Keynes and the casino


A short extract from my proposed book, over the fold. Lots more like this to come! Comments and criticisms much appreciated, with free books for the top ten!

Dead Ideas from Live Economists: The Efficient Markets Hypothesis

When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done, JM Keynes, General Theory of Employment, Interest and Money Ch 12, p142 in Google Book edition, Atlantic Publishers

If there is one economic doctrine that has been central to thinking about economic and social policy over the last three decades, it is the Efficient Markets Hypothesis, or more properly, the efficient financial markets hypothesis. The EMH says that financial markets are the best possible guide to the value of economic assets and therefore to decisions about investment and production.
Although economists since Adam Smith have pointed out the virtues of markets in general, the EMH with its focus on financial markets is specific to the era of finance-driven capitalism that emerged from the breakdown of the Keynesian Bretton Woods system in the 1970s. The EMH justified, and indeed demanded, financial deregulation, the removal of controls on international capital flows and the massive expansion of the financial sector that ultimately produced the greatest financial crisis in history.

Some more linking material to come here

Keynes and the casino

Few economists have been successful investors, and quite a few have been disastrous failures. But after a narrow escape from disaster early in his investing career John Maynard Keynes made a fortune for his Cambridge college by speculating in futures markets It is a striking paradox that Keynes was among the most scathing of all economists in his assessment of the role of financial markets.

“Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done” (General Theory Ch 12, p142 in Google Book edition, Atlantic Publishers

During the decades of the long Keynesian boom, financial markets were tightly regulated, and, as a result, financial crises disappeared almost entirely from the experience and memory of the developed world. At the margin, substantial profits could be made by finding ways to work around the regulations, while relying on governments to maintain the stability of the system as a whole. Not surprisingly, there was a warm reception for theoretical arguments that presented a more favorable view of financial markets.

Keynes’ views were reflected in the systems of financial regulation adopted as governments sought to rebuild national economies and the global economic system in the wake of World War II. The international negotiations undertaken at a meeting in Bretton Woods, New Hampshire, in 1944, where Keynes represented the British government, established an international framework in which exchange rates were fixed and movements of capital tightly controlled.

National governments similarly adopted policies of stringent financial regulation, and established a range of publicly-owned financial institutions in response to the failures of the private market. In the United States, a host of regulatory bodies were established to control financial institutions. The Glass-Steagall Act established the Federal Deposit Insurance Corporation (FDIC) and prohibited bank holding company from owning other financial companies. The Federal National Mortgage Association (later quasi-privatised as Fannie Mae, and then renationalised during the early stages of the 2008 meltdown) was established to support the mortgage market.

Although the details of intervention varied from country to country, the effect was the same everywhere. Banking in the 1950s and 1960s was a dull but secure business, resembling a public utility in many respects. Parents scarred by the Depression urged their children to look for ‘a nice safe job in a bank’.

The Efficient Markets Hypothesis changed all that.

89 thoughts on “Keynes and the casino

  1. @SeanG

    Menzies also said “the people need protection from monopolies” Sean. Another idea sacrificed on the alter of liberalism (Goldman Sachs…gets big because they are brilliant, The grocery industry gets concentrated “because they are clever.” Big oil and big pharma can teach us all a lesson about business intelligence…Im sure).

    But economic liberalism has chased very few with monopoly power in the past few decades Sean, to the extent the ordinary man is becoming impatient with lack of regulatory action by governments concerning monopoly market power.

    So Menzies wasnt liberal enough? Is that what you are telling me? Because now, no social net is positive to economic liberals (no social net at all…and correct me if I am wrong) and de-regulation ensures monopoly power grows and anti comptetitive practices grow unchecked, but its not our right to interfere?? Is that it?

    So what is really important is total unfettered freedom in markets with no government intervention or presence because the right of the individual rides over it all?

    Even Menzies views Sean

    What you also ignore also is the fact that a person who is “flexibly employed” ( and in many cases this may mean tenuously employed) lacks the “animal spirits” to spend freely in the economy (theirn confidence is sapped), deprived as they are of security of employment or tenure or a reasonable expectation that their work will continue and the ordinary man adjusts savings accordingly…to save for the lean times which are unknown at the point they decide to be more careful with their expenditure …and we all know savings is a leakage…so the mere unquestioning acceptance of NAIRU (and an ever upwardly adjusting NAIRU) with its concommitant acceptance of a higher “human labour force discard rate” becomes an escalating drag on the economy which then requires an even higher NAIRU to justify.

  2. Donald,

    Six Sigma is implemented in service as well as manufacturing firms. It is about variations in performance and output. Six Sigma does improve productivity and it can be applicable to government as well as private sector.

