Mark to Keynes
By Daniel M. Ryan
As the total bill for the various bailout programs has kept accumulating and multiplying, there's been more and greater pushings of Lord Keynes and his economics. Ostensibly, we had outgrown Keynesianism. Many had become reconciled to a combo of supply-side economics and Schumpeterianism, a combo that got the label ‘laissez-faire' loosely attached to it. Despite the demurs of hard libertarians, many soft libertarians went along with it for free-advertising or prestige reasons.
Ironically, the same categorization could be made about what is being called "Keynesianism" and the real thing. Contrary to certain current views, straight Keynesianism is different from what now passes for its mention. The central difference between the real thing and vulgar Keynesiamism is that the former puts primacy on inducing businesspeople to invest. The Keynes-called "collapse of the investment function" is the causal force working to keep a damaged economy in high-unemployment (pseudo-) equilibrium for a sustained period of time. The now-ballyhooed "liquidity trap" merely pertains to a situation where monetary policy is relatively ineffective: it's Keynes' term for a sudden but sustained decrease in the velocity of money, which carries the risk of a collapse in the money supply itself overwhelming the central bank's best efforts to reflate.
To be fair to the Keynesians who are now having their day in the frozen sun, many of them do know that "liquidity trap" merely implies "shift towards fiscal policy from monetary policy." It may not be charitable of me to the supply-siders to point it out, but it is true that they never really got to the point of growing beyond Keynes. They differ from more government-oriented Keynesians in this way: they believe that inducing businesspeople to invest through cuts in marginal tax rates makes more sense than inducing investment through boosting government spending. If the current loose use of ‘laissez-faire' is accepted, then supply-siders can be tagged as "laissez-faire Keynesians," even though they're really Keynesians who have worked, or brought, an appreciation of the free market into their thought corpus. To put it in pragmatic terms, supply-siders believe that it's better for the government to induce investment that serves the non-governmental consumer: doing so keeps entrepreneurs from seeing the government as their patron and, er, adjusting their entrepreneurial talents accordingly.
Another point for the supply-sider side is the fiscal-policy approach depends upon what Prof. Robert Higgs called the ratchet effect in Crisis and Leviathan. In order for fiscal policy to serve as a reliable way of inducing investment, government spending has to be raised to a permanently higher plateau. Otherwise, cyclicality problems will emerge in the government-stimulated sector. Thus, Keynesians need the supply-side approach to unwind stimulus programs when no longer needed…which is a crucial component to Keynesianism itself.
As far as who is Keynesian and who isn't, there is a reliable way to spot a Keynesian, including a foxhole Keynesian. All Keynesians have this facet in common: they tend to disbelieve, if not scoff at, the idea that a full recovery is endogenous to the free market. The more assertive ones insist that the narrative describing the process of free-market recovery is "mythical," "theocratic" or some such. The less assertive point out that the free-market alternative is riskier, and it consumes too much time even if complete collapse is avoided. Both believe that a "killer swan" is lurking in the free-market preserve, and might wreak devastation one of these days.
This attribute, though, isn't the decisive once that earmarks a Keynesian. A Keynesian, at bottom, is someone whose conception of the homo economicus jibes with Keynes' own. To put it bluntly, the closest real-world approximation to Keynes' is the momentum trader.
The goal behind momentum trading, like all trading, is to buy low and sell high. Unlike other speculators, though, momentum traders place a premium on piling into uptrends and avoiding downtrends. You could offer a momentum trader a hard-hit stock with a well-covered dividend that yields a full 10% as of now, and (s)he would refuse it if there was no evidence that the stock's downtrend had not ended. Until that point is clearly reached, a dedicated momentum trader would prefer T-bills at a near-zero return. The rationale given – "what if that turkey keeps falling and erases the big yield with a capital loss?" – is analogous to the reason advanced by Keynesians as justifying the government stepping into the overall economy. No economically rational businessperson, Keynesians aver, would want to invest in the teeth of a downtrend not visibly expired.
The homo economicus of the (usually Austrian-based) free-marketers is far more like the value investor. A value investor not only sells "too soon," (s)he also tends to buy too soon. Central to the value-investment credo is radical skepticism about market timing. Every value investor worthy of the name insists that timing the bottom is a fool's exercise, if not a descent into vainglory. Consequently, the only sensible decision criterion is the expected return with a margin of safety factored in. The margin of safety should be enough to compensate for initial losses along the way to full recovery.
This kind of homo economicus would have been induced to invest in 1931, it's true. 1932 would have been a horrible shock for this kind of investor, regardless of the investment taking place in Wall or Main. Some would have lost all during the course of the Great Depression, perhaps because their margin of safety had tragically turned out to be retrospectively inadequate. But others wouldn't have. As prices of capital goods kept falling, and as the differential between falling final demand and more-rapidly falling demand for capital goods widened margins, more and more value-oriented investments are made. Since value investors are individualistic and sometimes idiosyncratic, this process has a long-tail character to it that makes its workings largely unseen. When enough value-oriented businesspeople have invested, capital-goods providers will begin to recover. (This recovery, of course, includes re-hiring.) As recovery spreads, the economy makes its way to overall auto-catalytic recovery. The path towards this recovery is as unpredictable, and (for some) as frustrating, as the recovery of a value stock's price.
Of course, the homo economicus is an ideal type – and which variant is most appropriate is really rooted in difference of tastes, as none of us can control how other people's entrepreneurial drives are expressed. It's still true that de gustibus non disputatum. This point being noted, though, there has been an institutional reform which has pushed Wall Street into a mode that is completely compatible with the Keynesian model. That reform is mark-to market accounting.
Mark-to-market accounting mandates that holdings be revaluated using the bid price of an investment periodically. It might be every month, every quarter, or every trading day. Regardless of the specific period, it requires investment professionals to recognize unrealized capital gains or losses as real income or real losses. If you've ever stumbled upon a financial firm that's reported negative revenue during this past crisis, mark-to-market accounting is the reason for it.
Observe that the use of it also mandates value investors to report, if not act, like momentum traders. Value investors can no longer shrug off, say, a 20% capital loss as a wintry prelude to a prosperous spring. They have to take any such loss onto the books as it happens, with the expectation that today's loss will end up magnifying tomorrow's profit. Consequently, they have to keep their books in a manner consistent with the momentum trader's point of view. "You see it? Your 10% yield really was wiped out by a capital loss. Maybe you should have waited like I would have."
As pointed out above, a momentum investor is an unconscious Keynesian: (s)he has to be. So, it's unsurprising that the first post-mark-to-market crisis has made a Keynesian out of almost every Wall Streeter. Given how mark-to-market accounting was sold in the first place, it seems that there may be such an animal as a ‘laissez-faire' Keynesian. Loosely defined, of course.