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THE GENERAL THEORY OF EMPLOYMENT,

INTEREST, & MONEYby

John Maynard Keynes

Part I: Elements of the General Theory

Page Contents

HYPERLINK "http://www.futurecasts.com/Keynes,%20The%20General%20Theory%20(I).htm" \l

"Keynesian theory" µKeynesian theory§

HYPERLINK "http://www.futurecasts.com/Keynes,%20The%20General%20Theory%20(I).htm" \l "Labor

market theory" µLabor market theory§

HYPERLINK

"http://www.futurecasts.com/Keynes,%20The%20General%20Theory%20(I).htm" \l"The General Theory" µThe General Theory§

FUTURECASTS online magazine

www.futurecasts.com

Vol. 6, No. 5, 5/1/04.

HYPERLINK "http://www.futurecasts.com/Default.htm" µHomepage§

Introduction to Parts I & II

Keynesian theory:

In the source of Keynesian theory, "The General Theory of Employment, Interest, and

Money," John Maynard Keynes purports to provide a "general theory" for self-regulatingcapitalist market systems. He asserts that it is applicable generally in all economic

circumstances. Classical concepts, on the other hand, operate only in those rare "special"

circumstances where full employment is possible.

With disconcerting frequency, Marxian stupidities were invoked with approval, althoughin only one instance explicitly crediting Marx.



However, it is Keynesian theory that - if applicable at all - is applicable only in very

narrow circumstances - like the "special" circumstances of the depths of the Great

Depression where political leaders proved incapable of reforming the fundamental policystupidities that prevented recovery.

Keynes nevertheless successfully convinced multitudes of supposedly knowledgeableeconomists to accept a series of black-is-white arguments. Savings became bad and

deficits became good, and the prudent accumulation of reserves for foreseeable and

unforeseeable contingencies was imprudently responsible for disastrous consequences.The accumulation of capital assets becomes an economic obstacle rather than an

economic advantage. Investment and employment is stimulated by inflation and hindered

by price declines. Market liquidity becomes more of a problem than an advantage.

Free trade has disadvantages and closed economic systems have advantages because of

the greater ease of manipulating the latter. With disconcerting frequency, Marxian

stupidities were invoked with approval, although in only one instance explicitly crediting

Marx.Although controversy over war debts and other international debts and trade war

protectionism was raging around him, Keynes has not a word to offer about the obviousroles of such government policies in the business cycle in general and the Great

Depression in particular. See Great Depression Chronology Series, beginning with "

HYPERLINK "http://www.futurecasts.com/Depression_descent-'29.html" \t "_top" µTheGreat Depression: The Crash of '29§."

Keynes provides a rationale for pursuing short term relief from economic problems bymeans of budgetary deficits and monetary inflation - palliatives that must ultimately just

make matters considerably worse.

Over a century of capitalist economic history was thus ignored, as were all arguments

to the contrary, until Keynesian theories were put to the test in the 1970s - and predictably failed miserably wherever pursued.

Nevertheless, Keynesian concepts are once again popular and in use today - especiallyin the United States under the Bush (II) administration. They remain very popular with

political leaders, since they provide intellectual cover for doing what political leaders

have always done when seeking to put off confronting the real problems that afflict aneconomy. Keynes provides a rationale for pursuing short term relief from those problems by means of budgetary deficits and monetary inflation - palliatives that must ultimately

just make matters considerably worse.



The influence of Marx:

It is evident that Keynes rejected much of the worst of Marxian doctrine. Keynes relies

on competitive markets to allocate resources where Marx naïvely relies on socialistdirectives. Keynes uses market exchange values instead of Marx's impractical concept of industrial labor use-values. Keynes had infinite faith in paper money managed by

governments - Marx had none. (Both are wrong on this last one.)

Keynes can thus omit all of the twisted indeterminate and nonfunctional definitions

and redefinitions of economic terms that Marx relied upon for the defense of his narrowindustrial labor use-value concept and for support of his propaganda myth. Profits -

frequently referred to as "income" or "yields" - takes its obvious place for Keynes as adetermining factor for capitalist economic activity. Although he views capitalism asunable to operate at optimal levels for any length of time, Keynes recognizes - unlike

Marx - that capitalism is inherently stable within the parameters of the business cycle.

Moreover, Keynes avoids many of the weaknesses of logic that permeate Marx's work.See the series of articles beginning with HYPERLINK

"http://www.futurecasts.com/Marx,%20Capital%20(Das%20Kapital)%20%20Vol%201%

20(I).htm" \t "_top" µKarl Marx, "Capital (Das Kapital)" vol. 1 (I)§, "Value Determined by an Abstract Labor Standard."

Keynes, like Marx, ignores the particular reasons why particular periods of economic

trouble have taken place.

Keynes appears totally ignorant of the inherent inefficiency of government management.

Nevertheless, Marx's "mature capitalism" fallacy - for which Keynes cites Marx

with approval - is the central feature of the General Theory, and Keynes relies upon someindeterminate concepts of his own to support his "mature capitalism" theme. In the

process, Keynes, like Marx, ignores the particular reasons why particular periods of

economic trouble have taken place.

Like Marx, Keynes believes the ownership interest is not an essential element in

capitalist productivity. Stock market investors are "functionless." Ignoring Adam Smith'swarnings about the weaknesses inherent in the separation of management from



ownership, Keynes agrees with Marx that good management and supervision is always

readily available and can be procured simply by offer of a suitable salary.

Like Marx and all socialists, Keynes appears totally ignorant of the inherent inefficiency

of government management. See, " HYPERLINK

"http://www.futurecasts.com/Government_futurecast.html" \t "_top" µGovernmentFuturecast§," Part II, "Government Management." He has total faith in the capabilities of

government and "community" administered economic systems. While Marx offers broad

socialist solutions, Keynes offers narrower administered solutions directed at controllinginterest rates, directing investment flows, redistributing wealth, and ultimately directing

the activities of major business entities.

To entice the credulous, Keynes like Marx offers a vision of an impossible utopia. If a

capitalist system is resolutely stimulated pursuant to Keynesian policies, it will generateabundant capital assets - "full capitalization" - so that capital assets are no longer scarce.

Then, there would no longer be any need for financiers and rentiers. While residual

entrepreneurs would continue to be tolerated, Keynes agrees with Marx that theentrepreneur will become unnecessary. See, HYPERLINK

"http://www.futurecasts.com/Keynes,%20The%20General%20Theory%20(II).htm" \t

"_top" µKeynes, "The General Theory of Employment, Interest, & Money§," Part II,"Interest Rates, Aggregate Demand, and the Business Cycle."

Keynes - also like Marx - assumes that the study of economics is a "scientific" endeavor.

He thus avails himself - or at least succumbs to - the "science" propaganda ploy that was

a central feature in the propaganda myth created by Karl Marx. His followers wouldardently continue this propaganda deception until forced to retreat somewhat by their

gross failures in the 1970s.