    With Welch’s 20-70-10 all you have to do is look at the results of his time there to see the amazing growth in revenues and profitability. GE always prided itself on being candid which is something not replicated by other companies. After nearly 20 years of this type of practice, GE was the largest company in the world. So it looked like it worked.

  3. Alice

    Let me give you a hint why Keyesianism itself was responsible for the inflationary breakouts in the 1960s. Keynesianism relied on hermetically-sealed national economies. In Ausstralia, it relied on US foreign investment to build big industry. The state provide protection for the development of monopoly industries like the car industry. The resulting government-created monopolistic production and competition among largely foreign capital within Australia was one of the causes of the inflationary breakout.

  4. Alice,

    A coupled of things.

    1) Monopolistic competition is a symptom of a lack of competition due to stringent regulation or the event where competition policy is not enforced. This is as much a problem during Keynesian economics than during the free market because if we look at the US economy as an example where you have a large number of very large companies you also see an amazing growth in smaller companies which compete and challenge the larger companies.

    Goldman Sachs, you bete noir, is one of two remaining Wall Street investment banks. Goldman gets competition from numerous other banks but employs the best people, has a culture that is about excellence so when they are challenged by other banks, hedge funds and private equity firms they adapt and survive while others like Bear or Lehman Bros can barely make it in a competitive environment. Schumpeter’s “creative destructionism” at its best.

    2) Where did I say that Menzies was not liberal enough? Liberalism, as I have said, is organic which changes with the environment. It was the experience of the Liberal Party in the UK, the Depression and WW2 that lead to the liberals to adopt a very centrist position of free enterprise with a strong social safety net. You need to learn more about Liberal history.

    3) When has anyone said that total unfettered markets is the best way to go? Do you even read comments on this thread or make things up as you go along?

  5. Alice

    Bob Hawke killed the Left in Australia, and Keating turned the ALP into the Australian Liberal Party.

  6. John, this is for dear Alice,

    It seems you were taught to work and play,
    Full of work and full of play,
    Have your say and let it out,
    Wright or wrong, let it out,
    Get up their nose and rub it in,
    They’ll never forget dear Alice.

  7. Markets are efficient. The so called Financial market as it is constructed is NOT a market. A market has the characteristic that as demand increases and supply cannot meet demand then prices rise so encouraging an increase in supply.

    So called financial markets are “markets” where as demand increases, prices rise but supply decreases. Similarly when demand decreases, prices drop but supply increases. This is not a market but a casino because the size of the price peaks and troughs are random when you have these positive feedback mechanisms in the “market place”.

    Don’t believe me? Our current situation is that the demand for money has increased, the price has dropped but the banks have difficulty lending money because the value of assets against which loans can be made has dropped and hence the supply of money has decreased.

    Also a system where inflation is tolerated and even targetted is flawed. How can we have an efficient market when the unit of measurement changes. It is like trying to keep to the speed limit when the unit of measurement, kms per hour changes in meaning, and we do not know what the change is until a couple of months after we have broken the speed limit.

    To stop the so called business cycle, to eliminate inflation, and to make financial true efficient markets then the “commodity” being traded – namely money – must follow the following rules.

    When the demand for money increases and price rises then the amount of money needs to be increased. When the demand for money decreases and the price drops the amount of money needs to be decreased.

    The solution. Stop using loans as the method to increase the money supply.

  8. S.Haines – cause of inflationary breakout in the 1950s was due to not only excess demand in the Australian economy but excess demand in the US economy. We were not as hermetically sealed as you like to imagine. Yes we had surging import demand but export demand came first and rose more sharply, but its also no accident that the wool export price crashed the same quarter in the same year that the US announced price controls to manage their own inflationary outbreak and we developed a large BOP deficit (51-52). The Uk (30%) and US (21%) accounted for for 51% of our entire wool production in 1950-51. and that boost at those prices added substantial export demand and income to the economy before the wool price fell. If you look at growth in all the other price and wage indexes for the period, the growth in the export price index far outstrips their contribution and aligns directly with the period of high inflation in 1950-52.

  9. How soon you forget Sean…the creative destruction of Goldman Sachs was prevented by a bailout of taxpayers funds.

  10. I would also like to let S.haines know that according to the Economic Record Vol 1. which notes “practically all import restrictions lifted by this time…” next to 4th quarter, 1950. So much for your comment that Australia was “hermetically sealed” and the inflation was driven by big government monopolisation.

    S.Haines – it appears your memory of economic history is rusty after all.

  11. 1950-1960 (the decade) S.Haines. Private subscription published by ERA House Pty Ltd. It should be in the reference section.

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