Most of us remember Keynes from our college economics courses as the guy who advocated deficit spending to "prime the pump" during downturns. And that was certainly part of his argument. But revisiting "The General Theory," what's striking is that it's a book about economic panics and the market psychology that produces them -- and the consequent need for government intervention. Parts of it could have been written this week to describe the cascading defaults of Bear Stearns, Lehman Brothers and AIG.According to Keynes and the post-war generation that built one of the most prosperous periods in world history, the role of the government was indeed to prime the pump and manage the markets by using rational intervention to aid them. The goal was to produce the greatest prosperity for the most amount of people, not to create a gilded age with sharp delineations of haves and have nots. Nor was the goal to destroy the markets. It was to understand that the rational intervention of human beings helped to preserve a true free and prosperous market.
The problem with financial markets, Keynes argued, was that investors were periodically seized by an extreme form of what he called "liquidity preference," which made them wary of putting their money into anything but the safest investments. "It is of the nature of organized investment markets . . . that, when disillusion falls upon an over-optimistic and over-bought market, it should fall with sudden and even catastrophic force," he wrote. "Once doubt begins it spreads rapidly."
That's a pretty good description of what has been happening on Wall Street over the past few months. We've gone from a bubble of overenthusiasm, in which interest-rate spreads took little account of risk, to a state of panic in which financial institutions are so risk-averse that they don't want to lend to anyone. As Keynes observed, "the actual, private object of the most skilled investment today is . . . to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow."
Keynes's revolutionary idea was that financial markets were not inherently self-correcting, as classical economics had argued. Left to itself, Wall Street might remain in a liquidity trap in which the markets would stay frozen and productive investment would cease. So it fell to the government to take actions that would restore confidence and stimulate investment. "I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands," he wrote.
As Ignatius, in his updated re-reading of Keynes, notes, this current market crisis has spun out of control so fast that it even would have daunted Keynes with its sheer size and depth.
What advice would Keynes offer Paulson and Fed Chairman Ben Bernanke? His first instinct, I think, would be to reiterate that markets, left to themselves, will not solve this sort of crisis. They need government help -- in this case, on a scale that would have daunted even Keynes -- including underwriting mortgage loans, backstopping the market for credit swaps and other steps. But if these measures are taken piecemeal, without broad political support, they may only add to the public's anxiety. Indeed, that's a real worry now: A Wall Street panic may become a Main Street panic.The key assumption, of course, is that these are democratically elected institutions that have the public's faith. To do that, we first have to admit there is a place for the government. Markets are not inherently smart, and government is not inherently evil. Under years of Republican misrule, which produced a corrosive private ideology and public policy, there has been an erosion of trust in government. Reagan and his heirs have made theirs a lasting legacy of mistrust for all government institutions. But in an elected democracy, what they have encouraged us to distrust is ourselves. And they've asked us to deny our ability as a community and a nation to solve our economic problems in ways that benefit the entire public good. They have fostered profound cynicism and greed. And finally it is they who have waged class warfare against the middle class and working people.
Keynes's biographer, Robert Skidelsky, makes clear that at every stage of Keynes's career, he tried to think broadly about the social and political consequences of economic policy. That was true in his famous denunciation of onerous German reparations payments after World War I, which he correctly warned would lead to a future war; it was true in the magnanimity of the post-World War II international financial system he helped create at Bretton Woods.
A truly Keynesian rescue plan should do more than bail out foolish investors. How might the pieces fit into a larger design? Well, if the taxpayers are going to acquire a stake in the nation's largest insurance company, perhaps that company can be the cornerstone of a new system of universal private health coverage. If the taxpayers are going to acquire $700 billion in real estate assets, perhaps the eventual profits can fund new investments in infrastructure or energy technology.
Keynes spoke in the finicky English of a Cambridge don, but listen to what he said: "When the capital development of a country becomes a byproduct of the activities of a casino, the job is likely to be ill-done." Keynes wouldn't have wanted to nationalize that casino; he was an active investor himself. But he reminds us that public purposes are best served by public institutions.
It's time to say that the Arthur Laffers, Jude Wanniskis and Milton Friedmans were emperors without clothes, whose ideologies have finally been exposed as the great failure of the last half of the 20th Century.