Keynes, Explained Briefly

http://www.aaronsw.com/weblog/keynes

by aaronsw • 17 years ago

58 64 17 years ago

10ren• 17 years ago

You might think this means that someone who actually did the work and tried to calculate expected profits would clean up, taking money from all the people playing musical chairs.

Warren Buffett made his money like this. He's the most successful stock-investor in the world, and the second richest person (after Bill Gates).

mikeryan2• 17 years ago

I'm not sure the point you're trying to make.

But Warren Buffet isn't really a stock investor (he is but thats not where he made his money). So if you're saying he's one of the stock investors playing musical chairs - I don't think you're correct.

Buffet buys "good companies" he invests in businesses more then stocks. If you're saying Buffet made his money by doing what this article said then I think you're right.. ;-)

barrkel• 17 years ago

I think you're playing semantic games. Buying stock in a business is investing in it. Either you're buying new issuance, in which case it goes straight into the company's bank account, or you're increasing the stock's price, thereby increasing the price at which new issuance can be expected to be made, not to mention other things like stock options for incentives / hiring, etc.

The other investment is lending, but I don't think you're suggesting that Buffet is primarily making money buying bonds, or getting even more involved with short-term loans.

Sam_Odio• 17 years ago

---

If you look at Berkshire Hathaway Holdings' balance sheet (1), you'll find their largest asset class is "Equity securities." Equity securities == stock.

Most other assets on the balance sheet are consolidated from subsidiary companies in which Berkshire... holds stock.

What most people don't realize is that buying stock is investing in the business.

1) Berkshire's 10Q: http://www.berkshirehathaway.com/qtrly/2ndqtr09.pdf

btilly5• 17 years ago

My understanding is that Warren Buffett is a good stock investor and a great manager. If you look at his portfolio he likes to buy and hold companies. The CEOs of the companies that he buys unanimously say that they have learned a tremendous amount from him.

Therefore there is strong argument for saying that he makes winners rather than buying them. And the first big winner that he made was a textile company that he bought because he realized it was perfectly positioned to sell insurance instead. The name of that company is Berkshire-Hathaway.

Buffett has another key advantage. Many of his profitable deals are not publicly available. For example look at the Goldman Sachs deal he did last year. He bought $5 billion in preferred stock that pays a perpetual 10%/year, with a 5 year option for $5 billion in stock at $115/share. They then were able to talk up his investment as a "vote of confidence", and he threw his weight into TARP.

If we assume a 5% discount rate, he spent $5 billion for $10 billion in future earnings, with a 5 year option that is potentially worth a lot more than that. That is worthwhile even if he only thought they had a 30-40% chance of surviving. It isn't hard to come out smelling like roses when opportunities like that get offered to you.

azgolfer2• 17 years ago

We are in the process of debunking Keynes yet again. How many times does his theory have to fail before people stop believing it ?

hristov2• 17 years ago

When has it failed? Keynes has not really been followed since Reagan. It is the neoclassists and the neoconservatives that are failing now.

bena• 17 years ago

I'm beginning to think that Keynesian economics is a lot like communism: "It's never worked because no one was doing it right."

Maybe it just can't be done right. Maybe the problem is people.

cromulent3• 17 years ago

Do you mean that his theories caused this downturn, or that the government stimulus is a mistaken way to recover from it? Or both?

steamer252• 17 years ago

Sounds about right (both). Causes of this downturn: --Low interest rates/easy money during the Greenspan years (central planning) --The housing crisis precipitated by government interventions such as Fannie, Freddie, anti-redlining regulations, etc. encouraging/forcing banks to lend to those who would be unable to repay.

The future has yet to pan out but I, for one, expect the pork ("stimulus") to offer some short-term boosts/bubbles as people make cash grabs. But in the long term as people realize that the green paper is being devalued and they are encouraged to make poor investments things will get markedly worse or at best we'll miss out on what could have been. E.g., people are building windmills and ethanol stills instead of coal plants and oil rigs because the former are subsidized and the latter increasingly regulated. Unfortunately, it's a gamble as to whether windmills will match the effort put into them and there's a growing consensus that ethanol costs more than it affords outright.

Think of it this way: If you put a dollar into a decent investment, you might expect a $1.10 in return. Similarly if you made a bad investment you might get $0.95 back. Now expand that to the net worth of the whole country. Depending on how well we manage our existing wealth in spite of the disincentives, it could take a long time to burn through 60 trillion dollars a nickel at a time. Maybe we'll continue to grow but the opportunity costs will mean it happens by pennies instead of by nickels.

perkoff• 17 years ago

"Thus lowering interest rates increases investment — it reduces the cost of getting money, which reduces the cost of making stuff, which means more things can make a profit."

The problem with this reasoning is that Keynes only considers the demand side for capital. What about the supply side? Will lower interest rates encourage savings?

aaronsw3• 17 years ago

Huh? Lower interest rates are the result of an increased supply of capital -- by the government printing money.

startingup2• 17 years ago

Government printing money increases capital? Do you even know what "capital" means? By your definition Zimbabwe has extreme amounts of capital ... that seems to have done them a lot of good.

bokonist2• 17 years ago

So those are Keynes’ prescriptions for a successful economy: low interest rates, government investment, and redistribution to the poor. And, for a time — from around the 1940s to the 1970s — that’s kind of what we did. The results were magical: the economy grew strongly, inequality fell away, everyone had jobs.

