The Bear’s Lair: The incredible shrinking man

Since I am away this week, I am republishing a “classic,” in this case a review of Robert Skidelsky’s third volume of his Life of Keynes. The review was written and published by UPI in March 2002; it therefore takes no account of the frightening renaissance in Keynes’ reputation since the 2008 crisis.

In reading “Fighting for Freedom” the third volume of Robert Skidelsky’s biography of John Maynard Keynes (Viking, 2001, $34.95), I was struck by how much of Keynes’ economic thinking has since been discarded by mainstream economists. Truly, in terms of his remaining intellectual footprint, to borrow the title of the cult 50’s sci-fi movie, he is becoming an Incredible Shrinking Man.

Skidelsky, as is appropriate for a man who has spent over 20 years writing a biography of Keynes (the first volume came out in 1983) doesn’t tell you this, of course. Instead, the inconsistencies and the sillier excesses in Keynes’ economic outpourings are glided over, and Skidelsky as it were takes an average, fitting Keynes neatly into membership of Britain’s 1980’s Social Democrat Party, an enterprise in which Skidelsky himself was intimately involved. In the first volumes, written two decades ago, this was still more or less possible, in the latest volume, which deals with Keynes’ activities from his first major illness in 1937, just after publication of the “General Theory of Employment, Interest and Money” until his death in 1946, the strain is showing.

To be fair, Keynes in these years was dealing with the problems of a war economy, and with British postwar reconstruction, both circumstances more extreme than we have seen for several decades. Nevertheless, his solutions were eccentric, and in many cases counterproductive. To ask the question “Was Keynes a Keynesian” is to misunderstand the man; his economic prescriptions varied all over the map, according to the short term problems with which he was faced.

While the “General Theory” is internally consistent (if in many points provably wrong) Keynes himself deviated from the book’s prescriptions whenever he found it convenient to do so. In this he was consistent of his time and intellectual milieu; the Bloomsbury Group were famous for their abandonment of fixed intellectual and moral preconceptions, while scientific thought at the time was also abandoning fixed Newtonian principles in favor of relativity and quantum mechanics. However, it’s one thing to believe in Heisenberg’s Uncertainty Principle, it’s another to apply it to your intellectual output so that you behave like a sub-atomic particle, darting about all over the place and impossible to pin down.

Personally, Skidelsky tries to make the reader like Keynes, but fails. Keynes was a past master of the witty put-down, but there was little kindness attached to the wit — one observer thought that “he must have been responsible for more inferiority complexes among those with whom he came into contact than anyone else of his generation.” Outside economics, Keynes was a patron of the arts, founder of the Cambridge Arts Theatre and from 1941 Chairman of the forerunner of the Arts Council. One is however unsurprised to learn that he spent several months, at the peak of his wartime work, in maneuvering to ensure that architect Sir Edwin Lutyens, probably the one artistic figure of the era on which we can all now agree, was kept off the Council because he might oppose Keynes’ preferred Modernism. Artistically, Keynes was a centralizer — no “obscure concerts in village halls” for him; rather, he was instrumental in establishing the mediocre money-pit of state subsidy that is the Royal Opera House, Covent Garden.

For previous biographers of Keynes both his sexual tastes and his financial position were passed over — fair enough, because his wife, former ballerina Lydia Lopokova, lived until 1982. Skidelsky dwelled at some length in his first volume on Keynes’ homosexual proclivities, but of more interest throughout are his financial affairs. Here, from the scattered information Skidelsky gives on Keynes’ finances, one can draw a startling conclusion.

Far from being a genius investor, as the legend had it, it is fairly clear although not provable that Keynes was nothing more than a ruthless insider trader on a substantial scale. His net worth, very modest in his early years, took off sharply, more than doubling in the year after he got a senior Treasury job in 1914, as he borrowed substantial sums of money in order to speculate. Again, having mostly by successful speculation accumulated a fortune of over 500,000 pounds (equivalent to $25 million at today’s prices) by 1936, he then lost no less than two thirds of it in the 1937-38 downturn, at which point he was out of favor with the Chamberlain government and without sources of inside information. So bad was his investment performance that the National Mutual Insurance Company, of which as a supposed investment expert he was Chairman, fired him in October 1938, in spite of his plea that “it is from time to time the duty of a serious investor to accept the depreciation of his holdings with equanimity and without reproaching himself.”

Keynes need not have worried. War was coming; by 1940 he was back on the inside information circuit, and he died in 1946 once more worth 480,000 pounds, having nearly trebled his investment portfolio in a period when British stocks (in which alone from 1939 he could legally invest) were up only modestly from their 1938 levels.

