Power of Story: Slippery Flaws of Keynes' Bathtub

Probably, you are a good detective and have already perceived that my love and concern for economics has less to do with graphs, axis points, or shifts and slopes of curves, and more to do with those things behavioral. The classical aspects are certainly important to the presentation of an economic concept, but I am more interested in the why and how everyday people choose to adopt certain economic concepts.

That is why I am a cultural economist, and why I continually repeat that all global transformation takes place at the intersection of culture and economics. In fact, I am coming to believe that all transformation, whether global, national, corporate, institutional, or personal, takes place at the intersection of culture and economics.

When the studies of economies and cultures are combined, it is an exciting and revealing adventure. It can open our eyes to the understanding of motives, methods, behaviors, successes, and failures. Religious beliefs, for example, and political persuasions even influence purchasing patterns. Our economic environment has the flexibility of metamorphosis in reaction to current events and the preferences of respective groups. That makes for an exciting study.

How does the economic system affect a culture? And how does a culture affect an economic system? Those were the questions I would ask myself as I traveled and visited more than 150 different countries of this world. When in Rwanda, I would try to learn about the inequities of the economic model, as well as try to understand the flash points of the culture that would cause strife violent enough to promote the genocide of over a million simple citizens in a thirty day period. In Cambodia, I would try to study why a leader like Pol Pot would torture and kill everyone who was educated and those outside the agrarian culture. During my many trips to Vietnam, I would try to find out why and how the Vietnamese people were becoming such budding entrepreneurs by 2004.

A similar curiosity has made me interested in the economic and cultural shifts that took place in Europe and America during the Great Depression period and the time leading up to World War II. John Maynard Keynes at one point had stated,

There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose. (1) 

I guess I am still curious about what is happening even to this day concerning that insightful statement. As I see the present U.S. Senate and the Federal Reserve chairman (as of December, 2013) encouraging the full acceptance of alternative international currency systems, such as Bitcoin, PayPal, or an existing international credit/debit card, I can’t help but speculate on the effect the debauching of our present currency system would have on the international standard of value traditionally controlled and enjoyed by the U.S. dollar. What would you do for a currency if the dollar becomes a hyper- inflated relic of the past through monetization of uncontrolled deficit spending and debt?

Speaking of Mr. Keynes . . . for one more minute let’s again visit his aggregate expenditure economic model (the bathtub). Let me share here only two of the five historically recognized slippery limitations to Keynes’ theory:

  • Balancing the books or the budget is not a priority. It is simply not an issue to the bathtub folks. The idea is to spend your way into prosperity. Spend like you are rich, and the self- fulfilling prophesy will make you rich. Government is the true source of wealth and unending supply.
  • There is no way of measuring the real rate of inflation with the model. You have no basic idea of what is happening to the true value of your money because it doesn’t really matter. In our earlier discussions, we carefully examined how arbitrarily increasing the aggregate money supply without increasing products or services into the system simply devalued the currency and forced all prices to go up.

When the kings clipped or drilled out the gold in the coins to make new coins, and used the new coins as additional money, then the value of all the coins was reduced. If you double the supply of money in the system, you nearly cut the value of the present money in half. The Keynesian’s concern is to keep the bathtub full and let the stimulation of the new spending try to cover the gap.

Inflation has historically been measured by the Consumer Price Index (CPI), where the Feds pick a market basket of selected items and track the prices. If the prices go up during the period by 9%, then it is calculated that the inflation rate has increased by 9%. In the 1980s people reacted negatively to the high rates of inflation, so Congress and the Federal Reserve arbitrarily put a cap on how much inflation there could be in the system. They targeted the inflation rate not to exceed say 2.5%. And it didn’t.

We all empirically knew, however, that the prices we were paying were doubling even though the CPI was only increasing by 2.5%. How does a thing like that work? It requires tinkering with the yard stick. It requires changing the items in the market basket that you are pricing, (The Great Inflation Cover-up, Fortune: April 3, 2008). It is only necessary to go back into the market basket of measured products, pull out the expensive items like food, utilities, and housing and replace them with cheap imported goods like $2 shirts from Hong Kong and $1 sox from China. The CPI prices then tend to comply with the targeted percentages. No problem.

On January 25, 2012, the Federal Reserve took it one step farther. They announced that with regard to calculating inflation, the Federal Reserve would no longer be using the CPI, but, rather, a new index they labeled Personal Consumption Expenditures Price Index (PCEP). But the problem is still the ugly gorilla in the room . . . how do you hide or ignore the monetizing of seventeen trillion dollars of deficit spending and debt into our economic system without admitting to hyperinflation? What pin prick of the bubble will cause the loss of confidence in the present currency and economic system and tip over the bath tub? (3)

One of my ongoing concerns is the persistency of the call to keep the bathtub full even though the present level of debt has never before been so great. . When real people in real business situations pursue such lines of business reasoning, they end up in bankruptcy court. And yet, in the October 25, 2013 issue of The Week (p.36), Tim Koechlin pushes his demand, “. . . but, in a stagnant economy like ours, cutting spending is like ‘bloodletting an anemic patient.’ If we want to reduce the jobs deficit, the government needs to spend more . . . .” How will history judge and record this episode?

Next Week: Roosevelt and Keynes correspondence

(Research ideas from Dr. Jackson’s new writing project on Cultural Economics)