates the present to the future than do other economic phenomena, such as nonmonetary goods. Their present value, too, reflects anticipations regarding the future, no more and no less so than does money.

From this first misconception regarding the nature of money, all other misconceptions flow automatically. Being defined as a subtle link between present and future, the demand for money (its supply being given), which Keynes, in line with his general inclination of misinterpreting logical-praxeological categories as psychological ones, terms “liquidity preference” or “propensity to hoard,” ³³ is said to be functionally related to the rate of interest (and vice versa). ³⁴ “Interest,” writes Keynes, “is the reward of not-hoarding,” ³⁵ “the reward for parting with liquidity,” ³⁶ which makes liquidity preference in turn the unwillingness to invest in interest-bearing assets. That this is false becomes obvious as soon as one asks the question “What, then, about prices?” The quantity of beer, for instance, that can be bought for a definite sum of money is obviously no less a reward for parting with liquidity than is the interest rate, which would make the demand for money then the unwillingness to buy beer as much as it is an unwillingness to invest. ³⁷ Formulated in general terms, the demand for money is the unwillingness to buy or rent nonmoney, including interest-bearing assets (land, labor, and/or capital goods, or future goods) and non-interest-bearing assets (consumer or present goods). To recognize this is to recognize that the demand for money has nothing to do with investment or with consumption; nor has it anything to do with the ratio of investment-to-consumption expenditures, or the spread between input and output prices (the discount of higher order or future goods versus lower order or present goods). Increases or decreases in the demand for money, other things being equal, lower or raise the overall level of money prices, but real consumption and investment, as well as the real consumption-investment proportion remain unaffected; and such being the case, employment and social income remain unchanged as well. The demand for money determines the spending/cash balance proportion. The investment/consumption proportion, pace Keynes, is an entirely different and unrelated matter. It is solely determined by time-preference. ³⁸

The same conclusion is reached if changes in the supply of money (liquidity preference being given) are considered. Keynes claims that an increase in the supply of money, other things being equal, can have a positive effect on employment. He writes, “so long as there is unemployment, employment will change in the same proportion as the quantity of money.” ³⁹ Yet this is not only a highly curious pronouncement because it assumes the existence of unemployed resources instead of explaining why such a thing should possibly occur—for, obviously, a resource can be unemployed only because it is either not recognized as scarce at all and thus has no value whatsoever, or because its owner voluntarily prices it out of the market and its unemployment then is no problem that would call for a solution. ⁴⁰

Even if one were to waive this criticism, the statement would still be fallacious. For if other things were indeed equal, then the additional supply of money would simply lead to increased overall prices and simultaneous and proportional increased wage rates, and nothing would change at all. If, contrary to this, employment should increase, this is only possible if wage rates do not rise along with, and to the same extent as, other prices. However, other things then can no longer be said to be equal, because real wage rates would be lowered, and employment can only rise while real wages fall if the relative evaluation of employment versus self-employment (i.e., unemployment) is assumed to have changed. Yet if this is assumed, no increase in the money supply would have been required. The same result (increased employment) could also have been brought about by laborers accepting lower nominal wage rates.

3. INTEREST

With logic and economic theory thrown out of the window, in his discussion of the interest phenomenon Keynes abandons reason and common sense entirely.

According to Keynes, since money has a systematic impact on employment, income, and interest, interest, in turn—quite consistently, for that matter—must be conceived of as a purely monetary phenomenon. ⁴¹ I need not explain the elementary fallacy of this view. Suffice it to say here again that money would disappear in equilibrium, but interest would not, which demonstrates that interest must be considered a real, not a monetary phenomenon.

