36 - The greatest debate to never happen
Opinions expressed are solely my own. Shout out to my friend and colleague John Schneider and my parents for some great edits.
On a mild summer evening in 1942, two intellectual giants crossed paths at Cambridge University in England in what could have been the most spectacular debate of the century. Sixty year old John Maynard Keynes was a living legend. His economic doctrine, preaching consumer-based consumption encouraged by government spending, had gained immense popularity in the years after the Great Depression. Frederick August Von Hayek, 43, was little known at the time but would soon publish his seminal book, The Road to Serfdom. He was the polar opposite of Keynes in his belief that economies should be allowed to go through cycles without the interference of government. The winner of a public debate could decide economic ideology for the next eight decades.
Unfortunately, a debate did not happen and never would. World War II was raging, and Cambridge was considered a potential target of German bombing. The two men spent that evening up on the University roof scanning the night sky for German Suka’s. We can only speculate what they discussed, but the odds are it wasn’t University gossip. Keynes would die in 1946; but his economic doctrine would live on and become so widely used that he would remain one of, if not the, most famous economist in the modern era. Hayek would live on for many more decades, promoting his economic beliefs that would only really gain traction when the Keynesian philosophy proved to be more than fallible.
The players
In order to understand their respective economic beliefs, we must first understand what influenced both Keynes and Hayek. John Keynes was born in Cambridge in 1883. Both parents were intellectuals– his father a lecturer and his mother a social reformer. Early in his career, Keynes followed a similar path starting a career in a government position and then moving to a position as a lecturer at Cambridge. During World War I, he was called on by the English government to serve as an economic advisor which he did exceedingly well. His service to the Crown during the first Great War propelled him into a bevy of government roles. In this capacity he served as England’s economic ambassador at many international economic events of the time.
Keynes' power and influence around the world reached a crescendo in the late 1930’s after publishing The General Theory of Employment, Interest and Money. His book called for aggressive government spending to help pull the world economies out of the deep rut they had been in for over half a decade. His years of experience witnessing record unemployment and, in many countries, starvation, caused him to believe that something more had to be done. At the time, his ideas were revolutionary and made him the face of a movement against the prevailing ideology of that era. After the war, Keynes was a part of the English delegation to the Bretton Woods conference, an event that laid the foundation for the modern economic system. His most well known acts before his death in 1946 were to champion the creation of the International Monetary Fund and World Bank.
Fredrick Hayek was born in Vienna in 1899, almost twenty years after Keynes. His father was a doctor, but Hayek tended to be more interested in theater and play writing than medicine or even education. Hayek served a brief stint in the Austro Hungarian army during World War I. After returning to Vienna at the end of the war, Hayek decided to attend the University Vienna and study philosophy and economics. It was during his time as a student that he witnessed some of the worst economic conditions of any country after the war. Extensive money printing by the Austrian government, pent up consumer demand from years of war rationing, and the removal of price controls, resulted in astronomical inflation, starting in the low 100’s% and peaking in the mid- 1,000’s%. His time living in these conditions impacted him greatly and played a large role in shaping his views on economics.
At university he met, studied, and worked for some of the most well-known economists of the time. Unlike Keynes' style of economics, the Vienna school preached (aptly) “Austrian economics” which Hayek would eventually champion on the world stage. The Austrian school of economics believed that rather than “stimulate” the economy through government spending, private investment from businesses and individuals needed to pull depressed economies out of their slump. After graduating, Hayek accepted a role as professor at the London School of Economics and, unwilling to return to Austria during World War II, eventually became an English citizen. Throughout the second half of his life, Hayek published extensively, worked as a professor of economics at the University of Chicago where he influenced the works of Milton Friedman, and won the Nobel Prize in Economics.
Influence over time
The study of economics is often confused with the study of finance. Economics is focused on the overall consumption and production within a society. Finance, on the other hand, is the study of how money is allocated to different projects across a society. Today, many people discuss the stock market as if it were the economy: but in fact, it's more of an indication of individual perception of the economy. Over time, the disciplines of economics and finance have begun to merge; and, many would argue, much to the detriment of what would traditionally be called economics. Understanding the difference is important because economists like Keynes and Hayek weren’t focused on the stock market but rather unemployment and inflation. At a high level, the study of Economics can be boiled down into the analysis of a few specific metrics and how people can influence them:
Unemployment
Inflation
Interest rates
At a time when war was raging, empires were falling, and entire economies were collapsing, economics was a popular topic of conversation. The theories of classical economics dominated the first quarter of the 20th century. The prevailing belief of the time was that high unemployment leading to depression was a natural part of economic cycles. If left to its own devices, over the long run, unemployment would work itself out when the economy inevitably began another growth cycle. Keynes scoffed at this notion as naive and impractical, famously saying “...in the long run we are all dead….” To him, the time for action was now, and it was the government's responsibility to take that action.