The savings gap:

Keynes provides us with psychological propensities to consume and save. He blames

the business cycle and involuntary unemployment on the notion that wealthy nations -"mature" capitalist systems - will inevitably save more than can be profitably invested,

leading to periods of economic decline - if not chronic economic decline. Like Marx's

concepts, none of this can be measured, and in fact all the evidence is exactly theopposite.



As assets accumulate, people and businesses can - and observably do - rely more on their asset wealth than on monetary savings.

The decline in savings rates in the U.S. in recent prosperous times has been notorious for decades.

Mature - wealthy - capitalist systems require and have lower rates of savings - not

higher. As assets accumulate, people and businesses can - and observably do - rely more

on their asset wealth than on monetary savings. Their asset wealth supports vast increasesin the purchasing power of credit, naturally stimulating both consumption and

investment, with profit rates and interest rates sensitively adjusting these flows except

when other factors undermine the pertinent markets.

Except during the depths of already developed severe depressions, financial

intermediaries and the money markets have no trouble instantly putting all savingsto work in commerce. As is repeatedly pointed out throughout the articles on Marx,

"Das Kapital," and Keynes, "The General Theory," there is absolutely no evidence that

excess savings play any role in initiating periods of economic distress.

In fact, savings declined substantially in the last full year before the Great Depression -

the first decline since WW-I - accompanied by a substantial decline in the number of

savings accounts. The decline in savings rates in the U.S. in recent prosperous times has been notorious for decades.

Considering the extent and nature of man's weaknesses - and the stubbornness with

which policy stupidities are frequently maintained, it is astounding that capitalism can

function as well as it does.

The roots of the business cycle are to be found in the multitude of pertinent

weaknesses of man - NOT in weaknesses alleged in capitalism. Indeed, considering theextent and nature of man's weaknesses - both in the private sector and government sector

- and the stubbornness with which policy stupidities are frequently maintained, it is

astounding that capitalism can function as well as it does.

It is always the nitty-gritty of analyzing particular factors involved in particular periods

of economic distress that is required for an understanding of the business cycle.Economists who are too lazy or inept for this task - or unwilling to offend political

patrons or private employers - have nothing to tell us. No simplistic "General Theory"

will suffice.



Labor Market Theory

Labor markets:

Theories of supply and demand in labor markets are attacked by Keynes.

Contemporary theories purported to show how labor markets balance factors of supplyand demand to assure reasonable levels of full employment, and to correct periods of

anomalous conditions. However, by 1935, when "The General Theory" was published,

such theories looked like lame ducks.

Full employment is a "special" case in capitalist economics - labor markets clear at

reasonably high levels of employment only during certain special periods of full

employment - and the natural course of capitalist economics - the "general" case - is for

employment levels to fall well short of full employment.

The Great Depression had ravaged diverse nations all around the world and left

hoards of men unemployed and underemployed for half a decade. Clearly, contemporarylabor market theories provided no explanation for what was observably occurring -

something Keynes spends an initial chapter emphasizing.

However, Keynes never addresses the particular reasons why this should be happening.

Instead, he merely assumes that full employment is a "special" case in capitalist

economics - that labor markets clear at reasonably high levels of employment only duringcertain special periods of full employment - and that the natural course of capitalist

economics - the "general" case - is for employment levels to fall well short of full

employment.

This basic assumption of Keynes is thus very similar to that of Karl Marx. The

assumption substitutes for any functional examination of the actual causes of the Great

Depression and lesser periodic economic downturns. Like Marx, Keynes presents the prospect of periods of massive and intractable unemployment as a natural feature of

capitalist economics.

Professor Pigou:

Classical theory recognizes the obvious qualification that competitive labor markets

like other markets can be prevented from clearing by market imperfections.



Labor markets clear to the point "where the utility of the marginal product balances thedisutility of the marginal employment," according the classical theory as presented by

Pigou.

• There is "frictional unemployment" caused by such things as seasonal or other

intermittent work, the time required to find new work when a job is terminated for any reason, and similar factors.• There is also "voluntary unemployment," which includes those who refuse or

are unable to work for any of a variety of reasons.

• And, of course, market imperfections - such as unions and cartels and

government requirements - will impact results.

"Subject to these qualifications, the volume of employed resources is dulydetermined, according to the classical theory, by the two postulates" that wages equal the

marginal product of labor, and that the utility of the wage when a given volume of labor

is employed is equal to the marginal disutility of that amount of employment. The latter

postulate, however, is not objectively determinable. It is subjectively determined by eachindividual worker.

"But these two categories of 'frictional' unemployment and 'voluntary' unemploymentare comprehensive." Classical theory rejects the possibility of "involuntary

unemployment" in competitive markets.

Keynes, however, touches on another factor, but without further comment. The "output"

from the employment of labor and capital is determined only after a deduction of all

"other costs" besides the costs of wages and capital. (Thus - a far bigger factor today thanin the 1930s - regulatory costs and payroll taxes and other non-wage labor costs can have

a direct impact on labor markets.)

Labor markets clear to the point "where the utility of the marginal product balances thedisutility of the marginal employment."

The particular presentation of the classical theory that Keynes uses as his target is

that of Professor A. C. Pigou, a prominent English economist. Pigou provided a

macroeconomic econometric description of the national labor market.

Due to the need for oversimplification in all macroeconomic econometric presentations,

Pigou's work is necessarily invalid. Substantial outcome determinative factors are

necessarily omitted. Everything that cannot be described as an equation is necessarily

omitted. Problems of measurability and definition inherently permeate all macro-econometrics. Macroeconomic statistics inherently include gross inaccuracies. See, "



HYPERLINK "http://www.futurecasts.com/Economic_statistics.html" \t "_top"

µEconomic Statistics and Macro Econometrics, The Figures Lie."§

Explaining with admirable insight why such problems are inherent in all macro-econometrics, Keynes jumps on those that afflict Pigou's work. He quickly attacks "the

tacit assumptions, which govern the application of his analysis, [that] slip in near theoutset of his argument."

The labor market has significant peculiarities. Its supply and demand schedule is

inherently complex because of the nature of the supply - human labor. These factors must be kept in mind when evaluating any labor market theory - including that of Keynes.

• When goods cannot clear a market, businesses face costs for storage so the goods

are sold at discount or are scrapped. When businesses can no longer profitably

serve a market, they decline or go out of business. However, unemployed workers

don't disappear. They find ways of surviving. The surplus retained inventory problem is thus always more severe.

• Labor can - and during the Great Depression frequently did - work for food and/or

lodging without a "wage" that could be included in the national statistics.Although not sustainable as a permanent matter in those years before the welfare

state - such laborers didn't support families - this could suffice even for a period

of years. People hung on as farm hands or shop broom pushers or pushcartvendors or as smallholder farmers, yet were properly classified as "unemployed"

since they were still anxious to find wage work.

• Wheat and capital and mass produced goods are fungible. Labor is not fungible.