Retribution and government investment may or may not be good ideas, but they are orthogonal to the problem of the business cycle.

For some reason, Keynes missed the entirely obvious fact that the fall in aggregate demand originates in collapsing credit bubbles. The credit bubbles happen for a very specific reason - a bug in the Anglo-American tradition of banking in which banks do not match their maturities. When the credit bubbles collapse, and people's bank accounts are wiped out, they stop spending. The supply/demand curve for luxuries and durables goes vertical as people cut expenses in a futile attempt to fix their balance sheets. When they stop buying cars, Detroit lays off workers.

The economy was more stable from the 40's through the 70's because the creation of FDIC insurance de facto turned banking into 100% reserve, maturity matched system (de facto, even though it still had a veneer of the old system). Effectively, with an FDIC insured bank, the individual deposits their money with the government, and then the government gives banks a separate license to print money to make loans. This broke down when the shadow banking sector grew up, and started maturity mismatching without the formal backing of the government.

In summary - the business cycle is really misnamed. It's the "banking cycle". To stop cyclical unemployment, fix the banks.

catzaa3• 17 years ago

Well, the simple fact is that the above quote from the article is completely wrong.

The 80ies was one of the longest periods of sustained US GDP growth (and the 40ies&70ies weren’t that magical). During the 80ies the USA tacked on the equivalent of Germany’s GDP to itself.

This article is poorly written and a waste of time. I suspect that the author’s motivations for it are more political than it is economical. http://www.blogmybrain.com/stock_apps/graphical_economy/NIPA...

http://investintaiwan.nat.gov.tw/en/env/stats/gdp_growth.htm...

bokonist2• 17 years ago

The business cycle has since the 1970's has been a bit worse than the cycle from '45 to 75. Nothing like the current financial crisis happened during that time.

I don't know how the overall growth rates compare. GDP calculations are full of subjective assumptions. I think there is some truth to the statement that the rate of economic growth has slowed, but that's a much longer argument, and not relevant to my original point which was about the business cycle.

biohacker422• 17 years ago

This is not brief. It's not one of the better things I've red on Keynes. It doesn't treat alternative economic theories seriously. And lastly and most important of all, economics discussions on hacker sites are as bad if not worse then political and religious discussions.

Perceval2• 17 years ago

I agree, it's a rather poor summary of Keynes. The author seems to be writing it in order to cheerlead government intervention, not because Keynes is particularly relevant to the current causes of the financial crisis. A great deal of ink has been spilled since Keynes on topics like the endogenous money supply and debt deflation. The author doesn't seem to show any awareness that there are both post-Keynesian and non-Keynesian insights that significantly complicate his neat little package.

aaronsw3• 17 years ago

It's a direct summary of Keynes' book _The General Theory_. Have you actually read it? Keynes has often been misconstrued by later writers.

amalcon• 17 years ago

Worse, because people don't consistently realize they're bad.

natmaster• 17 years ago

People believing Keynes is the reason we're in this mess now, and why 'noone' (the Keynesians) didn't see it coming.

Try this on for size: http://mises.org/etexts/austrian.asp

bendotc• 17 years ago

Another excellent article from mises.org: http://mises.org/story/2066

And in case you're wondering: yes, I'm being sarcastic.

sethg• 17 years ago

Until the 1970s, where inflation climbed up and up and up and finally peaked at over 15%.

According to my amateur understanding, economists disagree about exactly how the US got into that mess (which is why Keynes was regarded with some suspicion), but it's important to note that the Fed got us out of it by raising the crap out of interest rates and triggering a recession (as Keynes would have predicted).

startingup2• 17 years ago

Quote (supposedly "explaining" why unemployment happens):

It used to be, Keynes says, that wealthy men just thought investing was the manly thing to do. They weren’t going to sit around and calculate what kind of bonds yielded the greatest expected return. Bonds are for wusses. They were real men. They were going to take their money and build a railroad.

But they don’t make rich people like that anymore. Nowadays, they put their money in the stock market. Instead of boldly picking one great enterprise to invest in, they shift their money around from week to week (or hire someone else to do it for them). So these days, it’s the stock market that stimulates most new investment.

Even accepting this explanation, it is worth asking why they don't make rich people who invest in building real stuff rather than chasing paper anymore. What happened to the innate human drive, curiosity and so on? Why is it that downturns in 19th century corrected themselves, but now we need more and more government intervention, progressively more every cycle?

In Economics cause and effect are often difficult to separate, but one reasonable hypothesis is that the widespread adoption of Keynesian policies themselves caused rich people to chase paper, leaving it to government/Federal Reserve to manipulate the stock market to try to stimulate investment indirectly. In other words, Keynesian policies beget more Keynesian policies, in the process generating a whole bunch of Keynesian economists who can "correctly" claim "We told you"; we reach the point where the government runs most of the economy, robbing people of initiative ("we don't make real men anymore").

If you travel to socialist countries, you will observe this in effect. The population displays a curious passivity ("that is the government's problem"). No one thinks about taking the initiative because the incentives systems are all wrong.

catzaa3• 17 years ago

> If you travel to socialist countries, you will observe this in effect.

That is so true. There are countries in which government jobs are the most prized jobs (high salary, flexible working hours and extremely high job security).

This for me at least is a sad phenomenon.

