The Conversation – Keynesian and Austrian Economics

Gary Johnson describes himself as fiscally conservative – what does he mean by this?

Well, there are many elements to fiscal conservatism, but one of the most foundational is the difference between Keynesian and Austrian economics; two different schools of thought regarding how macroeconomics work. Below is a great infographic from The Austrian Insider. (It may seem a bit complicated at first, but don’t tune out – I’ll break it down below.)

(image)Keynesian vs Austrian Economics

Keynesian economists essentially believe that savings are bad for the economy at large. Savings pile money into bank accounts, under mattresses, and in cookie jars – what this prevents is the money circulating in the economic system. Wealth is created (slowly), but it isn’t out in the economy working, and that’s why Keynesian economists view it as bad. The fluid flow of money and credit through the system is what allows the economy to function.

Austrian economists view savings as good; when people are given an incentive to save, they protect themselves from personal tragedy (like being laid off, or unexpected medical bills) and from public disaster (like Hurricane Katrina wiping out their possessions). Although the rate of growth may not be as explosive, it builds on a more solid foundation that can withstand this big thing called “Life,” where the only constant is change (and not always good change, at that). These savings will eventually be spent, but generally only on sound investments.

If you boil it down even further, Keynesian economists believe that the fundamental responsibility of stimulating the economy and protecting citizens from inevitable disaster, small and large, lies with the government, and that through effective central planning and monetary policy, the government can effectively eliminate economic slumps and keep us on track for steady growth without any real setbacks. Conversely, Austrian economists believe that the fundamental responsibility for how the economy works lies with the consumer, and that each individual should have the power, the freedom, and the responsibility to manage their own money. Austrian economists accept that booms and busts are part of normal economic cycles, and that both small- and large-scale setbacks can be weathered through personal responsibility (e.g., savings) and wise choices (e.g., sound personal investment strategies).

The clearest difference between the two schools of thought is that Keynesian economics believes that the most important economic factor is spending money, and Austrian economics believes that saving money is the most important economic factor. Austrian economists assume that spending money will happen (after all, you can’t just stop eating, paying rent, and buying clothes) and that saving money puts the onus on the consumer to make wise choices, thereby building a firm economic foundation that can withstand the shocks and challenges of life. Keynesian economists believe that with a strong enough central government, savings are essentially unnecessary – there will always be a program to bail you out of whatever problem you may get into.

OK, so that all makes sense. So how do these two schools of thought affect you and me, as consumers and taxpayers?

Well, the US government has operated under Keynesian principles since the creation of the Federal Reserve bank in 1913. One of the effects of this is what is known as the fractional reserve banking system.

On the surface this looks good: effective investment of capital makes the economy work. There are several problems inherent within the system, however. One of them is answering the question of what happens when a certain percentage of people decide to withdraw their money from the system – since that money is now spread all over the place, most of it not really existing, what happens? The Keynesian answer is what’s known as a bank holiday: close the banks and prevent people from withdrawing their money. Wow, that doesn’t sound very empowering. Let’s hope that never happens.

Another problem is that fractional reserve banking places huge pressure on investments to actually be sound, while failing to put in place solid measures for that to be accomplished. Let’s take the recent housing bubble, for example. Let’s assume, for simplicity’s sake, that every single investment in the chain in the above video was placed into the housing market. Since everyone was buying, property values skyrocketed – until everyone realized that (a) they were participating in a buyer’s frenzy and the real property values didn’t support the price tags, and (b) banks were lending to many borrowers who did not possess the ability to pay the bank back. When people started defaulting on bad loans and property values collapsed, all of the money and credit created in this balloon rapidly evaporated – because 90% of it was fake to begin with. That’s a problem.

In a fractional reserve banking system everything works well as long as the money created by the expansion of credit continues to exist (e.g., there’s no significant devaluation of assets the value is used to create, like the housing market collapsing), very few people ever default, and few people withdraw their money from the system at any given time. When those things happen, this shaky façade of a system is at risk of collapse – and Keynesianism’s answer is more government bailouts, exactly like you saw in the Great Recession.

Libertarianism’s basic philosophy embraces the role of small failures in life by allowing us to experience, first hand, what is good and bad behavior. For example, if you’ve ever sold anything on Craigslist and accepted a bad check, you know that you’ll never accept a check again. You risked something, you lost, and you learned from that mistake. A Keynesian response to this would be to create a government program where you could submit proof of having received a bad check and be reimbursed by the government. This rewards bad (i.e., unnecessarily risky) behavior by bailing you out of a situation you never should have put yourself in – now, there’s no need to avoid accepting checks. People would take advantage of this and start writing bad checks for stuff all over Craigslist, most people would accept the bad checks because they know they’re going to sell items more quickly, at a higher price, and still get paid regardless (if the check is good, by the buyer – if not, then by the government). The government then picks up the tab, and pays for it in one of two ways: by taxing you more (so it can pay you for risky behavior) or by printing new money (which slowly destroys the purchasing power of the money you already have by inflating its value). Imposing new taxes is never politically popular, so since 1913 the easy answer has been to create more money. Unfortunately, the effect of that has been to erode 95% of the purchasing power of the dollar in the last hundred years.

Over the past hundred years we’ve experienced incredible economic growth, but it has come at a cost. The current US debt stands at more than $19.3 trillion and continues to grow. The greater problem, however, is what is known as our unfunded liabilities; these are things we’ve promised to pay, can calculate the approximate cost of, and are bills coming due within the next few decades. These are things like Social Security, Medicare, and Medicaid – we know people will use them, and we can do a pretty good job of calculating the approximate cost. These costs currently run in the range of a staggering $127 trillion. To put that into perspective, in 2015 the federal government took in a record-setting $3.2 trillion in taxes – more than it ever has before. In order to pay for the programs we’ve already obligated ourselves to under the Keynesian mindset explained above, we would need to continue to tax at this record-setting rate and then spend every single federal tax dollar we took in on these unfunded liabilities for the next forty years to fund them. That, on its face, is simply impossible.

This is a problem that must be addressed, but neither Trump nor Clinton have made it a central tenet of their platform. Conversely, the very first sentence on Gary Johnson’s campaign website under the “Issues” tab addresses our current financial situation specifically. Johnson also rightfully calls this arguably our single greatest threat to national security. Johnson has spoken about our financial situation at every opportunity.

Government growth, government debt, and government unfunded liabilities are unsustainable. This is probably the single greatest issue in the presidential campaign, and it deserves to be addressed as such.

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