Skills are not fungible. In particular, agricultural skills are of little use inmanufacturing or most services. Even unskilled labor varies in levels of strength,

dexterity, reliability, educability and education. This became especially important

in 1930 and thereafter with the collapse of the export markets for grains and

cotton and thus the collapse of the entire U.S. agricultural sector - still a hugesegment of the U.S. economy in the 1930s. There was a collapse in auto exports -

about 20% of the U.S. market - at the same time.• Labor mobility operates under significantly greater constraints than the mobility

of products or capital - especially in small nations.

• Trade unions and collective bargaining, in any event, have an impact on

competition not reflected in labor market theory.• And, as stated, it is the factors of supply in the labor market that are subjective

and fuzzy, not the factors of demand.

Thus, labor market adjustments are never precise or rapid - even without modern factors

of rigidity.



Pigou ignores influences outside the labor sector that may impact "the rate of interest or the state of confidence."

Pigou assumes there is no "voluntary unemployment," Keynes points out. All whodesire work can find it if they are just willing to accept low enough wages. Pigou

assumes "that the rate of interest always adjusts itself to the schedule of the marginalefficiency of capital in such a way as to preserve full employment."

However, this ignores influences outside the labor sector that may impact "the rate of

interest or the state of confidence," Keynes properly notes. Both of these factors are

major variables, either of which may impact risk-reward ratios and thus investment.

Without such factors, Pigou's work is limited to the "special case when marginal labour-

cost is equal to marginal prime cost" - when all factors extraneous to Pigou's work andaffecting employment permit full employment.

A rise in prices relative to wages will create an increased demand for labor that is

frequently satisfied without any increase in money-wages. This is proof that involuntary

unemployment existed from which such demand could be satisfied.

Pigou's labor market supply and demand schedule thus explains "what level of real

wages will correspond to any given level of employment." It "is not capable of telling uswhat determines the actual level of employment." It has no bearing on "involuntary

unemployment."

In similar manner, Keynes duly pokes holes in existing labor market theories that

purport to explain how market influences tend towards reasonable levels of full

employment. Especially during the midst of the Great Depression, such theories clearlydidn't reflect reality.

Workers resist reductions in money wages far more than reductions in real - inflation-

adjusted - wages unless the latter reach severe proportions. However, labor market theoryassumes that workers respond to fluctuations in real wages. The theoretical relationships

between employment levels and real wage rates simply aren't there in the real world. A

variety of other factors besides wage levels impact price levels and thus real wages.

Money wages in fact fell fairly sharply in the first three years of the Great Depression - but not nearly as sharply as prices. Those workers who managed to keep their jobs - the

majority of workers - were living quite well. Keynes is quite right that wage rates are

simply not as elastic as other prices.

Keynes points out that a rise in prices relative to wages will create an increased demand

for labor that is frequently satisfied without any increase in money-wages. This is proof



that involuntary unemployment existed from which such demand could be satisfied. "[If]

the classical theory is only applicable to the case of full employment, it is fallacious to

apply it to the problems of involuntary unemployment" which in 1935 was everywhere.

Keynes, however, does not dispute that real wages - that price levels - "are uniquely

correlated" to volume of output, so that an increase in employment can only occur in theshort run if accompanied by a decline in real wages as prices move higher and increase

the demand for labor. However, prices may decline - causing an increase in real wages (as

they did during the Great Depression). Thus, "a willingness on the part of labour toaccept lower money-wages is not necessarily a remedy for unemployment." (Indubitably,

there are many factors other than prices and wages that impact labor markets.)

Then, Keynes provides this remarkable segment:

"The pitfalls of a pseudo-mathematical method, which can make no progress except by

making everything a function of a single variable and assuming that all the partial

differentials vanish, could not be better illustrated. For it is no good to admit later on thatthere are in fact other variables, and yet to proceed without re-writing everything that has

been written up to that point."

As Keynes candidly points out elsewhere, this can be said for ALL macroeconomic

econometric models - those even with multiple variables - no matter how complex theymay be.

"A scientific theory cannot require the facts to conform to its own assumptions," Keynes

states with profound wisdom. It must explain observable reality. Keynes properly

pummels Pigou's work on this basis.

Keynes himself fails to provide work that meets this basic requirement. However, to hisgreat credit, he candidly attaches suitable warnings of imprecision to his own macro-

econometric analyses - and even to some of his non-econometric work - warnings that his

followers would generally disregard.

Then, Keynes touches on a point related to weaknesses in his own approach.

"Professor Pigou has altogether omitted from his analysis the unstable factor, namely

fluctuations in the scale of investment, which is most often at the bottom of the

phenomenon of fluctuations in employment."

The reasons why investment levels fluctuate are many and varied. Except for thegeneralized over-optimism that afflicts prosperous times, and the fears that accompany

periods of distress, Keynes omits or grossly oversimplifies them.

The Problem With Savings:



The element based on idle supplies and equipment is minimized or intentionally omitted

by other theorists. However, Keynes insists that it has relevance - most noticeable for

inventories of consumable supplies like copper. The importance of this factor increaseswhen conditions of surplus and idleness are expected to last for significant periods.

Everything but land or some precious commodities during inflationary times will become obsolete or deteriorate over time or incur carrying or opportunity costs ultimately

in excess of its value, rendering this element of very minimal importance, indeed. For example, the price of copper declined sharply during the first three years of the Great

Depression, resulting in massive forced sales of surplus inventories.

The entrepreneur's profit and factor costs together are the total income for the

entrepreneur and his employees.

The profit - which Keynes refers to as "the income" - of the entrepreneur is the excess

of the proceeds over factor and user costs. The entrepreneur's profit and factor coststogether are the total income for the entrepreneur and his employees.

With costs of the supply of employment thus defined, Keynes provides a supply and

demand schedule for his "General Theory" based on the intersection of aggregate proceeds of employment and aggregate costs of the employment that achieves those

proceeds. He uses the phrase "aggregate supply function" for the former and "aggregate

demand function" for the latter. The point of intersection is "the effective demand for labor."

Keynes uses this term - "effective demand" - to distinguish it from previous theories

of labor supply and demand that assumed that the market would always clear at a point

that could be defined as full employment. "Says Law" - "supply creates its own demand"

- is a prominent feature of such views.

Labor market theories are based on competitive markets. When markets are disturbed

because of ordinary excess - such as various "bubbles" in the private sector - the periods

of increased unemployment can reasonably be attributed to temporarily increased levelsof frictional unemployment while those excesses are sorted out under the pressures of

economic decline. Such periods of economic decline are generally less than three years in

duration.

It is when inappropriate private monopoly or cartel polices or government policies

stubbornly resist such sorting out that labor markets fail. Conditions of involuntaryunemployment can then last for a decade. Indeed, they can and do last indefinitely.



It is thus more accurate to say that traditional labor market theory is indeed "general" - but only for economic systems and their labor markets that are reasonably flexible and

competitive and subject to reasonably competent government policies. During the Great

Depression, and during the chronic inflation and stagflation of the 1970s, that was

definitely not the case.

Says Law has its problems - but it was never presumed to operate outside reasonably

competitive markets operating in economic systems subject to reasonable government policies.

