Keynes and Green Cheese

In a time when all money was based on gold, John Maynard Keynes had an outlandish diagonsis for the global economy. Solutions for our times might sound just as weird.

200-odd pages into General Theory--a dense, sober, jargon-wed text of raw economic theory--Keynes falls prey to fancy in order to describe the fundamental institution of his economics.

"There is no remedy but to persuade the public that green cheese is practically the same thing [as money] and to have a green cheese factory (i.e., a central bank) under public control" (Keynes, 1936, p. 235).

40 odd years later the green cheese factory came true in near perfection when, on August 15th 1971, Nixon ordered the gold window of the FED closed. The dollar was officially fiat. And, more recently, on June 27th 2009, the logical acme of Keynes reasoning was proposed by Zhou Xiaochuan, the govener of the central bank of China. Mr. Zhou suggested that a new fiat international reserve currency should be created and monitered by the IMF.

Keynes was not an idealist; he treated governments and markets pragmatically. From the easily determinable facts of his times he was able to pose the question "What kind of monetary and fiscal insitutions would aide humanity in these times?" His answer to this question was a monitored and careful general expansion of the money supply. Keynes solution was more than outlandish: the idea of a green cheese factory, sounded perposerous to his audience: gold is money, the only way to make more money is mine more gold.

Lord John Maynard Keynes, now remembered as the architect of all modern fiscal and monetary institutions, wrote in a time when the population was growing exponentially and was expected to keep growing that way, and when the implimentation of useful tools and durable structures was for the first time lifting a whole society (the American one) into the middle class.

Keynes discovered that monetary expansion increases employment and accelerates the extension of capital--i.e. those useful tools and durable structures. Things like roads, factories, power plants, appliances, water treatment facilities, cars, and all sorts of machines made commercial labor more productive and living more comfortable and safe. Capital extension in the US demonstrated for the rest of the world how durable and semi-durable equipment could be employed by a market economy or concievably by a centralized planning agency to increase wealth and eradicate extreme poverty.

Increasing the money supply does cause economic booms, but also busts--bubbles, but also troubles. Monetary inflation stimulates investment in durable and semi-durable equipment and increases employment by simultaneously cutting productive costs (decreasing interest rates and lowering real wages) and raising the expectation of profit (higher prices). Keynes warned that too much money at once can push prices too high too soon, before wages keep up, and demand will drop off, which reverses the positive effects of money creation. In the case of sagging demand, the government, Keynes argued, ought to put demand on all sorts of things--maybe fight a war or provide some service like national highways or a national health care system. The other danger of money mis-managment should sound familiar; by producing too much money now, and concequently lowering interest rates, and then producing less and less money, raising interest rates, will cause a large number of fix interest loans on the margin to 'go bad.' Maybe in these cases, Keynes might argue, the government ought to buy all the toxic assets. Who knows? Despite busts, bubbles and troubles, Keynes bet that one 1-5 year recessions for every 8-12 years of boom growth was a good trade.

The dream of green cheese and its net positive effects was not based on the precepts of an ideal science. Economics for Keynes was a conditioned, descriptive chain of reasoning with assumptions and premises that relied on real economic and political conditions. A literal 'real economik.' Hence, an analysis of Keynes fundamental premises and those of our times could be the first place to look for the contiunation of the open conversation about the recent monetary and fiscal problems and the structure of monetary and fiscal institutions for the 21st century.

Unlike in Keynes' time when population seemed unbounded exponential growth, today, population is expected to level off around 10 billion.

Logarithmic population graph with shaded varients and dashed line showing if there were no change in fertility rates. Source: Wikipedia: ESA, United Nations.

An increasing population means more of all things economic. A growing population has always been the first and most obvious argument in favor of inflationary monetary institutions. A shrinking or level population raises the question--"what will the economy of a world with a constant human population even look like?"

In Keynes time it was obvious that major roads would be built and populated with cars, a huge number of buildings would be built to house and shelter the work and families of the world, factories for clothing, hospitals for health, and farmland would need to be set aside and developed. Now, however, in the richest countries all these capital commitments have already been made, and we are entering into a time when cannot predict the future shape of economic development. The internet, for example, was not predicted in any way by futurists or science fiction writers, and yet it has driven the productivity and growth of the global economy for the last 10 years. Humanity is also in the position to begin to see some weird gadgets like computers computing as fast as a human brain and the ability to grow organs in petridishes.