Moreover, Keynes, in talking about “functional relationships” and “mutual determination” of variables instead of causal, unidirectional relations, becomes entangled in inescapable contradictions as regards his theory of interest. ⁴² As has been explained above, on the one hand Keynes thinks of liquidity preference (and the supply of money) as determining the interest rate, such that an increased demand for money, for instance, would raise the interest rate (and an increased supply of money would lower it) and that this then will reduce investment “whilst a decline in the rate of interest may be expected, ceteris paribus, to increase the volume of investment.” ⁴³ On the other hand, characterizing the interest rate as “the reward for parting with liquidity,” he contends that the demand for money is determined by the interest rate, such that a fall in the interest rate, for instance, would increase one’s demand for cash (and also, one should add, one’s propensity to consume) and hence lead to reduced investment. Obviously, however, a lower interest rate can hardly both increase and decrease investment at the same time. Something must be wrong here.

Keynes, however, combines falsehood and contradiction into one of the most fantastic conspiracy theories ever heard of.

Since interest, according to Keynes, is a purely monetary phenomenon, it is only natural to assume that it can be manipulated at will through monetary policy (provided, of course, one is not restricted in this by the existence of a 100-percent-reserve commodity money standard such as the gold standard). ⁴⁴ “There is,” writes Keynes, “no special virtue in the pre-existing rate of interest.” ⁴⁵ In fact, if the supply of money is sufficiently increased, the interest rate supposedly can be brought down to zero. Keynes recognizes that this would imply a superabundance of capital goods, and one would think that this realization should have given him cause to reconsider. Not so! On the contrary, in all seriousness he tells us

that a properly run community equipped with modern technical resources, of which the population is not increasing rapidly, ought to be able to bring down the marginal efficiency of capital in equilibrium approximately to zero within a single generation. ⁴⁶

It is “comparatively easy to make capital goods so abundant that the marginal efficiency of capital is zero (and) this may be the most sensible way of gradually getting rid of many of the objectional features of capitalism.” ⁴⁷ “There are no intrinsic reasons for the scarcity of capital.” ⁴⁸ Rather, it is “possible for communal saving through the agency of the State to be maintained at a level where it ceases to be scarce.” ⁴⁹

Don’t worry that this would imply that no maintenance or replacement of capital would be needed any longer (for, if this were the case, capital goods would still be scarce and hence command a price), and capital goods instead would have to be “free goods” in the same sense in which air is usually “free.” Don’t worry that if capital goods were no longer scarce, then consumer goods could no longer be scarce either (for, if they were, the means employed to produce them would have to be scarce, too). And don’t worry that in this Garden of Eden, which Keynes promises to establish within one generation (why so long?!), there would no longer be any use for money. For, as he informs us, “I am myself impressed by the great social advantages of increasing the stock of capital until it ceases to be scarce.” ⁵⁰ Who would dare disagree with this! ⁵¹

Yet more is to come. Because, as Keynes sees it, there are some obstacles on the path toward paradise. For one thing, the gold standard stands in the way, because it makes the expansion of credit impossible (or difficult at least, in that a credit expansion would lead to an outflow of gold and a subsequent economic contraction). Hence Keynes’s repeated polemics against this institution. ⁵² Furthermore, there is the just explained problem of his own making: that a lower interest rate supposedly increases and decreases investment simultaneously. And it is to get out of this logical mess that Keynes comes up with a conspiracy theory: For, while the interest rate must be reduced to zero so as to eliminate scarcity, as we were just told, the lower the interest rate the lower also the reward for parting with liquidity. The lower the interest rate, that is to say, the lower the incentive for capitalists to invest, because their profits will be reduced accordingly. Thus, they will try to undermine, and conspire against, any attempt to resurrect the Garden of Eden.