Locke16892• 17 years ago

I don't want to post this again some I'm just going to link my post from forever ago. Educate yourself.

http://news.ycombinator.com/item?id=786552

cturner2• 17 years ago

I'm usually outspoken against obvious non-hacker news on this site. I'm being a hypocrite because I've been looking to write up a folksy 'leaves on the fire' economic analogy for a while and this presented a good opportunity.

    Although, honesty, it doesn't have to be things we all need.
    They could hire people to do anything. This is why inspecting
    the stimulus money for waste is so ridiculous - waste is
    perfectly fine, the important thing is to get the money into
    circulation so that the economy can get back on track.

The madness begins. You could hire people to throw bricks through the windows of rich people. And - indeed - you will get the economy moving. Once, perhaps more than once. But people have memories, and your ability to pull this trick declines every time you use it. The actions the government has on the economy change the way that it responds to stimulus for subsequent events. When Keynes wrote his stuff it was like putting leaves on the fire. Whoosh! A century on... it's still like putting leaves on the fire.. except the heat has gone and the leaves aren't getting hot enough to light up.

If you print and redistribute money to the unemployed on a means-tested basis, you are directly punishing the people who have accumulated wealth (the purchasing power of their money is eroded) for the benefit of those who didn't (that's why they're able to pass the means-test). Why would rational people expose themselves to economies that do this to them?

    Capitalism seems to go through frustrating cycles of
    booms and busts. [...] The right solution was to take
    their money away. Give it to the poor, who will spend
    it on something useful, like food and clothing.

No, the right solution is for the government to permanently stay out of it, and let it stabilise of its own accord. That way, over the course of time, people learn to moderate their behaviour, and you don't create moral hazard traps all over the place that take the heat out of the fire.

A commenter wrote, "We are in the process of debunking Keynes yet again." Although the stimulus is "Keynsean", it's operating in an environment that is substantially different to that which he knew and wrote about. For this reason, I don't think it's any more valid to use the current situation as a criticism of Keynes any more than as a valid criticism of capitalism.

Another commenter wrote, "In summary - the business cycle is really misnamed. It's the "banking cycle". To stop cyclical unemployment, fix the banks."

The current system does have a very influential banking cycle. However, the perspective of 'business cycle' is preferable to 'banking cycle'. A certain proportion of people overextend themselves. It's an aspect of human nature. You have correction periods where they get pulled up for these errors. It is a more universal perspective. There is an inevitability about the business cycle regardless of government action, whereas the same is not true of a 'banking cycle'. Adjusting banking policy won't change human nature.

A book about recursion effects (i.e. the way a stimulus event will cause the system to respect to the same stimulus event differently in the future) is _The Crash of 2008 and What it Means: The New Paradigm for Financial Markets_ (Soros, 2009). It's not really about the 2008 crash, that's just a cute veneer he's put on it to sell more copies of a book that's really a book about philosophy with a very economic bent.

For a stronger Keynsean defence, read Read _Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism_ (Akerlof/Schiller, 2009) for a purist criticism of recent politics and defence of the Bush/Obama stimulus. Though I disagree with the core, the breakdown of 'animal spirits' is useful in its own right, and surely a better lens for viewing what goes in in an economy than 'efficient markets'.

Something that's long-term scary about the current situation is that the political might of nation-state governments has reached a point where private banking is being eliminated globally. In the past it was possible for successful people to look after themselves and generate wealth for the rest - but this is being undermined. The Swiss made the mistake of giving the banks too much backing and have sold out whilst saving the furniture, Luxembourg and Ireland are too European, South Africa is too African, Lietchenstein and Carribean countries are too small, Iceland and the UK are beholden to creditors.

The situation presents a huge opportunity for Chile, Australia and New Zealand. Australia has a gun banking sector already with strong foreign exchange services in at least three centres and would be the strong option. New Zealand cares far less about foreign policy links to the US and has a libertarian party already in parliament. The natural party of government in Chile is the left and they'd be suspicious of private banking but the right are polling well. Chile and Australia have added benefit of metals in the ground. Any could implement special trade zones that created private banks with strong reserve criteria not linked to the government and suck all all the wealth. They'd need to do a currency trick to avoid undermining their export economies but could do this by having two currencies that float independent of one another, or just by having the private banking system store the money in gold or against a commodities index like Goldmans GSCI.

cromulent3• 17 years ago

It seems you are suggesting that the best solution to a stalled economy is not to have government stimulation, but to let it "stabilise of its own accord". Has this been tried? Any examples? For some reason I thought that there was a general consensus that the government needed to prop up banks and stimulate the economy.

edit: Honest question, btw.

btilly5• 17 years ago

Yes, it was tried. The attempt was followed by the Great Depression.

It is understandable that some are reticent to repeat the experiment.

mynameishere• 17 years ago

Yes, http://en.wikipedia.org/wiki/1921_recession

Historian Thomas Woods argues that President Harding's laissez faire economic policies during the 1920/21 recession, combined with a coordinated aggressive policy of rapid government downsizing, had a direct influence (mostly through intentional non-influence) on the rapid and widespread private-sector recovery

babyshake• 17 years ago

"Inspecting the stimulus money for waste is so ridiculous — waste is perfectly fine, the important thing is to get the money into circulation so that the economy can get back on track."