There will be an end to the historical process of capital extension. The development of Africa and Haiti will signal the end of economies of development ex nihilo. With the end of capital extension however does not come the end of economic growth. A new and explosive trend in development that has already been taking place for twenty years might be called capital intensification. If you intensify capital, you design durable and semi-durable tools that do more with less. Compare cell phones to telephones, or solar panels to coal power plants. The sectors of capital intensification are telecomunications, green energy, the internet, medicine and biotechnology. These secotors make use of very few resources while adding huge productive and consumer value to the market. As capital intensive industries grow, they will take up a proportionally larger and larger part of the economy, just as capital extensive industries and their financial compliment edged undercapitalized industires (agriculture and folk industry) into just 2% of any capitally extensive economy.

Capital intensive industries have a different financial anatomy than capital extensive ones. Whereas extensivity required huge and long term investment, intensivity is fast-paced and has minimal fixed costs; extensivity tended towards vertical alignment and horizontal hegemony, intensivity leans towards companies creating their own market niches and then cooperating and competing in diverse webs of service and exchange. Whereas, as Keynes reasoned, extensive industries need a climate of rising prices to offset their fixed capital costs, intensive industries live and grow within a climate of the expectation of gradually falling prices.

If the world faces a shrinking and then steady population and growing non-inflationary industry, both these signals suggest that the monetary and fiscal policies of the future will be largely stationary. An actively deflationary money--that is, shrinking the money supply--makes no sense under almost any conditions, since it does the opposite of inflationism, raising all costs and lowering all expectation of profit, hence impeding all commercial venture and causing huge unemployment. However, a monetary institution, or group of institutions, that create a flexible but stationary money supply might better match the world in which we live in or will live in within the next 25 years.

The economic effects of a flexible and stationary money supply would be shifting the time preference of demand, the gradual and steady increase of all real wages, limited government fiscal policies and higher, floating interest rates--incentivizing saving and inhibiting reckless and finally bootless investment behavior.

Right now, Mr. Zhou's proposition to create an international fiat reserve currency is the most probable future of global money. Given the power of the players involved (big government, a military industrial complex, jarrasic industry), any other idea besides greater and greater monetary inflation will encounter petulance, resistence, and ignorance. However, if Keynes' reasoning depends on conditioned premises, and those premises have changed, the logical conclusion of Keynes' ideas might in fact harm the present and future economy. Just as Keynes solution sounded outlandish and improbable, solutions for our present economic maladays and the future of money in general can be difficult to believe. For the sake of brevity, this author will outline only one possible way of creating a flexible and stationary money supply.

One way to assure a flexible yet stationary money supply is to allow for a regulated market of private money. The major regulations would be a 40% reserve requirement of all deposits, no taxation on money providers (since this would constitute taxation on money itself), the banishment of any 'too-big-to-fail' catagory, and the preservation of free entry for new moneys. With these regulations in place moneys would be launched, probably by major banks, but also by communities and small entrepreneurs. Competition would be based on the preservation and even growth of each money's value, since who will 'buy' money that will loose its value over time. Banks would carry multiple balances of different currencies. Commerciants, laborers, landlords, and retailers would detail what money's they excepted for payment. Electronic money and mobil payment systems would simplify any paper bill problems without eliminating cash itself.

The exact dynamics of such a monetary structure would be complicated, and far outside of the scope of this article; however, a rough sketch is possible. Without a central agency to increase the money supply, no coherent national or global plan of inflationism could be made, therefore the market would determine the interest rates and values of money, causing a higher and more realistic representation of risk. Currently, with 10-5% deposit reserves, the money supply can multiply 9-20 times from the uncoordinated actions of the banks, but a 40% reserve would allow the money supply to multiply by 2.38 times making the two responsibilities of banks possible: the coordination of liquidity demand schedules with investment scheduals. Fiscal policies would be limited by the real ability of a government to pay back its debt to private banks--the knee-jerk exchange of treasury bills for dollar bills between government and federal reserve would be a thing of the past.

Right now maybe we need the 'spend our way out' fiscal policies, maybe we need the green cheese and its factory, but Keynes would be the first to agree that we live in a world much different than his. The population will slow its growth and stop before the end of the present generation. Africa is looking at develping faster than Asia did in the next generation. GM and California are in chapter 11 and Google and Apple are creating technological and financial benchmarks. All these conditions suggest that our monetary and fiscal policies are being outmoded by progressing real economic and social conditions. Perhaps, after a year or two of deleveraging, and then eight more years of global capital extension, we might not need any more green cheese and we will need something else.