Driven by “animal spirits,” ⁵³ “gambling instincts,” ⁵⁴ and “addicted to the money-making passion,” ⁵⁵ they will conspire so “that capital has to be kept scarce enough.” ⁵⁶ “The acuteness and peculiarity of our contemporary problem arises, therefore,” writes Keynes,

out of the possibility that the average rate of interest which will allow a reasonable average level of employment [and of social income] is one so unacceptable to wealth owners that it cannot be readily established merely by manipulating the quantity of money. ⁵⁷

In fact,

the most stable, and least easily shifted, element in our contemporary economy has been hitherto, and may prove to be in the future, the minimum rate of interest acceptable to the generality of wealth owners. ⁵⁸

Fortunately, we are informed, there is a way out of this predicament; through “the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital.” ⁵⁹ And surely they deserve such a fate. For “the business world” is ruled by an “uncontrollable and disobedient psychology,” ⁶⁰ and private investment markets are

under the influence of purchasers largely ignorant of what they are buying and of speculators who are more concerned with forecasting the next shift of market sentiment than with a reasonable estimate of the future yield of capital assets. ⁶¹

As a matter of fact, don’t we all know that “there is no clear evidence from experience that the investment policy which is socially advantageous coincides with that which is most profitable;” ⁶² indeed, that the decisions of private investors depend largely on “the nerves and hysteria and even the digestions and reactions to the weather,” ⁶³ rather than on rational calculation?! Thus, concludes Keynes, “the duty of ordering the current volume of investment cannot safely be left in private hands.” ⁶⁴ Instead, to turn the present misery into a land of milk and honey, “a somewhat comprehensive socialization of investment will prove the only means.” ⁶⁵

The State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage [must take] an ever greater responsibility for directly organizing investment. ⁶⁶

I trust that none of this requires further comment. It is too obvious that these are the outpourings of someone who deserves to be called anything, except an economist.

4. THE CAPITALIST PROCESS

Such a verdict finds still more support when Keynes’s theory of the capitalist process is finally considered. That Keynes is no friend of capitalism and capitalists should be obvious from the above quotations. In fact, by advocating “a socialization of investment” he comes out openly as a socialist. ⁶⁷ For Keynes, capitalism means crisis.

He identifies essentially two reasons for this, the first one, to which Keynes attributes the cyclical nature of the capitalist process, has already been touched upon. Surely, so long as the course of the economy is largely determined by capitalists who, as we have heard, “are largely ignorant of what they are purchasing,” and who conspire “to keep things scarce,” it cannot be a smooth and even one. Depending mostly on people who base their decisions on their “digestion and the weather,” the capitalist process must be erratic. Moved by the “waxing and waning” of entrepreneurial optimism and pessimism, which in turn is determined by the “uncontrollable and disobedient psychology of the business world,” booms and busts are inevitable. Business cycles—so the central message of chapter 22 of Keynes’s General Theory, the “Notes on the Trade Cycle”—are psychologically determined phenomena. This is surely incorrect. A psychological explanation of the business cycle is strictly impossible, and to think of it as an explanation involves a category mistake: Business cycles are obviously real events, experienced by individuals, but experienced by them as occurring outside of them in the world of real goods and real wealth. Beliefs, sentiments, expectations, optimism, and pessimism on the other side are psychological phenomena. One can think of one psychological phenomenon as affecting or influencing another one, but it is impossible to conceive of a psychological phenomenon as having any direct impact on outcomes in the outside world of real things and goods. Only through actions can the course of real events be influenced; and any explanation of the business cycle then must necessarily be a praxeological (as opposed to a psychological) one. Keynes’s psychological business cycle theory in fact cannot explain that anything real happens at all. However, as real things are made to happen people must act, and allocate and reallocate scarce resources to valued goals. One cannot act as arbitrarily, though, as Keynes would have it, because in acting one is invariably constrained by real scarcity which cannot be affected by our psychology at all. Nor does Keynes explain with his theory why entrepreneurial mood-swings would result in any particular pattern of business fluctuations—such as the boom-bust cycle, that he supposedly wants to explain—instead of any other conceivable pattern of fluctuations.

