On The Ignorance Keynes Fostered

The other day, I had the occasion to discuss Obama’s “stimulus package” with a leading designer and was not at all surprised to hear from him the confident assertion that all would be well soon because the US is “pumping so much money into the system.”

Of course, Obama will not be pumping in “money.” He will be pumping in fiat paper notes that are debt masquerading as money.

So let us take the extreme example: Suppose gold was money in Goa, and miners discovered lots of gold underground. If all this gold was introduced into circulation, would the Goa economy be “pumped up”?

When I offered this example to my designer friend, he hemmed and hawed for a while and finally concluded that the end result would be a fall in the price of gold, which amounts to the rise in price of everything else.

He was forced to concede that the end result of pumping in paper dollars would be much worse than increasing the amount of gold in circulation, if gold was money.

My designer friend then asked me the most interesting question: Why do so many learned people advocate increasing the money supply?

“Ignorance,” I replied.

This ignorance has been brought about by Keynesian teachers and textbooks. In an earlier age, before Keynes, when classical liberalism ruled, such errors in thinking would never have occurred.

For example, let us take Richard Cantillon’s “Essay on Commerce” published in 1730, about 50 years prior to Adam Smith’s Wealth of Nations.

There is a chapter in Cantillon’s book entitled “On the increase and decrease in the quantity of hard money in a State.” Money was “hard” in 1730, and Cantillon discusses the effects of an increase in the quantity of gold.

Cantillon begins by saying:

“If Mines of gold or silver be found in a State and considerable quantities of minerals drawn from them, the Proprietors of these Mines, the Undertakers, and all those who work there, will not fail to increase their expenses in proportion to the wealth and profit they make: they will also lend at interest the sums of money which they have over and above what they need to spend.

All this money, whether lent or spent, will enter into circulation and will not fail to raise the price of products and merchandise in all the channels of circulation which it enters.”

But Cantillon does not stop here. He goes on to say who will lose and who will gain from this inflation. This is a very important point: that there will be losers too in this process. Cantillon refers to John Locke having “clearly seen that the abundance of money makes everything dear, but he has not considered how it does so. The great difficulty of this question consists in knowing in what way and in what proportion the increase of money raises prices.” It is Cantillon who was the first classical liberal to elucidate this process. He says:

“If the increase of actual money comes from Mines of gold or silver in the State the Owner of these Mines, the Adventurers, the Smelters, Refiners, and all the other workers will increase their expenses in proportion to their gains. They will consume in their households more Meat, Wine, or Beer than before, will accustom themselves to wear better cloaths, finer linen, to have better furnished Houses and other choicer commodities. They will consequently give employment to several Mechanicks who had not so much to do before and who for the same reason will increase their expenses: all this increase of expense in Meat, Wine, Wool, etc. diminishes of necessity the share of the other inhabitants of the State who do not participate at first in the wealth of the Mines in question. The altercations of the Market, or the demand for Meat, Wine, Wool, etc. being more intense than usual, will not fail to raise their prices. These high prices will determine the Farmers to employ more Land to produce them in another year: these same Farmers will profit by this rise of prices and will increase the expenditure of their Families like the others. Those then who will suffer from this dearness and increased consumption will be first of all the Landowners, during the term of their Leases, then their Domestic Servants and all the Workmen or fixed Wage-earners who support their families on their wages.”

Thus, as with gold, so with Keynesian “pumping money”: those who get to spend the new money first will gain, while those who get to spend it last will lose. Those who are savers, and those who live off fixed incomes, will lose the most. Inflation is thus a hidden tax on the poor. Increasing the money supply redistributes real wealth. There are many losers in the process - especially among the poor. This was the understanding in 1730 AD.

We can therefore concur with Hayek who said that the greatest mischief done by the Keynesians was that they obscured from living memory an understanding of money that existed 300 years ago – and which has to be painstakingly reconstructed. You can read Cantillon here.

Also read how the Russians are contemplating a return to the gold standard here (thanks to LRC).

Sound money, hard money, sunnah money – that is the way forward.

Away with Keynesian hogwash.