He believed that when unemployment is high, governments should lower interest rates and spend heavily on public works projects. That spending would put more money in consumers’ pockets which low interest rates would encourage them to spend instead of save. He acknowledged the results of government intervention wouldn’t be immediate; however, they would be far quicker than the nebulous “long run” that classical economists were still waiting for. Thanks to world event’s and the failure of the Hoover administration to stem the Depression, that exact formula was implemented in the United States.
Historians give the administration of President Franklin D. Roosevelt (FDR) credit for pulling the country out of the Depression; however, most economists ignore FDR and ascribe the success to Keyne’s economic ideas. The administration’s focus on war preparation resulted in a massive injection of government money into the American manufacturing base (the largest in the world at the time). Factories’ reopening to build ships, planes, and guns led the US not only out of the worst economic downturn in history but into the longest period of economic prosperity. It also provided the groundwork for the well known concept of “consumer economics,” in which spending is perceived to be good. The US government encouraged US citizens to continue to spend the money they had earned during war time on more goods and services to keep the economic wheel spinning. Americans are notorious around the world for being consumption-based which has a history in Depression-era economic policies. Old habits die hard.
Times were great in the post war years, spurred by this new found societal approval of spending, but there was a catch. Allowing the government to “steer” the economy through spending in the way that Keynes prescribed also meant that there was potential for massive inflation. The formula was simple and well known. Increasing the amount of money being spent in the economy increases demand for a limited number of goods/resources which in turn causes prices to rise (inflation). If you increase spending significantly then prices will go up significantly. Keynes dismissed any notion that massive government spending could cause crippling inflation or that that inflation was generally a bad thing.
Hayek, who was forever traumatized by his post WWI experience in Austria where the cost of bread rose 10x over a few years, had the exact opposite opinion of government spending and inflation. Seeing what was happening, he argued that the government should not only stop their uncontrolled spending but go even further by discontinuing their efforts to “guide” the economy. His greatest fear was that inflation and artificially low interest rates would lead to unnatural levels of employment and consumer excess. That excess would be emphasized by economic crippling inflation. In the face of good times, no one wanted to listen to naysayers from Austria.
The fall of Keynes
The ideas of Keynes became economic truths that persisted throughout the 1950’s and 1960’s. The United States and most of the developed world that was following similar policies avoided inflation in large part because of globalization facilitating the transfer of cost-saving technology and allowing countries to specialize at what each was best at. Keynes' fall from grace began in the 1970’s when something his economic doctrine believed to be impossible, namely low interest rates and high unemployment known as “stagflation”, became a reality. The world realized the great Keynes had not accounted for the possibility that the government could be in a position where low interest rates didn’t result in higher employment. It was a time when the teachings of Hayek became more prominent and resulted in his winning the 1974 Nobel Prize in economics.
During that time, Milton Friedman took the lessons of Hayek and the historical success of Keynes and created what is today called “Monetarism.” Friedman’s model acknowledged the perceived need of governments to intervene in times of economic stress, but doing so through monetary policy (central bank action) vs fiscal policy (government action) which was viewed as far less invasive. Rather than the government spending to increase economic activity, the central banks should step in, increase the money supply by purchasing investments, and put capital back in the hands of the people. The approach was seen as a middle ground between the high touch government intervention of Keynes and the no touch preferences of Hayek. Friedman’s ideology has been a popular one since the 1970’s and has remained the main ideological foundation for both government officials and economists alike.
Where we are today
The greatest debate to never happen is the one between the ideas of Keynes and Hayek and whether or not the economy should/could be guided by the government. Keynes believed that the economy could be simplified into key economic elements similar to scientific discipline. These elements could then be controlled by a well run government. High unemployment meant that the government should lower interest rates and spend heavily on public works projects. Hayek believed that the economy was far more unscientific. Further, he believed it was absolute lunacy to think that any government could “guide” the economy the way that Keynes described. He argued that the less governments interfered with the workings of the economy, the better everyone would be. The ideological debate between these two intellectuals and their theories didn’t occur at a time when the foundation of economics was being laid. Instead the debate has been fought indirectly between different factions over the past few decades. The result has been a mixed model best embodied by the policies of Milton Friedman.
Those who believe that the ideas of Hayek have not yet been able to find a way out of a system heavily influenced by Keynes ideology. That was until 2009 when the first block on the Bitcoin network was mined. Bitcoiners are enormous fans of Fredrick Hayek’s anti-government stance on monetary policy and the whole field of Austrian economics. Bitcoin itself is something that stands in stark contrast to the policies and ideology of Keynes and Friedman which is exactly why so many in traditional finance dismiss it. It represents economic beliefs that have never had a chance to stand in the limelight of the world stage and be legitimately considered. The promise of Bitcoin is that one day the ideals of Hayek may come to fruition, and Bitcoin may be that vehicle for change.
NOTE: If you want to see what a modern version of that debate could have looked like, check out this video.