The implicit goal of inspecting for waste is to reduce moral hazard. Repeatedly, all over the world, we see that corruption and a lack of trust in government can have significant negative effects, including both high rates of tax delinquency and divestment from domestic assets.

frig• 17 years ago

Why would rational people expose themselves to economies that do this to them?

Amongst other reasons:

- the cost (in terms of wealth taken) of redistribution is less than the cost of letting things sort out (eg in fallen asset prices or lost opportunities)

- (for those with only a little accumulated wealth) the prospect of attempting to accumulate wealth -- but failing at it -- is very likely and the consequences of failing at it are very high

...though as always a specific situation requires specific analysis, and there's no particular reason to believe the math works out one way or the other in a given scenario (and, also, to pretend to know the shape of someone else's preferences).

You might be able to do better than means-tested (flat-rate payouts to everyone! minksy-style "employer of last resort" arrangements!) but the underlying dynamic doesn't materially change: (loosely speaking) devaluing currency by X% takes away a lot more wealth from billionaires then from dollar-menuaires; if programs A and B both result in X% devaluation but A is means-tested and B isn't the difference in "cost of program" to the wealthy would be a rounding error.

Locke16892• 17 years ago

People are stupid and will not learn crap. We've seen it over and over and we'd see it again and again.

stevedekorte• 17 years ago

The rise in unemployment is due to the mass mis-allocation of resources caused by government intervention into the economy.

Principally, the creation of the central bank and it's long term policies of credit expansion (with moral hazard), low interest rates (underpricing of risk) and of debasement of the currency.

Also, the creation of government backed housing lending institutions (also with moral hazard) that made low interest high risk loans (expanding credit and risk) and tax distortions that encouraged investments in overpriced assets.

nathanwdavis• 17 years ago

  *The best solution is probably a small tax on each trade.*

Don't we already have a tax on stock market trades - The Capital Gains tax? And since it is higher for short-term trades this already provides disincentive to engage in speculative trading.

steamer252• 17 years ago

The best solution is probably to let the speculators fall on their faces and serve as examples for the rest instead of punishing the responsible investors to create a bail out.

randallsquared2• 17 years ago

Indeed, as long as actual fraud isn't involved. The only way to prop up failure is to punish success.

jpwagner• 17 years ago

Good read.

One glaring issue I see is that if you redistribute wealth and "give it to the poor, who will spend it on something useful, like food and clothing", then the next time they need money for useful things, where do you think they will look?

This logic assumes that the poor will take the money they need, then go forward continuing to look for employment as if they'd never been given a handout. This is not practical.

cousin_it2• 17 years ago

John Maynard Keynes’ great insight was to see that all of this was nonsense. The job market is a very special market, because the people who get “bought” are also the people doing all the buying. After all, why is it that people are hired to farm wheat? It’s because, at the end of the day, other people want to buy it. But if lots of people are out of a job, they’re doing their best to save money, which means cutting back on purchases. And if they cut back on purchases, that means there are fewer people for business to sell to, which means businesses cut back on jobs.

Except this applies to all other markets too. If people can't sell stuff, they won't be able to buy stuff, and this effect can balloon in the same manner. Good luck with your economics, Aaron.

lionhearted• 17 years ago

[I line-by-lined the entire post for Aaron pointing out some things, and it came out really, really long. By far my longest comment here - Aaron and others, I hope you find some value in this. I'm exhausted, and I've not edited this with tremendous rigor, but I hope there is value here]

I actually know a lot of Keynes. He was a very smart man and had some interesting ideas, but there were a lot of problems too. The original piece had some problems with it, so I'm going to comment here and let Aaron know via email. If it suits him, I would be happy to be republished, or to contribute to his site so as to spread knowledge. I consider myself in the service of humanity, as I believe he does, so the more we can fight ignorance, the better. Last time I made a commentary like this he asked that I email him with it, so I'm doing so this time at me@aaronsw.com, and I do so humbly this time.

In the article, there is a mix of interesting ideas, some not-so-good ideas, and some ethical judgments. I think he and I have several of the same end goals, so I'm just going to point out a few points that I think could be tweaked so as to account for secondary effects and make the best world possible.

> But they’re typically forced back to the fundamental conclusion of the textbook: that people are just demanding to be paid too much.

One thing to remember is that an employee's "fully loaded cost" is more than his take-home pay. There's employer-side social security tax tax and unemployment insurance, benefits, and administrative costs on the business side. On the employee side, they pay income tax and social security tax. So a business might pay $107,000 to an employee in annual salary and expenses, but the employee gets $50,000 after taxes. Generally, a gap between fully-loaded costs and takehome compensation increases unemployment.

> But if lots of people are out of a job, they’re doing their best to save money, which means cutting back on purchases.

> Everyone knows why: put some money away today and it’ll be worth more tomorrow.

Okay - why is money worth more tomorrow? Because, the theory goes, by putting it in the bank, you're asking the bank to lend it out for you. The bank guarantees an interest rate to the saver while charging a higher rate to the borrower. The borrower puts down collateral that the bank can sell if they don't pay. So, when people save more, the banks immediately have more to lend, so people who want to do interesting things can take the money and do the interesting things. These interesting things - building computers, cars, producing medicine, improving the quality of circuits, rennovating and improving real estate, building new real estate, and so on - makes the world "wealthier" - that is, there's new cool stuff, and better old stuff in the world. With this new and better stuff, the borrower makes more money. They pay the bank back plus interest, the bank pays the saver their money with interest, and all is good. The saver's money is worth more tomorrow (the money saved comes back, plus the interest) because it was used to better the world, and someone paid for that privilege.