When income increases, so does "the propensity to consume." However, the latter increases somewhat less than the former, according to Keynes, "since when our income

increases our consumption increases also, but not by so much."

Keynes then explains his theory of employment.

"When employment increases, aggregate real income is increased. The psychology of

the community is such that when aggregate real income is increased aggregateconsumption is increased, but not by so much as income. Hence, employers would make

a loss if the whole of the increased employment were to be devoted to satisfying the

increased demand for immediate consumption. Thus, to justify any given amount of

employment there must be an amount of current investment sufficient to absorb theexcess of total output over what the community chooses to consume when employment is

at the given level. For unless there is this amount of investment, the receipts of the

entrepreneurs will be less than is required to induce them to offer the given amount of employment. It follows, therefore, that, given what we shall call the community's

propensity to consume, the equilibrium level of employment, i.e. the level at which there

is no inducement to employers as a whole either to expand or to contract employment,will depend on the amount of current investment. The amount of current investment will

depend, in turn, on what we shall call the inducement to invest; and the inducement to

invest will be found to depend on the relation between the schedule of the marginal

efficiency of capital and the complex of rates of interest on loans of various maturitiesand risks."

Then he asserts his key argument.

"[There] is no reason in general for expecting that [the point of equilibrium will] beequal to full employment."

"The effective demand associated with full employment is a special case, only realised

when the propensity to consume and the inducement to invest stand in a particular

relationship to one another. This particular relationship, which corresponds to theassumptions of the classical theory, is in a sense an optimum relationship. But it can only



exist when, by accident or design, current investment provides an amount of demand just

equal to the excess of the aggregate supply price of the output resulting from full

employment over what the community will choose to spend on consumption when it isfully employed."

However, during prosperous times, investment levels generally run AHEAD of savings - pushing interest rates and prices higher in a familiar cyclical pattern as businesses

compete for savings and productive resources that are at such times always in SHORTsupply. Keynes amazingly attributes this last surge in interest rates to "fear." In fact, such

surges occur when optimism reigns supreme - "irrational exuberance" - and a lack of

caution is in fact the predominant characteristic.

During times of prosperity, everybody keeps their savings in banks - for superior

security and convenience as well as for some interest earnings - and the financingmechanism never has any trouble putting ALL savings to work in commerce. When

doubts arise, they strike equity values long before they begin to undermine a modern

financial system. So Keynes fails to explain how periods of prosperity initially break down.

When income increases, so does "the propensity to consume." However, the latter

increases somewhat less than the former, according to Keynes, "since when our income

increases our consumption increases also, but not by so much."

The greater the volume of employment, "the greater will be the gap" between aggregate

income and aggregate consumption that must be filled by investment to retain its stability. Whenever investment does not so rise, full employment cannot be maintained.

This "psychological law" is the key to the problem. The greater the volume of

employment, "the greater will be the gap" between aggregate income and aggregate

consumption that must be filled by investment to retain its stability. Whenever investmentdoes not so rise, full employment cannot be maintained.

"The propensity to consume and the rate of new investment determine between them the

volume of employment, and the volume of employment is uniquely related to a given

level of real wage -- not the other way around. If the propensity to consume and the rate

of new investment result in a deficient effective demand, the actual level of employmentwill fall short of the supply of labour potentially available at the existing real wage, and

the equilibrium real wage will be greater than the marginal disutility of the equilibriumlevel of employment."



"The insufficiency of effective demand will inhibit the process of production in spite of the fact that the marginal product of labour still exceeds in value the marginal disutility of

employment."

"The richer the community, the wider will tend to be the gap between its actual and its

potential production; and therefore the more obvious and outrageous the defects of theeconomic system."

Thus, Keynes derives his overall reason for economic dislocations. It has definiteMarxian overtones - that he acknowledges in a footnote.

"This analysis supplies us with an explanation of the paradox of poverty in the midst of

plenty. For the mere existence of an insufficiency of effective demand may, and often

will, bring the increase of employment to a standstill before a level of full employment

has been reached. The insufficiency of effective demand will inhibit the process of production in spite of the fact that the marginal product of labour still exceeds in value

the marginal disutility of employment.

"Moreover the richer the community, the wider will tend to be the gap between its actual

and its potential production; and therefore the more obvious and outrageous the defects of the economic system. For a poor community will be prone to consume by far the greater

part of its output, so that a very modest measure of investment will be sufficient to

provide full employment; whereas a wealthy community will have to discover muchampler opportunities for investment if the saving propensities of its wealthier members

are to be compatible with the employment of its poorer members. If in a potentially

wealthy community the inducement to invest is weak, then in spite of its potential wealth,the working of the principle of effective demand will compel it to reduce its actual

output, until, in spite of its potential wealth, it has become so poor that its surplus over its

consumption is sufficiently diminished to correspond to the weakness of the inducement

to invest.

"But worse still. Not only is the marginal propensity to consume weaker in a wealthy

community, but, owing to its accumulation of capital being already larger, theopportunities for further investment are less attractive unless the rate of interest falls at a

sufficiently rapid rate; which brings us to the theory of the rate of interest and to the

reasons why it does not automatically fall to the appropriate level, which [is covered later

in the book]."

Marx himself could not have written a more bleak picture of the fate of "mature"

capitalist economic systems. However, why, then, is there observably more

unemployment - and more intractable conditions of unemployment - in so many poor countries?

And how convenient this theory is. It relieves the Keynesians - again like the Marxists -



of the chore of analyzing the particular causes of particular periods of economic decline.

It is all, after all, just a function of mature capitalist systems - a weakness inherent in

capitalism - just as Marx said.

Keynes then acidly criticizes Ricardo and subsequent classical economic theorists for

insisting on a theory that observably doesn't explain the facts of the business cycle -resulting at last in the hopelessness of the Great Depression.

In this Keynes is clearly correct. Classical theory indeed doesn't explain the business

cycle. It doesn't deal with the factors of private and government excess and inappropriate policy that can temporarily or permanently undermine competitive markets. However,

Adam Smith wrote of several such factors that were thus recognized a century and a half

before Keynes was writing his General Theory. See, HYPERLINK

"http://www.futurecasts.com/Smith,%20Wealth%20of%20Nations%20(I).htm" \t "_top"µAdam Smith, "The Wealth of Nations§," Part I, "Market Mechanisms," and

HYPERLINK

"http://www.futurecasts.com/Smith,%20Wealth%20of%20Nations%20(II).htm" \t "_top"µAdam Smith, "The Wealth of Nations§," Part II, "Economic Policy."

Income, Savings, and Investment

Income:

Keynes defines the "income" of an entrepreneur as total revenue minus use of

inventory, wear and tear of productive assets - including productive equipment andfacilities - and also minus sums paid to other entrepreneurs. Calculations for discreet

periods include appropriate adjustments for inventory and productive assets at the

beginning and end of the period.

Wages and salaries paid are income to their recipients, but are balanced by theresulting changes in the value of inventories and other assets for the entrepreneur.

Inventory values are based on market exchange values - making this a much broader and

defensible application of the labor theory of value than that of Marx.