In 1937, Keynes was regarded in left and centrist circles as “The Economist as Savior” to use the title of Skidelsky’s previous volume. This was quite unfair. Keynes had indeed won popular applause by describing the gold standard as a “barbarous relic” and opposing Britain’s re-establishment of it in 1925, but his policies had no effect on Britain’s recovery from depression after 1931, since he was out of favor with Neville Chamberlain, Britain’s 1931-37 Chancellor of the Exchequer, of whom he remarked “If he could see even a little … his superbly brazen self-confidence would be fatally impaired.”

Chamberlain was thus able from 1931 to ignore Keynes’s barracking and employ a policy of Imperial Preference and tight control of government spending, both anti-Keynesian, to pull Britain rapidly out of slump.

After 1939, Keynes came into his own. For one thing Chamberlain, and by extension his orthodox brand of economics, were discredited. For another, his anti-inflation prescriptions in “General Theory” coincided more or less with orthodoxy. Further, certain of Keynes more eccentric economic ideas were more appropriate in a period of total war.

For example, import controls and state commodity buying cartels were clearly sensible in a period of rationing and raw material shortages, while his preferred ultra-low interest rates were also not inflationary at a period when a substantial portion of Gross Domestic Product was being shot at Germans. Thus in the early years of the war he worked well with Treasury mandarins, gave valuable advice on how to handle shortages and reduce inflation, and instituted the system of Post-War Credits, which provided an acceptable “savings” fig-leaf for the necessary punitive taxation of the working classes.

Nevertheless, even during this period Keynes performance as mobilizer of the war effort is less than impressive when one remembers that by 1943 British war production was far outstripped by German, under the direction of Hitler’s uber-economist Albert Speer.

From mid-1941 onward, Keynes’ principal focus was on Britain’s relations with the United States, on securing adequate resources to fight the war and survive the peace, and later on designing the post-war financial order.

In these endeavors his principal U.S. counterpart was Assistant Treasury Secretary Harry Dexter White. White, now known to have been a Soviet spy throughout World War II, was not in fact particularly anti-British, except where British interests conflicted with Soviet ones. Skidelsky does however point out one or two anomalies in the U.S. negotiating position that White caused, including the eccentric “Morgenthau Plan” (put forward by White’s nominal boss, treasury secretary Henry Morgenthau) which would have deprived Germany of industry and made it a purely pastoral country — apparently this was White’s idea; he wanted a nice clear run for the Soviet tanks to the Channel ports.

Keynes’ negotiation of lend-lease terms in the summer of 1941 was an unquestioned success, no doubt helped by the fact Hitler had attacked the Soviet Union on 22 June, bringing White’s patrons into the war. In the 1943-44 negotiations about the postwar economic order, Keynes was rightly concerned by the need to secure adequate liquidity for countries other than the U.S. Unlike the American negotiators, who favored some form of Gold Standard, Keynes was vehemently opposed to it, and was backed by Churchill (the burned child no doubt dreading the fire.) Keynes’ solution to the liquidity problem was to invent a new currency, “bancor” to be issued by what effectively became the International Monetary Fund. The United States, however, was having none of this, since they rightly suspected that bancor would become a mechanism for foreigners to acquire U.S. exports without paying for them; hence the eventual solution of a fund with cash capital subscriptions and a borrowing facility for each country that was only modestly in excess of the subscription.

Keynes thus failed in these negotiations to provide the liquidity that Britain would need. Believing as he did that not only exchange controls but import controls should remain after the war, that major commodities should be traded by government bodies, and that the price elasticity of traded goods was less than unity (thus making devaluation counterproductive), he neglected the exchange rate devaluation from the 1940-49 level of $4.03 to the pound that could solve Britain’s economic problems. Britain could indeed have gone onto a gold standard after World War II, but it needed to do so at a gold price of around 12.50 pounds per ounce, equivalent with gold at $35 to the $2.80 exchange rate at which the pound was finally fixed after four years of trauma in 1949. Such an exchange rate, which on purchasing power parity represented about a 30 percent devaluation from the pound’s 1913 level, would have allowed Britain to expand exports rapidly into the U.S. market, thus earning the dollars it needed to pay for raw materials and reconstruction.