The second reason for the instability of capitalism, and the desirability of a socialist solution, according to Keynes, is capitalism’s inherent stagnationist tendencies. His stagnation theory centers around the notion which he takes from Hobson and Mummery, and endorses, “that in the normal state of modern industrial communities, consumption limits production and not production consumption.” ⁶⁸ With this as one of his axioms only nonsense can follow.

Stagnation is due to a lack of consumption. “Up to the point where full employment prevails,” he writes, “the growth of capital depends not at all on a low propensity to consume but is, on the contrary, held back by it.” ⁶⁹ Combined with this underconsumptionist thesis is a “fundamental psychological law, upon which we are entitled to depend with great confidence both a priori from our knowledge of human nature and from the detailed facts of experience, that men are disposed, as a rule and on the average, to increase their consumption as their income rises, but not by as much as the increase in their income.” ⁷⁰ “As a rule … a greater proportion of income [will be] saved as real income increases.” ⁷¹

On its own, this second law, which is accepted as plausible here for the sake of argument (except for adding that consumption can, of course, never fall to zero), would not seem to indicate any trouble. So what? If savings overproportionally increase with increasing incomes, so much the better for the social product. ⁷² But Keynes, in his characteristic logic-carefree way of thinking joins this law to the thesis that production is limited by consumption, and he has then no difficulty proving whatever he wishes.

If consumption limits production, and if nonconsumption rises with rising incomes, then it indeed seems to follow that increasing incomes imply their own undoing by increasing nonconsumption, which in turn limits production, etc. And if this is so, it also seems to follow that wealthier societies, which non-consume more, should be plagued particularly hard by this “stagnitis”; and that in any given society it should be the rich, who nonconsume more, who contribute most to economic stagnation (except for the “minor” problem that one cannot explain, according to this theory, why individuals or societies could be wealthier than others in the first place!). In any case, Keynes accepts these conclusions as true. ⁷³ Accordingly, he presents his recommendations on how to get out of stagnation. In addition to a “comprehensive socialization of investment,” Keynes suggests measures to stimulate consumption, in particular an income redistribution from the rich (people with a low propensity to consume) to the poor (those with a high propensity to consume).

Whilst aiming at a socially controlled rate of investment with a view to a progressive decline in the marginal efficiency of capital I should support at the same time all sorts of policies for increasing the propensity to consume. For it is unlikely that full employment can be maintained, whatever we may do about investment, with the existing propensity to consume. There is room, therefore, for both policies to operate together;—to promote investment and, at the same time, to promote consumption, not merely to the level which with the existing propensity to consume would correspond to the increased investment, but to a higher level still. ⁷⁴

How is such a thing as simultaneously promoting investment and consumption in order to increase income conceivably possible? In fact, Keynes gives us his own formal definitions of the terms involved: “income = consumption + investment; saving = income - consumption; therefore, saving = investment.” ⁷⁵ Under these definitions, a simultaneous increase in consumption and investment out of a given income is conceptually impossible!