That's the theory anyway - in practice, banks don't actually do that any more. Which brings us to our next point:

> Money isn’t worth anything on its own, it’s only useful because it can buy things.

Kind of true, yes - but what you're talking about is what's called, "Money as a fiat currency". Anything can, and has been, money in the past. If I wrote a certificate that said, "Sebastian guarantees he'll work ten hours for you in the future on any legal project of your choice", and you trust me, I'll have just created "money". That's money backed by my labor. In the past, to standardize money, a few things have been done: It's been made into coins made out of precious metals that are of uniform values. It's been a result of trustworthy warehouses issuing certificates about the quality of goods in their warehouse, such as wheat or tobacco. Then people can exchange those certificates instead of carrying bushels of their crops around.

Fiat money (paper money, backed by nothing) is an illusion. And actually, if you look at history, every paper currency eventually goes to zero, because every government eventually ends. And when governments start to end, they tend to get desperate and what's called "debase" their currency by creating more of it. Debase: "to reduce the intrinsic value of (a coin) by increasing the base-metal contents" (from Merriam-Webster online). So that'd be mixing brass in with gold or iron in with silver. Looks like good stuff, but it's not. Governments do this to try to stay alive - from a war, or riots, or going bankrupt, or whatever. You can read about how it happened in Argentina recently, or any Soviet country as it was falling apart, or various African regimes, or the Confederacy during the U.S. civil war. Printing more paper debases a paper currency like mixing iron with silver debases a precious metals currency.

> But if everyone’s saving, that means people aren’t buying.

In normal banking, you can't save and get interest unless the bank is loaning the money out for people to use. If no one takes the money that the bank is getting in deposits, there can be no interest paid. The bank adjusts rates naturally to a small spread between what people are willing to deposit at and what people are willing to borrow at. It is possible for people to panic and put their money in a mattress and not use it for anything, but this goes against human nature: We like progress. Eventually, people stop panicking and put their resources to use. This is a fundamentally human thing to do.

> This is the multiplier: each dollar that gets spent provides even more than one dollar’s worth of boost to the economy.

I was going to just point out errors originally, but this line is incredibly important and a very important contribution Keynes made so I wanted to highlight it. Basically, every hour someone works on something valuable creates new wealth, which creates an incentive for other people to work, so they're willing to work another hour to build new stuff. It's a good thing. Very good.

> How do you decide how many trucks to make? Obviously, you make as many as you think you can profitably sell. But there’s no way to calculate something like that — it’s a question about what customers will do in the future. There’s literally no way to know. And yet, obviously, trucks get made.

There is very little certainty about the world, but "There's literally no way to know" is a bit strong. There are many ways people work to figure things out, and people have a decent but inexact idea about demand all the time. Yes, people do make bad decisions (too many trucks) and then sell them at a loss at times. Then companies with bad judgment die and their trucks are sold very cheap to recoup as much of the loss as possible, while only the most foresighted/lucky/skilled trucking companies remain. If all trucking companies go under, and people still need more trucks, then new trucking companies will be formed as the prices of older trucks start rising. One of the biggest misconceptions about capitalism is that it's "smooth" - it's not. There's bumps and breaks in the cycle, just like in humanity in general. Under all economic or governmental systems, people are prone to bad judgment. Under general freedom of action, these problems correct themselves over time though it can be really unpleasant. That opens the door to thinking about whether there's any general responsibility for people who make bad decisions or get hit with bad luck - personal ethical judgment, I think there is. The next question becomes where that responsibility, if any, might lie - I tend to think at a smaller level, because it's more prone to reciprocity and good will and less prone to corruption, but people can agree to disagree there. But that's ethics which I'll generally refrain from whilst discussing economics.

> But they don’t make rich people like that anymore. Nowadays, they put their money in the stock market. Instead of boldly picking one great enterprise to invest in, they shift their money around from week to week (or hire someone else to do it for them). So these days, it’s the stock market that stimulates most new investment.

Whenever someone buys stock, one of two things happens:

1. The company is selling the stock, and it gets the money put in. It hires people, buys equipment (say, trucks), or does other things companies do with money, all of which opportunities for work in aggregate. ("in aggregate" is a fancy word meaning "in total" - one truck purchase might be an unused truck somewhere, but all the truck buying in the world creates a demand for more trucks, mechanics, etc)

2. The buyer of stock buys it from another guy, who gets the money. There's still the same mix of money in the world. Before, Charles had 10,000 shares and 0 dollars. Paul had $10,000 and 0 shares. After, Charles has 0 shares and $10,000. Paul has 10,000 shares and 0 dollars.

So it's impossible for "all the rich to buy stock", thus running out the cash in the world. For every buyer there's a seller than now has the cash, or a company that now has the cash with which to build trucks, railroads, hire a marketing person, or whatever. Actually, it's funny, there's no way to create wealth without actually building stuff. Many of Paul Graham's essays cover this. (Fake paper wealth is eventually destroyed, and is unpleasant when it happens. Whether society has an obligation to people unskilled/unlucky enough to be holding fake paper wealth when it is destroyed is back to the earlier ethical question. Ethically, I have less sympathy for people with fake paper wealth than people whose routine of working is disrupted, but they probably deserve a bit of help too)

> But how does the stock market figure out what profits are supposed to be? In truth, it has no more clue than you do.