To demonstrate this, using information that could have been available to Keynes, one can examine the case of Morris Motors, Britain’s and after 1945 Europe’s leading automobile manufacturer, whose founder William Morris, Lord Nuffield was still very much alive and active, which was examined by the U.S. magazine Fortune in July 1946. Morris Motors was only about a tenth the size of the 1946 General Motors, but still amply large enough to compete internationally. Its cars were very much smaller than U.S. models, most of them too small for the U.S. market, because of a bizarre British tax system, established in 1920, that taxed cars by their horsepower — thus a standard 30 horsepower Chevrolet would cost a British owner about $130 per annum (equivalent to $1,200 per annum today.) Nevertheless, quality was according to Fortune at least as good as on cheap U.S. cars, and with larger models, equivalent to the smaller U.S. cars, on the drawing board, there was no reason that Morris could not sell into the U.S. market — except price. British labor was cheap enough, but British steel was 30 percent more expensive than in the U.S., so British cars were about 25 percent more expensive than they needed to be to gain U.S. market share. Thus, even though Morris Motors was the world’s largest automobile exporter, it was confined to British Empire and Commonwealth markets.

A sterling devaluation to $2.80 in 1945, combined with a rationalization of the British tax system, would have made British steel competitive in cost to the U.S., and Morris Motors amply able to compete in the U.S. market. It is not at all unreasonable to suppose that, with Nuffield at the helm until his death in 1960 — and in Britain producing the immensely successful Morris Minor (1948) and Mini (1959) — Morris Motors would have been able in the years after 1945 to equal the success in the U.S. market later achieved by Volkswagen and Toyota, both of which for several years after 1945 were out of action.

Keynes, who appears never to have studied industry closely, was probably incapable of appreciating this missed opportunity. Bank of England governor (1920-44) Montagu Norman’s epitaph on Keynes was “he must have been a great economist, but was a bad banker” — he was doubtless an even worse industrialist.

Keynes’ negotiation of the 1945 postwar U.S. loan to Britain was another missed opportunity. Again, the need was liquidity, and Keynes identified Britain’s funds requirement at around $5 billion, even more than which appeared to be available from the U.S. when negotiations began in September 1945. However, instead of working to maximize Britain’s liquid resources while the need was greatest, Keynes became obsessed by the need to pay interest on the loan, even at the highly concessionary rate of 2 percent per annum, and spent months negotiating complicated conditions under which interest would be postponed. Naturally the U.S. negotiators, who by now included several Truman-friendly bankers rather than the Roosevelt administration’s academic economists, balked at Britain’s reluctance to pay them for their money, and began to cut back the amount offered. The final deal was struck at $3.75 billion, with tight conditions on interest postponement and on resumption of sterling convertibility. Needless to say, when combined with an overvalued exchange rate and the new Labor government’s desire to build the new Jerusalem, the amount proved hopelessly inadequate, and Britain suffered the rigors of economic austerity through the 1950s, with meat rationed until 1954.

Keynes’ economic legacy was at best a mixed one. In Britain, his tolerance for import and exchange controls, and for heavy government spending, hobbled the economy until 1979 and prevented a “wirtschaftswunder” (economic miracle) such as occurred in Germany, Italy and later France. Keynesian deficit financing, which of course formed only one part of his stabilization program in “General Theory” has been used by politicians from then till now to justify increased government spending, and has done great economic and social damage thereby.

More damaging still has been his legacy, both direct and indirect, in the poorer countries of the world. Directly, his advocacy of import controls, contempt for the interest rate mechanism, and “Keynesian deficit financing” government spending policies have caused immense damage to emerging market economies, as they have attempted to produce prosperity by Keynesian (or, more often, sub-Keynesian) means. More damaging still has been his overthrow of classical economics by his “general” case, which greatly weakened, at least until the 1970’s reforms in Chile, the intellectual force of economic orthodoxy, and allowed all kinds of bizarre Third World socialism to flourish in policy terms and impoverish in real terms. Latin America in particular, a wealthy region in 1945 because of its neutrality in World War II and huge 1945 foreign exchange reserves, can blame Keynes very largely for its failure to develop as everybody in 1945 expected, and take its place among the world’s wealthy.

Since 1980, Keynes’ intellectual influence has declined. No significant economic faction today believes that interest rates have no effect on saving and investment, nor that import and exchange controls are economically beneficial. On the other hand, Keynesian cyclical remedies are still practiced, at least in recessions — they are after all highly attractive politically — and Keynes’ belief in the possibility of sub-optimal economic equilibrium, and his distaste for the gold standard, are still part of the accepted economic canon.

If the late 90’s bubble does indeed produce a deep recession, it will be a further test of Keynes’ theories. If Keynesian stimulus works — and it clearly hasn’t in Japan — then his intellectual influence will be maintained. If, on the other hand, no doubt after trying Keynesian remedies, Neville Chamberlain’s more orthodox economic policies are found to be more effective, then Keynes’ intellectual influence will shrink still further.

By 2046, the centenary of his death, Keynes may therefore be of only historical interest — or intellectually of the size in the last scenes of “The Incredible Shrinking Man,” fighting life or death battles with a spider.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)