Keynes is not terribly disturbed over “details” such as these. In order to get what he wants, he simply shifts, completely unnoted, the meanings of his terms. He drops the just quoted formal definitions, which would render such a result impossible, and he adopts a new meaning for the term saving. Instead of unconsumed income, saving quietly comes to mean hoarding (i.e., the act of not-spending money on either consumer or capital goods). ⁷⁶ Thereby the results can be easily made to come out right. For then savings are no longer equal to investment; and saving, being defined as the act of not-spending, automatically acquires a negative connotation, while investment and consumption take on a positive one. Moreover, now one must almost naturally be worried about savings exceeding investment, or so it seems, for this would seem to imply that something is leaking out of the economy, and that income (defined as investment + consumption) must be somehow reduced. Keynes certainly worries about this possibility. He calls it “a chronic tendency throughout human history for the propensity to save to be stronger than the inducement to invest.” ⁷⁷ And this chronic tendency must surely be particularly pronounced if incomes are high, for then, as we have been told, savings reach a particularly high proportion of income. But do not despair. Where something can leak out, something also can leak in. If savings is unspent money, then savings can be brought into existence, simple enough, by means of governmental money creation, so as to compensate for the outward leakage which tends to increase with increasing incomes. There is the danger, of course, that these compensatory “community savings” immediately leak out again by being added to the private sector’s cash hoardings (because, according to Keynes, the newly created savings would lower the interest rate, and this in turn would increase the capitalists’ liquidity preference so as to counteract such a tendency and to artificially “keep capital scarce”). But this can be taken care of by the “socialization of investment” as we know, and by some Gesellian stamped money schemes (“The idea behind stamped money is sound”). ⁷⁸ And once saving and investing is done publicly—through the agency of the State, as Keynes would say—and all money is spent, and no keep-things-scarce motive is in the way any longer, there is indeed no longer any problem with increasing consumption and investment simultaneously. Since savings is unspent money, and newly created money and credit is just as genuine as any other because it is not “forced” on anyone, savings can be created by the stroke of a pen. ⁷⁹ And since the State, contrary to the scarcity-exploiting capitalists, can make sure that these additional genuine savings are indeed being spent (instead of wandering into hoards), any increase in the supply of money and credit through governmental counterfeiting increases consumption and investment at the same time and so promotes income twice. Permanent inflation is Keynes’s cure-all. It helps overcome stagnation; and more of it overcomes the more severe stagnation crises of the more advanced societies. And once stagnation is defeated, still more inflation will abolish scarcity within one generation. ⁸⁰

Yet the wonders do not cease. What is this leakage, this surplus of savings over investment, that constitutes all such dangers? Something must leak from somewhere to someplace else, and it must play some role here and some there. Keynes tries to disperse such thoughts by asking us once again not to apply logic to economics. “Contemporary thought,” he writes, “is still deeply steeped in the notion that if people do not spend their money in one way they will spend it in another.” ⁸¹ It would seem hard to imagine how this contemporary thought could possibly be wrong, but Keynes believes it false. For him there exists a third alternative. Something, an economic good one would think, simply drops out of existence, and this means trouble.

An act of individual saving means—so to speak—a decision not to have dinner to-day. But it does not necessitate a decision to have dinner or buy a pair of boots a week hence or a year hence or to consume any specified thing at any specified date. Thus it depresses the business of preparing to-day’s dinner without stimulating the business of making ready for some future act of consumption. It is not a substitution of future consumption-demand for present consumption-demand—it is a net diminution of such demand. ⁸²

Still, the strictures of a two-valued logic do not quite crumble yet. How can there be any net diminution of something? What is not spent on consumer goods or capital goods must still be spent on something else—namely on cash. This exhausts all possibilities. Income and wealth can be and must be allocated to consumption, investment, or cash. Keynes’s diminution, the leakage, the excess of savings over investment, is income spent on, or added to, cash hoardings. But such an increase in the demand for cash has no effect on income, consumption, and investment whatever, as has already been explained. With the social money stock being given, a general increase in the demand for cash can only be brought about by bidding down the money prices of nonmoney goods. But so what? ⁸³ Nominal income (i.e., income in terms of money) will fall; but real income and the real consumption-investment proportion will be entirely unchanged. And people along the way get what they want: an increase in the real value of their cash balances, and of the purchasing power of the money unit. There is nothing stagnating here, or draining, or leaking, and Keynes has offered no theory of stagnation at all (and with this, of course, also no theory of how to get out of stagnation). He merely has given a perfectly normal phenomenon such as falling prices (caused by an increased demand for money, or by an expanding productive economy) a bad name in calling it stagnation, or depression, or the result of a lacking effective demand, so as to find just another excuse for his own inflationary schemes. ⁸⁴

Here we have Keynes in his entire greatness: the twentieth century’s most famous “economist.” Out of false theories of employment, money, and interest, he has distilled a fantastically wrong theory of capitalism and of a socialist paradise erected out of paper money.