Remember When Keynesian Were Interesting? - A Thread From Balaji

Yesterday’s Keynesians were more interesting than today’s Keynesians. They founded the system, after all. -- Balaji

WHERE’S THE MONEY COMING FROM? By Stuart Chase

IN 1925, Russia had been through a devastating war and a violent internal revolution. Her currency had been destroyed in a runaway price inflation, she was the world’s worst financial risk abroad and she had very little gold. Yet by the end of the first Five Year Plan in 1933, Russia had invested some 60 billion rubles in factories, new cities, cities, hydroelectric developments, armaments, houses, schools. There stood the new plant, ugly and solid. Without it Russia could never have met the onslaught of Hitler’s armies.

Where did the money come from?

In 1933 it was freely prophesied that Italy could not invade Ethiopia. She had no credit abroad and almost no gold. The effort would bankrupt her. Italy went ahead, conquered Ethiopia, and emerged without financial collapse.

Where did the money come from?

Hitler took over a Germany which was technically bankrupt. It had defaulted on its foreign obligations. When he proposed to build a powerful army, together with all kinds of grandiose public works, he was laughed at in London and New York. Germany was insolvent, and the whole idea was preposterous. The nations of Europe which have trembled under the thunder of panzer divisions know that Hitler built even more terribly than he promised.

Where did the money come from?

When Japan began to rattle her sword in the direction of Indo-China and challenge the United States and the British Empire, wiseacres said it was a bluff. The long years of the war in China had reduced the Japanese economy to a bag of bones. She was bankrupt and could not sustain a real fight. Yet she opened a new attack with devastating fury, and with military equipment in planes, tanks, artillery, ships, that was as excellent as it was unexpected.

Where did the money come from?

In 1939, the United States Congress declined to appropriate $4 billions for highways, conservation, hospitals, freight cars, in the bitterly contested “lend-spend” bill. It was widely held that the bill would lead to ruin and national bankruptcy. Yet since the fall of France in 1940, Congress has appropriated almost $300 billions for armaments–seventy-five times as much as the lend-spend bill–and a large fraction of it has already gone into tanks and guns. Far from being ruined, our national vitality has never been more vigorous, and great financial moguls assure us that we shall be able to swing the national debt.

Where did the money come from?

After the war America will need to maintain full employment, operate its industries at substantial capacity, provide the essentials of life for all its own citizens, and help foreign peoples who are starving and unable to pay for the supplies. There will be a towering political demand for a world delivered from chronic depression.

Where will the money come from?

…it is clear from these examples that what a great nation can “afford” in periods of crisis depends not on its money but on its man power and its goods. Russia, Italy, Germany, Japan, the United States, all used money in the situations mentioned, but money was obviously not the dominant factor. Man power and materials were the dominant factor.

Yet at other times, when crisis was not so acute, the money for necessary tasks could not be found. Unemployment, insecurity, want, dragged on. This is a puzzling paradox. At certain times a nation can afford what at other times, with no less money, it cannot afford. At certain times we are afraid of national bankruptcy, and at other times we give it hardly a thought.

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Some Notes (from Balaji)

1) An argument like this is refreshing relative to the mumbo-jumbo we hear from today’s Fed.

Chase is *agreeing* that the money is all an illusion, and all that matters is whether governments can whip (or incentivize?) their citizens into a productive lather. This was more possible at the time due to technology favoring total centralization of power, and less possible today.

2) Chase’s viewpoint is *adjacent* to the broken windows fallacy, but that’s not the entirety of it.

In Bastiat’s classical broken windows setup, someone smashes a shopkeeper’s window. And we see the money the shopkeeper allocates to the glazier for repairs but not what he would have spent it on — and we thus mistake the spending for economic activity *caused* by destruction.

But Chase’s initial conditions are different. He’s saying a country is essentially out of money, but then suddenly discovers productive capacity in the context of a war. For it to match the broken window setup, the shopkeeper wouldn’t have a shop. So then, where’s the money coming from?

3) In each case you can argue with his examples. For example, Russia under the New Economic Policy in the late 20s wasn’t as bad as Lenin’s war communism, so they would have had more wealth to work with.

And the American economy was hamstrung by the New Deal and (relatively) set free by war production, where many regulatory barriers were relaxed. For example, antitrust and labor laws (like Walsh-Healey) were suspended or ignored.

4) But there is something to what is being said here. There is a capacity for rebirth in a country (like the German Economic Miracle after the war) that isn’t typically there in a shorter-lived company. There’s also truth in the idea that the right management and motivation can get much more productivity out of a population.

5) However, I think it’s wrong to say that incentives (and therefore money) don’t matter because of the experience of wartime economies.

To the contrary, perhaps the most important reason war changes the economy has to do with the introduction of a huge new incentive for everyone: basically, work fast or die.

Note from Conntects Editor

Balaji Srivivasan is at the top of our list of great minds to follow. His writings are "can't miss" content be they at his Substack page, in his terrific ebook, The Network State, or simply on his Twitter profile where you can see his current cogitations in real time.

Tags: Balaji S. Srinivasan Stuart Chase Monetary Theory Keynesian Economics

#1

Carl Milsted, Jr on Jul 9, 2023 5:57 PM

Well, for starters, inflation constitutes an across the board pay cut -- unless wages are automatically indexed for inflation.

It's also an automatic partial debt forgiveness.

Ergo, leveraged business owners have more cash and cheaper labor to work with. Employment rises.

But eventually labor demands compensation, and investors adjust required rates of return.

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#2

Carl Milsted, Jr on Jul 10, 2023 8:48 PM

Been thinking about this further. Those quotes above do really make a cool case for Keynesian thinking. What's that catch?

And then I remembered that I had written something on this some years ago:

An Incredibly Simple Business Cycle Model

I simplified an economy down to just a potato farm. With such a simple model you can get business cycle like behavior based on cache flow. No money or markets involved, really.

And unlike some pronouncements from the Austrian School, my model does allow for doing something other than just letting "malinvestments work their way out of the system." But there is a price to the solutions.

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