Keynes' Global View

Keynes’ essays in persuasion are replete with prescient insights. No matter how much we’ve learned from him and other economists, we seem to continually get ourselves into trouble. In his words, we have once again “blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time – perhaps a long time.” I found one element of his analysis particularly interesting – his awareness of the global nature of the economic downtown. While great economists that preceded him had trouble extending their economic principles outside of a single society, or perhaps did so with many troubling assumptions, Keynes seems to have a keen sense of the global interconnectedness (even in the 1930’s) that greatly affected the economy of each country in the world. Perhaps this perspective was born out of the World Wars, which brought the effects of global economics into sharp focus. Either way, his prognosis and recommended treatment measures for the “Great Slump” involve global cooperation and agreement, which is a lesson that is remarkably applicable to our recovery from the Great Recession as well.

Keynes is sensitive to the macro-economic effects of changes in the behavior of a single player. He intuits that if “a particular country cuts wages, then, so long as others do not follow suit, that country is able to get more of what trade is going.” At the same time he warns that “if wages are cut all round, the purchasing power of the community as a whole is reduced by the same amount as the reduction of costs; and again, no one if further forward”. He believes that the solution to the global crisis will not be brought about by a Hobbesian game of selfish economic policies, but rather by serious cooperation on behalf of the world’s largest creditor nations.

He identifies a fundamental imbalance in the world economy, seeing a general lack of output of capital-goods. He traces this back to distorted credit markets in the postwar environment, and calls on the Central banks of Europe and the US to work together to open the flow of credit – for the world’s sake. There are certainly barriers to this kind of international cooperation. For example, he mentions that France has a desire to cling to the gold standard, and the US has recently maxed out its capital investments during the war and remains in somewhat of a hangover stage. However, his broad view of the global economic forces tells him that the world will remain in the Great Slump until the governments of the world’s superpowers can brighten the outlook a bit in their financial markets through effective, expansionary monetary and fiscal policy. The crucial step towards this goal, he argues, is first broad agreement about the source of the problem (which he takes pains to explain throughout his essays, though he comments that the topic is so complex that he can only present non-experts with the abridged version).  

All of this analysis rings true with the modern financial crisis. First, it is clear that the actions of one large player in the global economy can have resounding effects. When the US catches a cold, the rest of the world sneezes. The graph below shows the carnage of the financial crisis, which began with the bursting of the US housing bubble and collapse of a few global financial titans. The economies of the EU and Japan tanked shortly thereafter. We also see the effects of a long-developing global imbalance, in which the large deficits of the US, UK and other OECD countries were financed by the excess savings coming out of emerging economies (China, India, Brazil) and oil exporters (Middle East). The latter countries were fairly resilient in the face of global financial armageddon, while you can see that developed economies took quite the hit. 

What began as a global financial crisis due to the interconnected nature of banks quickly led to many “real effects”, just as Keynes speaks of in these chapters. Banks, which deal with the “veil of money” between owners’ wealth and real assets, suddenly dropped the curtains. This sudden revelation, followed by a credit crunch in reaction to years of free and loose credit practices, strangled the economy and killed jobs. Concurrently, trade flows took a huge hit.

Thankfully, many countries applied Keynes’ lessons and responded swiftly and aggressively with economic stimulus and expansionary fiscal policy as seen below. 

Still, the only road back to prosperity, as laid out by Keynes, is one of extensive international cooperation, particularly in regard to monetary policy. There are various obstacles to this type of international economic planning just as there were in Keynes’ time. Now, there are many more countries at the table (summits have gone from G-7 to G-20 and beyond), and one of the largest players, the Eurozone, is constantly on the cusp of crumbling thanks to a little Greek thorn in their side. The global crisis requires a global solution, and we seem to be inching towards that. Ultimately, I think Keynes would be proud.