The determination of equipment and facilities costs is one of the key problems faced

by Keynes. He here applies his "user cost" concept - deducting the value of the facilities

and equipment at the end of the period from what they would have been worth if left idle



with maintenance and improvements reasonable under the economic circumstances. He

provides a simplistic econometric formula for the calculation to "measure the sacrifice of

value involved in production" of output.

This is clearly an indeterminate figure. Moreover, except for things with very low

carrying costs - like land and precious substances - it is probably a negative figure. Highreal interest rates will tend to make the figure for even land and precious substances a

negative figure. Keynes later recognizes the impact of carrying costs. Use it or lose it!

A - U, revenues minus user costs, is the aggregate income of the economy.

Payments to other entrepreneurs for all other purposes are "factor costs." Both

factor and user costs are income to others. User costs plus factor costs equal the "primecost of output," which is deducted from revenues to determine "income."

"Income" is thus "gross profit." This is what the entrepreneur "endeavors to maximize -

- - [a concept] which agrees with common sense."

With this convenient simplification, Keynes can boil down the entire income of thenation to the "value" of production minus total user costs. Value is measured by revenues

- exchange values - rather than by the indeterminate industrial labor use-values of Marx.

A - U, revenues minus user costs, is the aggregate income of the economy.

"Income, thus defined, is a completely unambiguous quantity." (Keynes here overlooksthe ambiguities inherent in the inexact arts of the accountant, including such inherent

ambiguities as calculations of wear and tear and depreciation, and the value of private businesses as going concerns, and the value of sweat equity and human know-how.)

Since the entrepreneur "endeavors to maximize" his income - which is his gross profit -his expectation of such income determines "how much employment to give to other

factors of production." "[It] is the quantity which is causally significant for employment."

• Aggregate consumption is thus the exchange value of aggregate production

minus factor costs: Σ(A -A1).

• Aggregate investment is thus aggregate factor costs minus user costs: Σ(A1 -U).

• User costs are "the individual entrepreneur's disinvestment" - and the sums paid

to cover user costs are his investment - "in respect of his own equipmentexclusive of what he buys from other entrepreneurs."

• Consumption - in a completely integrated system - without international

commerce - thus equals the exchange value of output, and investment equals user costs.



Thus, since income is equal to aggregate sales minus aggregate user costs - and

aggregate consumption is equal to aggregate sales minus aggregate transactions between

entrepreneurs, savings must be equal to aggregate transactions between entrepreneurs

minus aggregate user costs; or Σ

(A1 -U). For "net savings," aggregate supplemental costshave to also be deducted; or Σ( A1 -U -V).

Aggregate income that people decide not to consume or invest is "savings."

Current investment - "the current addition to the value of the capital equipment which

has resulted from the productive activity of the period" - is equal to savings as defined

above. Omitting the Σ for convenience, Keynes summarizes aggregative elements as

follows:

"We have seen above that as the result of the production of any period entrepreneurs endup with having sold finished output having a value A and with a capital equipment which

has suffered a deterioration measured by U - or an improvement measured by -U where U

is negative - as a result of having produced and parted with A, after allowing for purchases A1 from other entrepreneurs. During the same period finished output having a

value A -A1 will have passed into consumption. The excess of A -U over A -A1, namely A1

-U, is the addition to capital equipment as a result of the productive activities of the

period and is, therefore, the investment of the period. Similarly A1 -U -V, which is the net

addition to capital equipment, after allowing for normal impairment in the value of

capital apart from its being used and apart from windfall changes in the value of the

equipment chargeable to capital account, is the net investment of the period."

Those "windfall changes," of course, are happening all the time in the markets, and canhave dramatic impacts on purchasing power and on all economic activities. Failure is a

substantial factor that Keynes does not include. There are always investments that fail

with substantial losses, and capital destroyed by the continuing processes of creativedestruction. On the other hand, the value of going concerns is generally greater than the

value of their physical assets.

Thus:

"Income = value of output = consumption +investment.Saving = income -consumption.

Therefore, saving = investment."

Aggregate income that people decide not to consume or invest is "savings."



Psychological Propensities and Inducements

Factors affecting consumption levels:

Aggregate consumption levels depend on certain objective and certain subjective

factors.

The accumulation of government surpluses as "sinking funds" to pay debts - or for anyother reason - can result in "severe contractions" of effective demand, according to

Keynes. Deficit spending by governments can result in "marked expansion" of effective

demand.

• Real wages - wages adjusted for price inflation or deflation - determine

consumption levels more than money-wages. Like Adam Smith, Keynes

determines purchasing power by the amount of labor - measured by Keynes in basic "wage-units" - obtainable in the market. If these wage-units change,

consumption will change in the same direction, but to a somewhat less extent

relative to given levels of employment. This may be altered somewhat by changesin income distribution between entrepreneurs, rentiers and labor.

• It is net income that affects consumption. Changes in income not reflected in net

income won't impact consumption.• Windfall changes in capital values - like securities and real estate price

fluctuations - will impact the propensity to consume.

"The consumption of the wealth-owning class may be extremely susceptible to

unforeseen changes in the money-value of its wealth. This should be classified amongst

the major factors capable of causing short-period changes in the propensity to consume."

Yet another similarity with the views of Karl Marx. Wealth and the consumption of

"luxury" goods increases instability in capitalist systems, according to both Marx and

Keynes. However, this is not evident in the historic record. The greatest periods of 20thcentury instability - the 1930s and 1970s - were clearly caused by colossal stupidity in

government policies, not by factors inherent in the private sector of wealthy nations. See,

HYPERLINK "http://www.futurecasts.com/Depression_mythology-I.html" \t "_top"

µGreat Depression Mythology§, "Summaries of Controversies and Facts," and "HYPERLINK "http://www.futurecasts.com/Understanding%20Inflation.html" \t "_top"

µUnderstanding Inflation§."

• Changes in real interest rates and perceived economic and financial risk levels

will impact the propensity to consume. This is more important for longer term

tendencies rather than short term tendencies unless the changes are fairly sharp.

Short term fluctuations are likely to be overlooked by most people. However,

capital asset values do respond more sensitively and immediately to changes inthese factors and thus provide a more immediate indirect influence on

consumption tendencies.



• Changes in "fiscal policy" - in taxation and government spending - have an

obvious impact. The accumulation of government surpluses as "sinking funds" to

pay debts - or for any other reason - can result in "severe contractions" of effective demand, according to Keynes. Deficit spending by governments can

result in "marked expansion" of effective demand.

Somehow, this has never been demonstrated in actual practice. The WW-II experience -

widely cited as proof - is seriously flawed. For some reason, economic history is litteredwith instances of economic crises caused or worsened by government indebtedness.

• Expectations of future earnings growth or decline may also impact

consumption levels. However, this is probably more important for individual

consumption than aggregate consumption, since changes will probably averageout, with aggregate changes occurring only slowly over extended periods.

This is probably in error. Even when wage levels remain stationary, individuals

generally expect future income to be greater than current income. The onset of arecession can have a dramatic impact, here, as can the onset of recovery.