This is akin to asking, "How does an eggplant figure out what dish it should be cooked in? In truth, it has no more clue than you do." I'm NOT joking or being snarky. The stock market is not designed to, and never can, make judgments about what profits should be. The stock market ONLY matches the lowest asking price of a stock to the higher buying price of a stock until they even out and become the same (with people continuously selling if someone is willing to buy for more than what they want, and someone continuously buying if people are willing to sell for what they want). People say, "The stock market reflects value, and people's trust, and blah blah blah..." This is nonsense. The stock market is not smart. It mixes buyers and sellers. The rest is propaganda spread by finance people. If people are buying and selling at stupid prices, then the stock market will be stupid. It doesn't figure out prices. It can't. It just lets people buy and sell to each other at the prices they want to. But...

> We forget about the most basic fact: that nobody has any clue what the stock price should be to begin with.

...this is untrue. There's plenty of information that goes into it. The easiest is "price/earnings ratio", called P/E. That means, how much does one dollar of profit cost you to buy? I was going to go on to describe P/E and other things of "fundamental investing", but it's beyond the scope of what I'm trying to explain here. There's lots of literature on it. Suffice to say, P/E is rather unsubjective, but the judgments you make on it are. Here's literature for the curious (there is problems with it, it's not meant to be a complete answer, it's just a good jumping off point):

http://www.investopedia.com/terms/p/price-earningsratio.asp

http://en.wikipedia.org/wiki/P/E_ratio

When people are buying things for an idiot crazy P/E ratio, bad things will happen to them. There's few guarantees in life, but that's almost one of them. Idiot crazy P/E ratio, you're getting burned. That almost always happens. "Fundamental investors" - that's people who invest based on how much money a company is making, their sales, their debt, and other objective factors like that, combined with a little information about the industry and an opinion on the company's management - they have ways of valuing companies. They can usually figure out what a company is "worth" beyond the hype and fads and craziness. It is not random or unpredictable.

> It’s like a giant game of musical chairs — everybody’s rushing not to be the one left standing when the music stops.

These people are called speculators, as opposed to fundamental investors. They do provide some valuable roles to society (liquidity is the big one), but this is not all the stock market is. Not by a longshot (and I'm not even a huge fan of the stock market, by the way).

> Or, you could say, it’s like those newspaper competitions where you have to pick the six prettiest faces from a hundred photographs. The prize goes to the person who picks the faces that are most picked, so you don’t pick the faces you find prettiest, but instead the faces you think everyone else will find prettiest.

This is true for speculators - you just described speculating pretty well. But fundamental investing doesn't work like that - if other people don't like a great company, you buy it all up and distribute the profits every year in a dividend to the investors. Companies used to offer dividends a lot by the way, it's just our brave new world where people don't. Why they don't is a long topic, but suffice to say, there is an "out" for people who like good companies that other people don't like. It's getting lots of dividends (profits from the company, in cash). It works pretty well.

> Calculating expected profits is really quite hard.

In new fields, like Facebook's profit in 2011, yes. In volatile fields, like Exxon in 2011, yes. In semi-stable fields, you can usually make some pretty educated guesses.

> It’s in the fundamental nature of your strategy that your investments seem crazy to everyone else.

This doesn't matter. If the company turns a profit, you can get dividends. You don't need people to like your stock unless you want to sell it all, which you don't want to do too often if you're investing for the long term.

> And when your stocks aren’t doing well (which is most of the time — they’re long-term picks, remember), people will take this as evidence of your failures and pull their money out.

This is true. It's also exceedingly stupid. A stock's price isn't what it's worth - it's what someone's willing to pay you RIGHT NOW. That'd be like if someone walked up to you, said, "Hey, I'll give you $200 for your $1,000 watch", and you panicked and sold it to them. It's really crazy.

> And that’s scary because — recall — the whole point of the stock market is to decide the crucial question of what we, as a society, should build for the future.

You need to be really, really careful writing things like this. The stock market is not a sentient being and has no general sense of ethics. It is a place where people exchange stocks for money at the "clearing price" (where people will buy and sell). There is no value judgment. It does not tell society what to build. It's simply where stocks are all the stocks are sold at the highest price someone will pay, and sold at the lowest price someone will sell, until everyone is stable. There is no intelligence or value judgment. The stock doesn't tell you anything except what the price people are currently willing to buy and sell is at.

> The best solution is probably a small tax on each trade.

That's actually an interesting idea. I always wondered why a company didn't issue stock that said, "Trading this stock requires the buyer to pay the company $1 to gain official voting rights and become legitimate owner of the company. Trying to exchange ownership or control of this stock or otherwise circumvent this agreement consists breach of contract and forfeits the stock." That would slow down stock trading and all speculation would bring new capital to the company. I don't know why it doesn't happen (laws, I'm guessing?).

> Even more perversely, it means economic performance depends in no small part on keeping businessmen happy.

