Prepare to be Schooled: Keynes vs. Hayek

Here is an entertaining way to learn about the two major schools of economic thought. Keynesian economics is what pretty much every government believes at this point. It postulates that governments can positively influence the aggregate demand (therefore dampen recessions) by changing interest rates and government spending.

This approach has created (especially in the US) a situation where entities have become too big to fail and fragile at the same time. At this point, the big entities game-theoretically hold the government hostage to bail them out every time they face difficulties. Politicians don’t want to risk their office seats so they do it… Plus there is always the danger of runaway inflation as a result of government interventions.

Hayek’s philosophy is to rely on markets to self regulate, but the danger here is that markets may not recover as fast. This philosophy is more about financial prudence and keeping the money supply independent from the business cycles. It encourages savings, arguably, better capital allocation decisions as money has scarcity.

Hayek’s view was largely ignored by pretty much everyone until bitcoin arrived. Crypto is an alternative financial system that is aligned with Hayek’s philosophy through the restriction of money supply.

The next crisis will show who was right, as we will have economic data from two independent alternative financial systems to judge the outcomes.

Anyway, these videos do a better job than me… enjoy!

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Well technically Keynes is correct with his premise of influencing market the problem is that after lowering interest rates and pumping economy in recession, when the market recovers the government should do the opposite - increase interest rates and start savings. No government does that because it’s controlled by politicians elected for a certain amount of time, who don’t care what happens after next election. This fuels the spiral of debt and the debt bubble will eventually pop releasing all the tension that was supposedly avoided during all those interventions.

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He is ‘correct’ because we haven’t tried anything else, which is why what happens in crypto during the crisis is important as it could validate Hayek’s theories–meaning if markets self-correct then we don’t need interventions. There will be volatility but it will be managed on a local level and not expand up to the national/global levels.

I doubt the financial system will change though… because admitting Hayek was right would greatly diminish the role of the government in economy.

Smaller countries are more prone to experiment thought.

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Well not exactly. There is no doubt that government intervention - increased spending - gives a bust to a failing economy. The problem is that - as I indicated in previous post - any increased spending should be preceded by a period of savings. The fact that no government does that and instead takes loans inflating the debt bubble is clear indication that Keynesian economy will ultimately fail with a big bang.

Actually I believe it will and crypto will have a huge role to play. I’m of an opinion that the credit bubble will sooner or later pop. When China drops petrodolar we may face an unprecedented situation and there will be a hyperinflation shadow looming over that dolar. If major fiat currencies fail, people will move to other alternatives such as crypto or precious metals (we have already seen this in Venezuela).

So yes, I personally believe financial system will change.

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I don’t think dollar is going to weaken anytime soon. For one thing China owns a lot of US debt. They hoarded it to a degree that they can’t get rid of it without a substantial decrease in value.

And don’t forget, USD is still a reserve currency for many countries around the world, so no one government in their right mind would want to see the USD lose its dominance.

What could happen though is that we would see another bubble burst and people (not governments) realize that they want protect their assets from the traditional financial system and move some part of these assets into crypto.

If crypto platforms like Cardano manage to capture a significant portion of world’s economic activity, then people might just leave the traditional financial system overall—kind of like going off grid.

But that might happen 5-10 years from now. Then and only then, governments may think about changing something. They will have two choices:

  1. Restrict crypto (this won’t work and it’s resource-intensive)
  2. Change economic policies to be less interventionist

If 2 happens it won’t mean that all of a sudden the Fed is abolished and we start naming squares after Hayek though.

We will probably return to a capped intervention model where government does something in extreme cases and even then it’s limited by law so markets can self-regulate.

PS: in all likelihood, we are both wrong. Reality doesn’t follow a neat path that our minds construct trying to make sense out of things.

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That’s probably true. There are way too many variables to successfully predict the economic future.

Current situation resembles a bit a mexican standoff due to globalization. Countries own each others debt have reserves in each others currencies, many companies are globally active. Nobody wants to make big moves but everybody wants to move to a better position. Unfortunately if a cracker goes off in the neighbourhood and some triggers may be pulled starting a mass slaughter.

For example I see one plausible scenario:

  1. America takes control of Venezuelan oil.
  2. Prices go down, Saudis sell less.
  3. Saudis want to sell more, they ask second biggest player - China - if they want to buy more.
  4. China demands Saudis switch to Yuan. Saudis comply.
  5. Last time someone wanted to abandon petrodolar they got overthrown or invaded - Kaddafi, Saddam - but Saudis or China are too powerful. The only option is sanctions.
  6. USA places sanctions. China is always headstrong - responds accordingly.
  7. Situation escalates. USA bans chinese products. China in response takes over US factories.
  8. USA loses big chunk of cheap product market and their producers that based factories in China suffer huge losses or even go bankrupt.
  9. Prices in US go way up due to lack of cheap products, people lose jobs and stop to buy. Real estate bubble pops.
  10. Economy slows down and goes into recession. Government pumps money into the market. It doesn’t help because prices for imported products are still high and people don’t have jobs. They don’t spend, dolar deflates.
  11. US prints even more money to the point cotton prices go up.
  12. At this point US and China probably lift the sanctions as it suffocates both of their economies.
  13. Market is flooded with cheap products again. As the dolar is deflated and people have finally money to spend - they go on the spending fest.
  14. Market gets flooded with all those overprinted dollars and it causes hyperinflation.
  15. People switch to crypto and precious metals for their savings.
  16. At some point the demand for money withdrawals from banks goes over the line. Banks become insolvent.
  17. People panic and with snowball effect try to switch to crypto and metals.
  18. Dolar becomes toilet paper. Banks collapse.
  19. US becomes insolvent. China owning most of the US debt sinks with it as well. Other countries follow (unless they already went bankrupt earlier, and most of those with hight debt would).
  20. New economic model is introduced. People get their power back or governments go on the path of tyranny.

Just one of millions possible scenarios.

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This could be a good plot for your next apocalyptic sci-fi book. Throw in robots and clones and you got your first customer.

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Nice to see that you’re getting there.

I am still having my doubts about the role of a purely deflationary currency (mainly in seeing how it would work) in traditional economies, but I am now more familiar with Austrian school of thought than before.

It makes more sense than the Keynesian approach in theory at least…

Sorry, I was not referred to the deflanatory currencies or any other alternatives, but to the fact that you’re heading off the “de-facto” Kaynesian school and looking for and trying to understand some other alternatives more deeply such as the Austrian school. Meaning that you’re stepped on the steep learning curve of Economics issues which are simply the mismatches between the supply (structural problems) and demands (cyclical problems).
EDIT: I simply meant that you’re willing to learn, which is the hard way and only very few follow that path.

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I am always open to learn new things. Come to think of it, microeconomics is much like Austrian economics although it is not labeled as such.

It is when you get to macro level that they introduce fiscal and monetary stimulus as functions inherent to economics.

I have yet to read the work of Hyek and Mises… to make up my own mind, but thanks for pointing out the alternative.

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