As long as the wage-unit in terms of money remains fairly stable, Keynes points out,

the propensity to consume will likely remain fairly stable.

"Windfall changes in capital-values will be capable of changing the propensity to

consume, and substantial changes in the rate of interest and in fiscal policy may make

some difference; but the other objective factors which might affect it, whilst they must

not be overlooked, are not likely to be important in ordinary circumstances."

It is changes in the volume of output and employment that most impact aggregate

consumption tendencies.

The savings gap:

Consumption tendencies adjust to income fluctuations but to lesser degrees and with

some delay.

Wealthy societies will save more than poor societies since immediate needs of the poor will require greater proportionate levels of spending. "These reasons will lead, as a rule,

to a greater proportion of income being saved as real income increases."



"For since consumers will spend less than the increase in aggregate supply price whenemployment is increased, the increased employment will prove unprofitable unless there

is an increase in investment to fill the gap."

Thus, savings will fluctuate with income fluctuations, but more in the short term than

in the long term. Cyclical fluctuations thus have a marked impact on savings rates.

"Thus, a rising income will often be accompanied by increased saving, and a falling

income by decreased saving, on a greater scale at first than subsequently."

Wealthy societies will save more than poor societies since immediate needs of the poor

will require greater proportionate levels of spending. "These reasons will lead, as a rule,

to a greater proportion of income being saved as real income increases."

Except for economic systems that cannot get above subsistence levels, this has not beenthe case. In fact, savings rates in the wealthiest nations - like the U.S. - have been in

notorious decline for decades, while savings rates remain high in nations still only

marginally beyond subsistence levels.

A major factor in the business cycle, according to Keynes, is thus the tendency of consumption increases and decreases to be proportionately less than corresponding

income increases and decreases. Thus, Keynes focuses on this mythological savings

"gap."

"For since consumers will spend less than the increase in aggregate supply price when

employment is increased, the increased employment will prove unprofitable unless thereis an increase in investment to fill the gap."

Somehow, the statistics generally fail to support this fundamental Keynesian conclusion.

Not only have savings rates been in notorious decline in recent U.S. history, they evendeclined substantially in the last full year before the Great Depression - during the great

surge of prosperity between mid 1928 and mid 1929. This savings decline was

accompanied by a substantial decline in the number of savings accounts. These were thefirst declines since WW-I. Keynes is clearly writing in response to Great Depression

phenomena - but fails to acknowledge, much less explain, this inconvenient fact.

By accumulating funds for future investments or emergencies, the dreaded savings "gap"

is expanded and the investments that might fill the "gap" are delayed.

Like Marx, Keynes points an accusing finger at financial reserves. By accumulating

funds for future investments or emergencies, the dreaded savings "gap" is expanded and

the investments that might fill the "gap" are delayed. Such reserves constitute "a drag on



employment" during periods of accumulation - "suddenly made good in a lump" when

the reserves are expended for the intended investment or emergency. (This stupidity could

have been lifted straight out of Das Kapital.)

"Thus sinking funds, etc., are apt to withdraw spending power from the consumer long

before the demand for expenditure on replacements - which such provisions areanticipating - comes into play; i.e. they diminish the current effective demand and only

increase it in the year in which the replacement is actually made. If the effect of this isaggravated by 'financial prudence,' i.e. by its being thought advisable to 'write off' the

initial cost more rapidly than the equipment actually wears out, the cumulative result may

be very serious indeed."

Then, Keynes provides these remarkably inaccurate sentences:

"In the United States, for example, by 1929 the rapid capital expansion of the previous

five years had led cumulatively to the setting up of sinking funds and depreciation

allowances, in respect of plant which did not need replacement, on so huge a scale that anenormous volume of entirely new investment was required merely to absorb these

financial provisions; and it became almost hopeless to find still more new investment on

a sufficient scale to provide for such new saving as a wealthy community in full

employment would be disposed to set aside. This factor alone was probably sufficient tocause a slump."

If there were so much excess savings, why were interest rates so high in 1929?

Investment demand was expanding exuberantly - clearly outrunning available savings

and pushing interest rates high enough to draw substantial funds from as far away asEurope. All types of debt - consumer as well as investment - expanded sharply well into

October, 1929.

While interest rates declined rapidly AFTER economic contraction began in August of

1929, the decline was from extraordinarily high levels and did not reach nearly normal

levels until economic decline became obvious in October, 1929. Indeed, they did notreach levels indicating a lack of investment demand for all available funds until many

months thereafter.

On a more logically firm footing, Keynes points to the problems of excess savings in1935 - in the midst of the Great Depression, when there was little profit inducement to

borrow the accumulated savings. He belabors government "prudence" in accumulating

sinking funds for future needs. The data Keynes relies on for this point - admittedly less than precise - also shows that

"net capital formation" remained high through 1929, and did not decline until thereafter -

after the Great Depression had already begun. The decline thus was the result of theslump - not its cause.



Keynes remarkably views the increase in capital in wealthy states as a problem rather

than as a strength.

"Each time we secure to-day's equilibrium by increased investment we are aggravating

the difficulty of securing equilibrium to-morrow."

Only if interest rates are managed so as to maintain levels of full employment do the

classical models hold and savings retain their status as virtues.

Prudence and savings thus come under sharp attack by Keynes.

"We cannot, as a community, provide for future consumption by financial expedients but

only by current physical output."

The terminology is different, but the fallacy is the same as that of Karl Marx.

Keynes remarkably views the increase in capital in wealthy states as a problem rather than as a strength.

True, the business cycle naturally involves tendencies to periodically over-expand

capital assets and inventories during prosperous periods. Periods of irrational exuberance

during prosperous times is a general factor in the business cycle properly recognized byall economists - including Marx and Keynes. Working these excesses off during periods

of economic decline poses obvious difficulties. Nevertheless, this is a short term problem

that is routinely dealt with during the ordinary business cycle - involving periods of decline of about three years or less. It is not the long term problem that Keynes is talking

about.

According to Keynes - and Marx - as savings increase for wealthy states, investment

must also consistently increase to circulate those savings and avoid secular economicdecline - a task that gets increasingly difficult in the face of a growing abundance of

capital assets.

"Thus the problem of providing that new capital-investment shall always outrun capital-

disinvestment sufficiently to fill the gap between net income and consumption, presents a problem which is increasingly difficult as capital increases. New capital-investment can

only take place in excess of current capital-disinvestment if future expenditure on

consumption is expected to increase. Each time we secure to-day's equilibrium byincreased investment we are aggravating the difficulty of securing equilibrium to-



morrow. A diminished propensity to consume to-day can only be accommodated to the

public advantage if an increased propensity to consume is expected to exist some day."

Keynes - writing during the Great Depression - clearly views the nation's livingstandards as ultimately static. His mind - thus little better than that of Marx - is incapable

of contemplating the constantly increasing standards of living of the 20th century, oncethe trade wars and financial obstacles of the Great Depression were removed.

