Making Sense of the Current Financial Turmoil

Fr. Seán McDonagh, SSC

As I listen to commentators, politicians and so-called financial experts trying to make sense of what is happening on the financial markets, I am reminded of the statement from Lord Acton that “those who do not learn from history are domed to repeat it.”

The roots of this crisis goes back at least as far as the 1930s, though some would push it right back to Adam Smith, author of The Wealth of Nations, who is often considered the father of modern economics. .In the wake of the horror of World War I and the Great Depression, Marxists and Liberal Capitalist thinkers were attempting to revise their theories in the light of the World War and the experience of the Great Depression.

Two of the most famous thinkers on the capitalist side were, John Maynard Keynes (1883 to 1946) and Friedrich Hayek (1899 to 1992). Keynes’s father, John Neville, was an economist who taught at Cambridge. John Maynard had a broad education in classics and mathematics. He also taught economics at Cambridge, but his circle of friends reached far beyond the academia. He was an important member of the group of artists, philosophers and writers who became known as the Bloomsbury group. In fact, he married a Russian ballerina, Lydia Lopokona.

Keynes public persona was also enhanced by the fact that, as a journalist, he could explain the seemingly complex ideas of economics in a clear way, thus making economics available to a wider audience. His initial claim to fame came from writing a book in 1919 called The Economic Consequence of the Peace. It argued that the reparation demands on Germany were too onerous and that they would lead to economic chaos and future conflict. He argued, as did Pope Benedict XV, that every effort ought to be made to re-incorporate Germany into the European economic system.

Keynes was not a socialist. He supported market-based capitalism. Adam Smith had argued that the government should not intervene to control markets or other factors of production. To be fair to Smith he believed that governments had an obligation to provide resources to fund the public services. However, most liberal economists or the 19th and 20th century only focused on Smith’s opposition to governments interfering with the market.

Keynes broke with his fellow economists by pointing out that the market system alone was not capable of addressing modern economic circumstances. In his book, General Theory of Employment, Interest and Money, he rejected the traditional laissez faire of unrestricted commercial freedom and argued that, in the modern era, markets had to be managed by governments.

He pointed out that, during a recession people did not normally invest in enterprises. This had a knock-on effect on the economy, leading to reduced demand, business failure and mass unemployment. Many of these points were highlighted in a 1932 article by Keynes, Hubert Henderson and Seebolm Rowntree entitled “We Can Conquer Unemployment”. They argued that it was precisely at this point in the downward swing of the economic cycle that governments needed to put money back into the economy, even if this meant deficit spending.

Naturally, when the economy was moving, full-steam ahead, the government should put money aside for the rainy day. Keynes argued that government intervention at a time of economic slow-down would have a multiplier effect. By putting money into the economy, governments were priming the pumps and, thereby, stimulating demand. This would allow companies to employ more workers, thus reducing unemployment levels. Workers would have money to buy good, thus stimulating growth.

It is not true to say that President Franklin Roosevelt fought the 1932 election on the promise of implementing Keynesian ideas. In fact, the opposite was true. He accused the Hoover Administration of being the “greatest spending Administration in peace time history”. It was only after a Black Tuesday on October 19th 1937 that Roosevelt’s Administration began to implement Keynesian policies. During World War II Keynesian economics spread to many other countries and remained the most dominant economic theory in the Capitalist countries of the world until the late 1970s.

In my next post, I will look at the economic theories of Friedrich Hayek (1899 to 1992) which were embraced by Margaret Thatcher and President Ronald Reagan. Like Keynes, he was opposed to socialism, but he was also hostile to any government intervention in the economy. The de-regulation mantra, “get the government off our back” slogan of the 1980s and 1990, which has led to the present crisis, owes much to writings of Hayek.