Monday, December 22, 2008

Keynesian Irrelevance VII: Zero Interest, Infinite Liquidity

Keynes did not quite foresee the current endless supply of money at zero interest, although he did write about the liquidity trap.

The liquidity trap is a situation whereby there is so much investment uncertainty such as deflation that even if the interest is zero, the general public still hangs onto cash (Cash is king!) - in order to preserve capital value as well as to wait for asset prices to stop falling.

The point that Keynes was making with the liquidity trap argument is that no amount of interest rate reduction would induce investors to put money into the future under conditions of deflation and therefore the government must step in to create jobs.

The point that I have been trying to make in this little series of snippets is to argue that we have gone beyond the liquidity trap argument; we are now in this new world phenomenon of cheap and endless money.

The zero-interest infinite-money supply is an extreme case - the money supply curve is infinite and therefore indefinite. Everything is now defined by the demand for money function alone - which therefore brings us back to square one - what do we do with money?

The demand for money must be for the purpose of investment which is derived by the need for people to consume. But the world has come to a stage of overproduction (due to economies of scale and extraordinary human efforts at efficiency) and the oversupply of money (thanks to irresponsibly ideological central banks) that what the world needs now is a break from these excesses.

But the adjustment costs are high - to only way to trigger a downward adjustment in prices is the destruction of excess money which implies the bankruptcy of banks and factories and the resultant unemployment. The next step is really the redeployment of the labour force to activities that increases human welfare beyong the basic needs of food and shelter. The answer could be the slowdown of the global economy so that people can enjoy their work and their lives - rather than forcing the unfortunate - the migrant workers - to work themselves to death under abject conditions.

While I understand the clever arguments for globalisation, I am increasingly disturbed by the senseless drive for profits and wealth by the elite, with the rise in income inequality and the greed of the financial and construction sectors and the decadence and arrogance of the nouveau riche.

I am increasingly being drawn to the idea of the steady development of a proper community and society whereby the family unit (the Malay concept of "keluarga") is wholesome and intact and that there is a steady drive for greater animal comfort as well as a better grasp of the meaning of human life and the sense of being.

We are now literally drowning in money and liquidity and we are trying to stay afloat.

The real economy must be refocused on the market, the financial system on prudence and risk taking and the government on providing a social safety net for the people.

If we, in the midst of prosperity, cannot take care of our poor, then we are suffering from a poverty of value despite our immense material wealth.

2 comments:

Adam Smith said...

Why Don't You Hedge Your Economic Future?

The Economy? They Paint It Black.
Let's Paint it Green, Will You?


What Are They Offering Except to Wait, Suffer and Be Patient Till, On the Long Run, The Crisis is Over?

A milder avatar of the present crisis started in Japan in 1993. Its consequence was called "Japan Lost Decade". It is 15 years old now.

Believe us they tried everything available: Keynesian Fiscal Policy, Zero Interest Rate Policy (ZIRP), Quantitative Easing... You Name It!


DIE ZEIT: Can the right monetary and fiscal policy keep the US out of a recession?

Master Conductor Alan Greenspan:

"Probably not. Global forces can now override most anything that monetary and fiscal policy can do. Long-term real interest rates have significantly more impact on the core of economic activity than the individual actions of nations.
Central banks have increasingly lost their capacity to influence the longer end of the market.

Two to three decades, ago central banks were dominant throughout the maturity schedule.
Thus, the more important question is the direction of long-term real interest rates."


Sir Alan 'El Maestro' Greenspan

The Great Irony of Success
© ZEIT online, 30.1.2008


"The long run is a misleading guide to current affairs. In the long run we are all dead.

Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again."

Sir John Maynard 'Invisible Hand' Keynes
A Tract on Monetary Reform (1923) Ch. 3

We Can't Afford to Wait That Long. Or Can You?

"The decadent international but individualistic capitalism, in the hands of which we found ourselves after the war, is not a success. It is not intelligent, it is not beautiful, it is not just, it is not virtuous—and it doesn’t deliver the goods.

In short we dislike it and are beginning to despise it. But when we wonder what to put in its place, we are perplexed.”

John Maynard 'Invisible Hand' Keynes


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"The composition of this book has been for the author a long struggle of escape, and so must the reading of it be for most readers if the author's assault upon them is to be successful, a struggle of escape from habitual modes of thought and expression.

The ideas which are here expressed so laboriously are extremely simple and should be obvious.

The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds."

Sir John Maynard 'Invisible Hand' Keynes
The General Theory of Employment, Interest and Money,
December 13, 1935 Preface



"At the present moment people are unusually expectant of a more fundamental diagnosis; more particularly ready to receive it; eager to try it out, if it should be even plausible.

But apart from this contemporary mood, the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood.

Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.

Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. Emperors and armies come and go; but unless they leave new ideas in their wake, they are of passing historic consequence.

I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval;

for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest.

But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil."

John Maynard 'Invisible Hand' Keynes,
The General Theory of Employment, Interest, and Money,
13 December 1935, p. 383.

Quoted by Master Conductor Sir Alan 'El Maestro' Greenspan.
Adam 'Defunct Economist' Smith
At the Adam Smith Memorial Lecture, Kirkcaldy, Scotland
February 6, 2005


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etheorist said...

I find the best way to get rid of the ideas of defunct economists is to work in the real world and observe how it really functions. Life is stranger than economic fiction.