Keynes fails to understand that widely accumulated assets - especially private homes -

would DECREASE the need for private savings. Businesses, too, would be able to rely

on the equity values of assets and businesses as going concerns as a substitute for savings. Thus, wealthy states with well developed and secure financial systems would

have far less need for high savings rates than less developed nations.

The propensity to save itself declines with the accumulation of capital and durable

assets. Anyone who has bought and furnished homes knows there are no natural limits to

the propensity to consume.

Fluctuations in income are the greatest influence on short-period changes inconsumption. Thus, substantial increases in interest rates actually reduce savings because

of the extent that they reduce economic activity, investment and incomes. Thus, "a rise in

the rate of interest must have the effect of reducing incomes to a level at which saving isdecreased in the same measure as investment." The more we try to save under such

circumstances, the worse it gets.

"The more virtuous we are, the more determinedly thrifty, the more obstinately orthodox

in our national and personal finance, the more our incomes will have to fall when interest

rises relatively to the marginal efficiency of capital. Obstinacy can bring only a penalty,not a reward. For the result is inevitable."

Only if interest rates are managed so as to maintain levels of full employment do the

classical models hold and savings retain their status as virtues.

The multiplier:

A rise in the rate of investment tends to increase employment by more than the sumsinvested, and a fall tends to similarly decrease employment.

In the normal case, "small fluctuations in investment will lead to wide fluctuations in

employment."



Inflation need be of no concern, since true inflation occurs only with full employment.

The existing propensity to consume changes only slowly in normal circumstances.

Given the existing propensity to consume, a given level of investment will not only resultin the obvious amount of employment - called "primary employment" - but will also

result in additional employment as a result of the consumption activities of those

primarily employed.

This is a "multiplier" factor that can be precisely calculated depending on the existing

"marginal propensity to consume" (which cannot be precisely calculated). Keynes provides a simple mathematical formula for determining the extent to which increases in

employment with a given level of capital equipment will result in further consumption

and employment. This same calculation can explain the further growth of employmentthat will flow from a given level of investment - the "investment multiplier."

Thus, if the community tends to consume - say - nine-tenths of any income increment,

the multiplier will be 10 - and that will hold as good for public works as for privateinvestment as long as the former doesn't displace the latter. (If it does, real wages will

decline due to the significantly lower productivity levels in the government sector.)

Thus, in the normal case, "small fluctuations in investment will lead to wide fluctuations

in employment." The amount of additional investment that will produce full employment

is thus small or large depending on the marginal propensity to consume the additionalincome flowing from increased rates of investment. Inflation need be of no concern, since

true inflation occurs only with full employment.

This is a common Keynesian assertion refuted by centuries of economic history as well

as subsequent experience with Keynesian policies during the stagflation period of the1970s.

Offsets:

Applied to public policy - to changes in expenditures for public works - various offsets

must be taken into account.

• Increased borrowing that pushes up interest rates, or increases in taxation, will

reduce the multiplier impacts of an increase in public works. Any rise in the costof capital goods due to the additional demand will reduce their marginal

efficiency for private investors. Thus, interest rates must not only be kept steady,



they must be pushed down, if increases in public works are to have their full

multiplier impact.

Deficit spending thus doesn't increase employment when the financial system is in tact.It is the monetization of debt to keep interest rates down that normally provides all the

actual stimulus.

• "Confused psychology" that causes loss of confidence in the private sector as a

result of increases in government works financed by deficits and the expansion of the money supply may produce negative impacts. This may increase savings -

"liquidity preference" - for contingency reserves, or diminish the marginal

efficiency of capital and thus private investment.

It may ultimately also cause capital flight and decapitalization as assets are milkedrather than maintained.

•

Foreign trade reduces the multiplier for domestic employment. The artificialconsumption and investment of Keynesian policies will increase imports - only a

minor fraction of which will be recouped as foreign economic systems respond.

This obvious negative impact on the balance of trade and international payments would be determinedly ignored by Keynesians, who would express amazement at the collapse of

the dollar in the 1970s after a decade of Keynesian policy implementation. Today, again,

Keynesian policies are accompanied by chronic currency devaluation.

• As full employment is thus maintained, the marginal propensity to consume

will tend to decline as real incomes increase.

Yet again, Keynes repeats that ridiculous Marxian notion of the weaknesses of "mature"

wealthy economic systems.

• To the extent that public works increase entrepreneurial profits rather than

labor wages, the multiplier will be reduced due to the lower propensity toconsume of the former.

But won't higher profits increase the inducement to invest, with even a higher multiplier

impact?

•The reduction in "negative savings" as the newly employed stop consumingtheir own savings or those of others will increase aggregate savings rates and

reduce the multiplier.

But won't this decrease - or limit the increase - of interest rates?



Closed economic systems are thus more amenable to Keynesian manipulation. Keynes

estimates that modern communities tend to consume about 80% of additional income,

providing a multiplier of about 5. However, if foreign trade "accounts for, say, 20% of consumption and where the unemployed receive out of loans or their equivalent up to,

say, 50% of their normal consumption when in work, the multiplier may fall as low as 2

or 3 times" the primary employment.

This, according to Keynes, is why employment fluctuated so much more in the U.S.

than in Great Britain during the first years of the Great Depression.

Foreign trade in the U.S. - artificially restrained by trade war protectionism andnaturally limited by the greater extent of the U.S. market - was proportionally much

smaller than in England.

Even unwise public works will more than pay for themselves during periods of severeunemployment.

The multiplier is not instantaneous. Its impacts are gradual. If the change in

investment rates is large and abrupt, various immediate impacts will cloud the picture

until the multiplier has its logical results.

When unemployment is high, the multiplier for increased investment or public works is

highest due to the higher propensity to consume. Thus, even unwise public works willmore than pay for themselves during periods of severe unemployment.

"Pyramid-building, earthquakes, even wars may serve to increase wealth, if theeducation of our statesmen on the principles of the classical economics stands in the way

of anything better."

Bush (II) could have used Keynes for a speech writer. Somehow, the major increases in

public works during the 1930s failed to end the Great Depression. Somehow, vast deficits

failed to end Japan's economic malaise during the 1990s. Somehow, numerous nationshave suffered financial collapse despite all the benefits of their vast deficits. Somehow,

the U.S. is rewarded with a chronically devaluing currency and the corresponding adverse

shift in its terms of trade as a result of all the "benefits" of its current vast deficits and

rapidly expanding money supply.

The inducement to invest:

Expected yields and current interest rates determine investment rates. Keynes

properly emphasizes expected yields rather than just current yields in drawing his



However, real interest rates at or near zero in the 1970s did not prevent the onset of

stagflation in the U.S. - with double digit levels of inflation and nearly double digit levels

of unemployment at the same time.

Keynes explains the business cycle in terms of a broad theory, "the fluctuations of

the marginal efficiency of capital relative to the rate of interest." Although the theories aresomewhat different, this is quite similar to the approach of Karl Marx. It enables them

both to ignore all the particular factors that contribute to particular periods of economic

distress.