Everyone is a businessman. Anyone who interacts with humanity in any way is, seriously, a businessman. There is no gap between a businessman and the rest of society. It's a relatively recent phenomenon that large conglomerates provided so much of humanities needs and wants, but we're actually shifting away from that as small businesses can get large-business economies of scale from competing providers. In short, the above quote is false. If the businessmen give up and leave, as long as someone half competent is willing to do anything that others are willing to pay for, the economy will not halt. (Though, talented managers - as rare as they are - are actually woefully unappreciated, and an economy losing them would really take some blows. This happened to the USSR, Red China, Nazi Germany, and various other totalitarian places - when a place gets evil enough, the most talented, enterprising, smart, and resourceful people dedicate all their talent to getting the hell out of there, which does in fact hurt an economy's growth quite a bit - for fun, look at how many of the wealthy people in the USA, Hong Kong, Israel, and other havens came from direct immigrants or first generation resourceful people fleeing totalitarian places)

> Most costs are pretty clear — you need to buy equipment and hire people.

This strikes me as a general flaw of Keynes - he doesn't recognize that buying and selling are always the same transaction. Any unclear demand is an unclear supply. A clear cost of equipment is a clear price of equipment. Whenever someone "puts their money in stocks", someone else has "taken their money out of stocks", or the company has gotten the money and will (presumably) start putting it to use.

> But since you need to make stuff now that you can only sell in the future, one of your big costs is going to be money to use in the meantime. And the cost of money is just the interest rate. (If you get a loan for a million dollars at 5% interest, you’re essentially paying $50,000 for the right to use the money now.)

Huge Keynes wrongness here - this one is ugly because it seems so correct on the surface. But this only applies to fiat, paper currency. The fake, illusion money you referenced earlier. You can't just "set" an interest rate, unless you're a government that doesn't mind debasing your currency. Debasing your currency makes the value of every bit of your currency go down. "And the cost of money is just the interest rate" - the interest rate is set by the same process everything else is: The price people are willing to sell (deposit) and buy (borrow) meet. Same as the stock market, same as the truck market, same as the labor market. Let's pretend for a moment that the government set the interest rate at zero percent - well, then people would borrow tons of money. But who would deposit it? Who would risk their money to get nothing back?

No one. So the government debases the currency by printing more. Again, "debase" is just the historical term from mixing the metals, it's not a value judgment. We could call it "making the value of all the currency that exists go down by printing more" instead, but the word already exists, and it's "debase". I'm not crazy about the word myself - it's just a historical throwback to people mixing base currencies (iron, brass) with precious metals (silver, gold) to create fake, lower quality, debased precious metal money.

Anyway, government manipulating the currency = debasing or inflating the currency artificially. The former leads to depression, the latter leads to inflation. (Why is complicated - in short, people stop using a kind of money if it gets debased too much - this is actually where ticking off rich people hurts - they stop signing and issuing contracts in USD, instead using something else. Remember, a paper currency always eventually loses all its value. Always, it's happened every time)

> Well, if the interest rate is the cost of money, the obvious answer is the amount of money in circulation. If there’s a lot of money lying around, you can get some pretty cheap.

The other things I've commented on are general details-based errors, whereas this is completely incorrect. Interest rates on non-fiat currencies in a free market are set at the rate where people are willing to sell (deposit) and buy (borrow) meeting, just like all other markets. The amount of money in existence does not matter - if someone has a gigantic pile of, say, gold or wheat or tobacco, but they're perfectly happy having a pile of it, they won't lend it out unless you blow them away. But most things have their price - someone credible starts offering 50%, 100%, 150%, maybe you lend your gold or wheat. Or put another way - how much money would you want back to lend a stranger your car? A hell of a lot more than 10%. What if they crash it? Break it? General wear and tear? Don't give it back? But if someone credible offered you, say, 100% of what your car is worth to borrow it for a year, you might just say yes to that. Maybe it's 1000%? Who knows? Yes, generally, more stuff unused will make people more willing to deposit (sell), but not always. Interest rates are set by people talking, negotiating, and where the buying price and selling price meet, just like everything else.

> Which means that, fundamentally, unemployment is caused by a lack of money: more money (assuming people don’t hoard it all) means lower interest rates, lower interest rates (assuming expected profits don’t crash) means higher investment, higher investment (assuming people don’t stop buying) means more employment, and more employment means higher prices, which means we’re going to need more money.

Keynes made a lot of good points. This part of his work - the "we can play with fiat currency to create wealth" part - is not some of his good stuff. Interest rates artificially low is what we had the last ten years - it meant people got stupid and crazy and wasteful with the free money. Interest rates artificially high means people develop less than they could and progress doesn't happen. With a non-fiat currency, based in real stuff, this balances naturally. Governments playing with fiat currency always - always - abuse it and bring it to zero.

Remember, it's not just the leaders that you like that are insightful that get to play with the currency. For every Thomas Jefferson or Marcus Aurelius, you get a George Bush or Nero. For every good Chancellor, you get a Hitler. These people get to play with the fiat currencies too. They make it go to zero to fund their warmongering and corruption and destruction. But inevitably, every government gets run by a bad person. Also inevitably, every fiat currency goes to zero.

> Money is created by the central bank (the Federal Reserve in the US), which decides what they want the interest rate to be and then prints new money (which they use to buy up government debt) until the interest rate is where they want.

Yes. They got us into this mess with their "low low rates!" of the last ten years. Now people are hoping they'll get us out of it. They've done so, so far, by lowering rates more. There's even talk of having a negative interest rate - paying people to take money! I could point out how crazy that is, and I will if the reason why is unclear, but suffice to say, the people at the Federal Reserve are just as prone to knuckleheadery as the rest of us, if not more so.

