Despite trillions of dollars that central banks worldwide have pumped some prominent commentators still maintain that it is not enough. For instance Martin Wolf wrote in the Financial Times on October 21 2008,

Yet, in current conditions, monetary policy will be insufficient. This is a Keynesian situation that requires Keynesian remedies. Budget deficits will end up at levels previously considered unimaginable. So be it.

We find it extraordinary to suggest that Keynes’ ideas are now coming back to save the world. Keynesian ideas have never left the rooms of government and central bank decision makers. The essence of the thinking of the most influential economists was and still is Keynesian. So various stimulus packages that are now introduced are a continuation of the same Keynesian policies we have been subjected to for many decades.

We suggest that the present economic crisis is the outcome of the large dosage of Keynesianism we have been given over many decades. In a nutshell John Maynard Keynes held that one cannot have complete trust in a market economy, which is inherently unstable. If left free the market economy could lead to self destruction. Hence there is the need for governments and central banks to manage the economy.

Successful management in the Keynesian framework is done by influencing the overall spending in an economy. It is spending that generates income. Spending by one individual becomes income for another individual according to Keynes. Hence the more that is spent the better it is going to be. What drives the economy then is spending.

Consumption and production

In the Keynesian framework the largest chunk of spending is on account of consumer outlays. Hence consumer outlays are regarded as the motor of the economy — consumption sets in motion real economic growth. But is consumption the motor of the economy? We suggest that one must make a distinction between productive and non-productive consumption. Whilst productive consumption is an agent of economic growth, non-productive consumption leads to economic impoverishment.

Productive consumption

For instance, a baker exchanges his ten saved loaves of bread for ten potatoes. The potatoes are now sustaining or funding the baker whilst he is engaged in the baking of bread. Likewise the bread sustains the potato farmer whilst he is engaged in the production of potatoes. So what we have here that the respective production of the baker and of the potato farmer enables them to secure goods for consumption.

What makes the consumption productive here is the fact that both the baker and the potato farmer consume in order to be able to produce. The consumption of both the baker and the potato farmer maintains their lives and well being, which is the only reason for production.

The introduction of money doesn’t change what was said so far. For instance the baker can exchange his ten loaves of bread for $10 — he then uses money to secure ten potatoes. Likewise the potato farmer can now exchange his ten dollars for ten loaves of bread. Observe that apart of fulfilling the role of the medium of exchange money has contributed absolutely nothing to the production of bread and potatoes.

Non-productive consumption

So far we have seen that to secure potatoes the baker had to exchange bread for money and then employed money to secure potatoes. Something was exchanged for money, which in turn was exchanged for something else or something for something is exchanged with the help of money.

Trouble erupts when money is created out of “thin air”. Such money gives rise to consumption, which is not backed by any production. It leads to an exchange of “nothing” for “something”. For instance, a counterfeiter has printed perfect $20. Since he secured this money not through the production of some useful goods the counterfeiter has therefore obtained the $20 by exchanging nothing for it.

The counterfeiter uses the $20 to buy ten loaves of bread. What we have here is the diversion of real funding — ten loaves of bread — from a potato farmer towards the counterfeiter. Note that the diversion takes place by the counterfeiter paying a higher price for bread — he pays two dollars per loaf. Previously the price stood at one dollar per loaf. Also note that since the counterfeiter doesn’t produce anything useful he is engaged in non productive consumption.

The potato farmer is now denied the bread that he must have to sustain him whilst he is producing potatoes. Obviously this will impair the production of potatoes. As a result less of potatoes will become available, which in turn will undermine the consumption of the baker. This in turn is going to impair his ability to produce. We can thus see that while productive consumption sustains wealth generators and promotes the expansion of real wealth - non-productive consumption only leads to economic impoverishment.

Printing money by the central bank produces exactly the same damaging effect as the counterfeiter money does. Likewise the creation of money through the fractional reserve banking produces the same damaging effect. The expansion of money sets the platform for non-productive consumption — an agent of economic destruction. In the Keynesian framework during a recession when consumers tend to lower their outlays it is the duty of the government to step in and boost its expenditure. For instance the government could employ various unemployed individuals to dig holes in the ground.

The money that the government will pay the workers will boost their consumption and this in turn will lift the overall income in the economy. In the Keynesian framework it doesn’t really matter whether holes in the ground contribute to individuals well being. What matters that people are getting paid and then using the money to boost consumption.

Government doesn’t earn money as such — it is not a wealth generator. So how then does it pay various individuals that are employed in various non-wealth generating projects? It secures the money either through taxation, or by asking the central bank to print money or by borrowing. If we ignore overseas borrowings it basically amounts to the diversion of wealth from wealth generators to government activities. This is the same outcome that money printing does — it sets in motion non-productive consumption. According to Mises,

…there is need to emphasize the truism that the government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens’ spending and investment to the full extent of its quantity. ( Ludwig von Mises, Human Action, 3rd revised edition, Contemporary Books Inc, p.744.)

From this we can conclude that since government is not a wealth generator it therefore can’t grow the economy. Contrary to popular belief then, the more government spends the worse it is for the health of the economy and thus for economic growth.

Various rescue packages that are aimed at saving the economies of the world are just laying the foundation for more misery in the months ahead. Many commentators and economic experts who advocate very strong government stimulus measures never bother to ask how those measures are going to be funded — by funding we mean real stuff. Where all the bread and the potatoes going to come from?

It also doesn’t occur to all the Keynesian sympathisers that it is the fiscal and monetary policies in the past several decades that have given rise to non-productive consumption. The outcome of all this is the vast amount of bubble activities. So how then can more of the same Keynesian policies, which have inflicted massive damage on wealth producers, revive the economy?

What is now required is not more Keynesian policies but rather allowing wealth producers to move fast and start generating real wealth. This of course means that what is required is plenty of productive consumption. More government spending and the massive pushing of money by central banks only strengthens non-productive consumption thereby delaying prospects for a meaningful economic recovery.

Frank Shostak is a former professor of economics who is now M. F. Global's chief economist.

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