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Keynesian Economics Is an Artifact

Summary:
Printing / borrowing money to generate the unsustainable illusion of “growth” sets up the collapse of the entire Keynesian edifice. Of the many delusions of modern economics, perhaps the greatest is that the dominant Keynesian model reflects permanent dynamics of advanced economies. Economics, along with other social sciences, makes an implicit claim that its econometric claims are the equal of the “hard sciences” of physics and chemistry. In other words, the econometrics of Keynesian economics is presented as possessing the same timeless validity of the natural sciences. The reality is that Keynesianism arose in an era of abundant cheap energy, and it is an artifact of that brief one-off period in which industrialization, consumption

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Printing / borrowing money to generate the unsustainable illusion of “growth” sets up the collapse of the entire Keynesian edifice.

Of the many delusions of modern economics, perhaps the greatest is that the dominant Keynesian model reflects permanent dynamics of advanced economies. Economics, along with other social sciences, makes an implicit claim that its econometric claims are the equal of the “hard sciences” of physics and chemistry.

In other words, the econometrics of Keynesian economics is presented as possessing the same timeless validity of the natural sciences.

The reality is that Keynesianism arose in an era of abundant cheap energy, and it is an artifact of that brief one-off period in which industrialization, consumption and the human population were able to expand by leaps and bounds due to cheap energy and new technologies that leveraged greater value (“work,” output) from the cheap energy.

Once energy is no longer cheap or abundant, the Keynesian model of paying people to dig holes and fill them as a means of boosting “aggregate demand” falls apart. In the Keynesian model, “growth” as measured by consumption (gross domestic product) is assumed to be permanent and the highest goal of any economy.

If an economy starts contracting (i.e. recession), the one-size-fits-all solution in the Keynesian model is to boost consumption, i.e. “growth” by any means available: paying people to produce no useful output (building bridges to nowhere, etc.), distributing newly created money via “helicopter drops” into consumers’ laps via tax rebates, tax cuts, increased social welfare spending, etc.

This “solution” implicitly assumes the energy needed to fuel this unproductive labor, investment and consumption is permanently abundant and cheap. It also assumes that the quantity of energy available to fuel the economy will always expand, and as a result new currency (“money”) can be issued by central banks with few (if any) constraints.

The connection between currency and energy is: “money” is nothing but a claim on future energy. Without energy to power the future economy, the “value” of “money” vanishes.

As a result, printing/borrowing vast sums of new money into existence when the supply of affordable energy is stagnating leads to inflation/ loss of purchasing power as the expanding supply of money is chasing a stagnating quantity of energy and what requires energy to generate output, i.e. the vast majority of the economy.

We have a test case for how well the Keynesian model works in periods in which energy is scarce and costly. That test case is the 1970s, the era of stagflation: as governments and central banks pumped freshly created money into the economy to generate “growth,” what they got wasn’t “growth”–they got inflation and stagnating output and consumption.

The Keynesian model failed to work as advertised. The reason is obvious: the model is an artifact of an era of cheap, abundant energy, as it only functions when energy is cheap and abundant.

In effect, the Keynesian model of how the economy works was saved by the discovery of super-giant oil and gas fields in the 1970s that expanded oil production and dramatically lowered the cost of energy for the rest of the 20th century.

The Keynesian illusion was again saved in the early 21st century by the widespread application of fracking technologies that boosted supply and suppressed the cost of energy.

Charles Hugh Smith
Charles Hugh Smith is an American writer and blogger. He is the chief writer for the site "Of Two Minds". Started in 2005, this site has been listed No. 7 in CNBC's top alternative financial sites. His commentary is featured on a number of sites including: Zerohedge.com., The American Conservative and Peak Prosperity. He graduated from the University of Hawaii, Manoa in Honolulu. Charles Hugh Smith currently resides in Berkeley, California and Hilo, Hawaii.

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