These sorts of games are quite common in economics. There are always infinite chains

of cause and effect in operation, and anything can be "proved" to be a substantive cause

by merely choosing where along the chain to begin the examination. Keynes candidly

admits that his choices of independent variables are not based just on their merits, but onthe basis of whether he believes that they can be conveniently manipulated.

The risk-reward ratio is properly brought into the picture at this point. Keynesdiscusses perceptions of risks both for borrowers and lenders, and the tendency of such

perceptions to decline to "unusually and imprudently low" levels during periods of

prosperity.

Prospective yield:

The state of confidence is a key factor in the evaluation of long term prospects,Keynes properly emphasizes. It is one of the "major factors" determining the investment

demand-schedule. Unfortunately, unlike other major factors - like the rate of interest - it

is very uncertain and nebulous.

Unless investors believed in - or strongly hoped for - success, they would not risk what

they have on the uncertain future.

Businessmen and investors are inherently optimistic, Keynes wisely recognizes.

Unless they believed in - or strongly hoped for - success, they would not risk what they

have on the uncertain future. Nor is this only a matter of profit.

"If human nature felt no temptation to take a chance, no satisfaction - profit apart - inconstructing a factory, a railway, a mine or a farm, there might not be much investment

merely as a result of cold calculation. - - - The actual results of an investment over a long



term of years very seldom agree with the initial expectation." (Yet another viewpoint

twisted by the experience of the Great Depression!)

The liquidity of the market provides support for investor confidence by reducing the great uncertainties of a long period into the much lesser uncertainties of a continuous succession of short periods. Liquidity thus facilitates the raising of capital.

Stock exchanges make investments liquid - facilitating the raising of capital, as wellas directing the allocation of capital. However, this liquidity also increases the volatility

of capital asset values.

Market valuation provides vital guidance on the basis of an implicit assumption that it is"uniquely correct in relation to the existing knowledge of the facts which will influence

the yield of the investment, and that it will only change in proportion to changes in this

knowledge." However, this is an obvious fiction. Such knowledge is neither precise nor unmitigated by many other operative factors. However, the liquidity of the market

provides support for investor confidence by reducing the great uncertainties of a long

period into the much lesser uncertainties of a continuous succession of short periods.Liquidity thus facilitates the raising of capital.

Keynes points out several factors that serve to undermine investor confidence.

• Stock market investors lack the insiders knowledge of how a business is actually

doing.

• Short term fluctuations in profits can have extraordinary impacts on stock

valuations.• Lack of knowledge renders market investors prey to substantial fluctuations in

mass psychology that may be totally unrelated to prospective yield.

• Professional market traders make matters worse by concentrating on unstable

factors of short term valuation.• Conditions in either the stock markets or the financial sector may cause a collapse

of investment demand - but confidence must recover in both sectors for recovery

of investment demand.

The volatility in stock markets is entirely appropriate, since the capital traded in these

markets - equity capital - is the risk capital of the economy. It is flexible and thus able to

absorb the winds of change.

If there is a substantial base of equity capital, it will suitably shield the vast mass of debtcapital, which can thus be comparatively stable. This is vital, since debt capital is

inflexible and will suffer total failure under strain.

Even more stable is the human capital of the nation. Human capital will survive for



decades, even during catastrophic conflicts. It took seven decades of autocratic socialism

to thoroughly destroy the human capital in the Soviet Union.

"[There] is no such thing as liquidity of investment for the community as a whole."

Keynes views Wall Street as dominated by speculative interests - rather than investment interests. The markets seem to him as acting like casinos. The culprit is market liquidity.

Keynes thus launches into a famous rant against market speculation and "the fetish of liquidity." (Marx, too, liked to invoke the concept of "fetish" to demean economic factors

that he wished to disregard.)

"[There] is no such thing as liquidity of investment for the community as a whole. The

social object of skilled investment should be to defeat the dark forces of time andignorance which envelop the future."

Who should society turn to to challenge these "dark forces" in the market? In fact, there

are very few investors or investment advisers who prove themselves capable of beating

the market averages over the long haul.

Writing from the despair of the depths of the Great Depression, Keynes laments that

long term investors face greater difficulties due to the greater risks inherent in long term

prospects. A large measure of the investment that does exist is due to the "animal spirits"- the impulse towards action - of entrepreneurs and investors, since nobody can truly

calculate the long term risks and prospects of enterprise.

"There is no clear evidence from experience that the investment policy which is socially

advantageous coincides with that which is most profitable."

Once free of the government policy stupidities that caused the Great Depression duringthe 1930s - the trade wars and vast defaulted debts from WW-I and thereafter - such

evidence of the superiority of long term investments would become abundant. Those long

term risks would be dispelled by acknowledgement of the long term vigor and productivity of the U.S. economic system which would increasingly prosper whenever

not too encumbered by government policies of gross stupidity. In nations like the U.S.

that enjoy the marvelous benefits of capitalism, only optimism pays.

Of course, Marxists and Keynesians would be too mired in despair over the

mythological difficulties of "mature" economic systems to notice. The imminent return of

the Great Depression would be a persistent element of their economic expectations.



Nevertheless, Keynes does score some valid points, here. Institutional investors must

justify their performance for each year and even for each quarter, glorifying short term

results over long term results. Fund managers adopt the conventional wisdom of their peers rather than risk error on the basis of personal analysis.

With the recent experience of the 1929 boom and bust, Keynes views Wall Street asdominated by speculative interests - rather than investment interests. The markets seem to

him as acting like casinos. The culprit is market liquidity.

"This is the dilemma," Keynes laments. Only the liquidity of the equity markets attract the

vast sums of equity capital on which the financial stability of the economy rests.

Keynes advises an increase in transaction costs by means of a stock transfer tax to

reduce this liquidity and speculation. That this would increase the costs of raising equitycapital does not escape Keynes' notice. "This is the dilemma," he laments. Only the

liquidity of the equity markets attract the vast sums of equity capital on which the

financial stability of the economy rests.

Keynes is probably unaware that all the speculative excess of 1929 was concentrated in

about 50 speculative leaders on the NYSE. As for the rest, there were as many losers as

gainers in the year prior to October, 1929. Such speculation is certainly a problem, but

not of such extent as could justify the limitation of liquidity for the vast bulk of themarket.

The crisis of confidence the afflicts the Great Depression world can only be cured by theradical idea of forcing people to either consume or invest their funds.

Keynes is thus driven to a remarkable radical conclusion. The crisis of confidencethat afflicts the Great Depression world can only be cured by forcing people to either

consume or invest their funds. The "hoarding" of funds that Keynes believed to be the

cause of the crisis might then be ended.

Again, this Marxian stupidity afflicts Keynes.

Idle savings were a result of the Great Depression, not its cause.

See, HYPERLINK "http://www.futurecasts.com/Keynes,%20The%20General%20Theory%20(II).htm" \t

"_top" µKeynes, "The General Theory of Employment, Interest, & Money§," Part II,

"Interest Rates, Aggregate Demand, and the Business Cycle."

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