> What do you do if the interest rate is zero and people are still out of work?

A very easy one would be to cut taxes, actually. Let's say currently, for every dollar an employer pays, the employee receives 50 cents. Well, now there's a big problem on your hands - the employee needs to be offered TWICE the money that makes it worth it for him to work to take a job. If the employee wants $3,000 after-tax per month, but the employer would have to pay $6,000 in employer-side taxes, employer-side insurance, administrative costs, employee-side taxes, employee-side insurance, etc, etc, well, you've got a problem. Now, there'll always be some gap - administrative costs, management, and so on. But cutting income taxes always reduces unemployment and fairly quickly. Actually, it's the only answer when the "debase the fiat currency" plan isn't working.

> The government has to step in.

Agreed.

> Instead of waiting for billionaires to build pleasure-domes, the government can hire people to build things we all need — roads, schools, houses, high-speed Internet connections. Although, honesty, it doesn’t have to be things we all need. They could hire people to do anything. This is why inspecting the stimulus money for waste is so ridiculous — waste is perfectly fine, the important thing is to get the money into circulation so that the economy can get back on track.

Okay, I was going to make a joke or be snarky, but I won't. This is a fallacy. Debasing the currency just moves the problems around. It means people won't want to hold U.S. currency, and won't want contracts written in U.S. currency. And remember, USD is "illusionary money", as you already mentioned and covered. Debasing it (making everything in existence already worth less) is a good way to get people to stop buying the illusion. Now, I didn't quote it, but you alluded to billionaires not wanting to buy pleasure domes and that being the problem. Actually, billionaires usually don't hold their billions in cash - they hold it in real estate, stocks (as already covered), and other assets. When a currency is debased, the price of everything rises pretty quickly. That means the billionaires get hurt less. You know who gets hurt the worst? That would be poor and middle class people who tend to keep much of their net worth in cash, and also people who have contracts that call for them to get paid a set rate in the future. Debasing the currency means the price of all their materials will rise, making their contracts not profitable at the rates they guaranteed to sell. So the break their contracts. It's a big mess. Debasing isn't the answer, especially past zero percent.

> Another good solution is redistributing income. Poor people are a lot more likely to spend money than billionaires. If we take some money from the billionaires and give it to the poor, the poor will use it to buy things they need and people will get jobs making those things.

1. This is a value judgment.

2. Wealth redistribution never hits the billionaires the hardest. EVER. Much of the stimulus went to already wealthy people. Wealthy people get better access to universities, police, parks, and public transit. The don't build public transit to very poor areas, and if they do, the areas become wealthy quickly with the poor people moving out. Poor areas aren't as well policed. And so on. It's very hard to redistribution involuntarily - by definition, you're creating a power vacuum that's supposed to take money and wealth from some people and give it to others. Who do you think is going to win in that arrangement - the most resourceful, educated, sophisticated, driven, ambitious people (the wealthy), or someone else? That's a serious question without any value judgment - I'd very much like to fight poverty. Personally, I fight children's cancers. I've run charity events for St. Jude's Children's Hospital in the USA and Great Ormond Street in London. But I'll tell you, I've seen some sickening things with laws that are meant to redistribute. I know some people that've gotten the money. Then they throw a "cash for clunkers" bone to poor people to get them stuck in more consumerism. A guy pays $10,000 in taxes, and they give him back $3,000 to buy a car he doesn't need or want. I know a guy that owns a bunch of unprofitable farmland and receives the subsidies. He just bought it on the math on government subsidies. But I digress - I'm with you ethically - raising the standard of living globally is important, and some people can have their standard of living go up faster. But "debase the currency" isn't the answer - it ruins nations. Other redistribution plans tend to make the wealthy get wealthier frequently. And if they're very, very successful, you get a USSR situation where your smartest people leave.

> Remember that money is just a kind of illusion.

Fiat money is an illusion, this is true. Debasing ("hey? what the hell? why does a cheeseburger meal cost $12 and a movie ticket cost $18?") breaks that illusion.

I apologize, I was going to go through the whole piece, but I've writing for a quite while and I'm getting tired. Aaron, I'm going to email you - if you'd like me to clean this up so it can be a formal post on your blog, or if I can otherwise be of service to you, please call on me. I'll shoot you an email now, and you have my best wishes. I think you're one of the most passionate, charismatic, and intelligent people I've seen write. I think you can be a tremendous difference maker in the world. I believe our goals are in line, so with the best methods, perhaps we can serve as champions of humanity.

IsaacL• 17 years ago

One of the reasons I read Hacker News is for the great comments on submissions, and this is one of the best I've seen. Thanks for taking the time to write that.

aaronsw3• 17 years ago

This is a long post, mostly filled with things that are either irrelevant to what I said or obviously wrong. But the basic place where it disagrees with Keynes is that it adopts the old-time monetarist view that printing money always "debases" the currency. This seems intuitive, but it's been proven just wrong. During the period I mention when we kept interest rates low, the economy grew steadily. When monetarist targeting was tried (under Volcker), we got a huge recession. The recent problem wasn't caused by low interest rates but a housing bubble. If Greenspan had simply given a speech pointing out the bubble instead of repeatedly denying it, it could have been averted.

Keynes, Explained Briefly

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