Review of the Book:

Keynes-Hayek: The Clash That Defined Modern Economics
by Nicholas Wapshott

Edward J. Dodson

[Published by W.W. Norton & Company, 2011. This review written on 9 January 2013]

What follows is a review by a person unburdened by rigorous formal education in neoclassical or Austrian economic theory. Although I have read Keynes, Hayek and many of the other economists referred to in this volume, my own academic studies and writings have concentrated on the political economy of history's moral and practical philosophers. These individuals viewed the world in a far more interdisciplinary fashion than most of those who chose economics as a discipline.

The clash described by Nicholas Wapshott might be better described as "The Clash That Tragically Defined Modern Economics" and diverted the approach by economists from the interdisciplinary analysis that was political economy. The story he tells is a story of two groups of economic theorists, each trying to explain away the inability of policies based on their theories to keep any economy from repetition of boom-to-bust cycles. Readers are rewarded by the author's capacity to convey the drama of this story even though necessarily filled with descriptions of the theoretical positions held by his two main protagonists: John Maynard Keynes and Frederick Hayek.

There are many, many passages contained in this book that deserve to be highlighted, commented on and even expanded beyond the author's context. Directly quoted passages from Nicholas Wapshott's text are followed with a page number reference. I must warn the reader of a rather long journey ahead should you care to explore these matters with me. Anyone with even a modest interest in economic history will enjoy reading this book. In fact, my review might make more sense to you after first reading the book itself. This is recommended if you have not previously studied the history of economic thought. My approach is to provide a critical synopsis highlighting key points of agreement and disagreement - as well as what both sides ignored in their exchanges.

From the very first pages, we learn from Nicholas Wapshott why the emergence of Keynes and Hayek as recognized theoretical innovators became so important to such a large portion of the world's population in the twentieth century:

"Hayek … was determined to prove that there were no simple solutions to intractable economic problems, and came to believe that those who advocated large-scale public spending programs to cure unemployment were inviting not just uncontrollable inflation but political tyranny." [Preface, pp. xxii-xiii]

In a century characterized by history's most destructive wars, by continuous political chaos and upheaval, and by widespread economic hardship in the face of a skyrocketing human population, Keynes and Hayek emerged as leading voices in the defense of democratic capitalism, as each defined this system of socio-political arrangements and institutions. Their main disagreements were in how to describe this system and what role was required of government to ensure its just and efficient operation. Their views defy characterization as liberal or conservative as we today think of these ideologies.

The economics Keynes learned as a young student came directly from the giant figure in the classical tradition of economics, Alfred Marshall; and "Marshallian economics was based on a commonsense understanding of the subject and how business worked in practice." [p.3] Keynes always thought economics should be put into practice, should play a major role in the evolution of public policies. He felt compelled, therefore, to warn not only the political leaders but the larger public of the certain outcome of the Versailles Treaty imposed on Germany at the end of the First World War. "Keynes's predictions that the burdensome reparations would lead to political instability and extremist politics, and that they might spark another world war would turn out to be chillingly prescient. [p.5] …[Keynes] wrote to the chancellor of the exchequer, Austen Chaimberlain, 'The Prime Minister is leading us all into a morass of destruction. The settlement he is proposing for Europe disrupts it economically and must depopulate it by millions of persons." [p.10]

After speaking his mind and finding his words fell on deaf ears, Keynes resigned from his government post and began putting his conclusion into book form, published as The Economic Consequences of the Peace. "Chamberlain, Keynes's employer, accused him of disloyalty. 'Frankly I am sorry that one who occupied a position of so much trust … should feel impelled to write in such a strain of the part his country played. …I cannot help fearing that our international course will not be made easier by such comments'." [p.13]

Keynes was guided not by loyalty to any political party or governmental leaders but to his conscience.

While Keynes was thrust (or thrust himself) into the forefront of debate over economic policies, Frederick Hayek was just beginning to develop his own thinking in response to his studies under Ludwig von Mises. His economics, coming from the self-described Austrian School, was "more theoretical and mechanistic, deriving from an intellectual rather than a practical understanding of how business might work."[p.3] Because of the Austrian School's focus on the role of prices in bringing an economy to a stage of general equilibrium, "Hayek became interested in how a peacetime economy transformed during war, when the free market gave way to the state's needs." [p.16]

Sound Money?

Nicholas Wapshott provides us with the details of the ongoing debates among economic theorists over the ideal design of monetary systems and monetary policy, and how the architects of opposing theories responded to the challenges of political realities. He quotes Keynes, stating: "Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency." [p.22] This raises the question, then, of what he meant by "debauch the currency?"

Not since the early decades of the Bank of Amsterdam, established in 1609, which served as a deposit bank and not as a lending institution, was the paper currency in circulation fully backed and redeemable in a fixed quantity of gold or silver. In The Wealth of Nations, Adam Smith describes the virtues of this system:

"The bank of Amsterdam professes to lend out no part of what is deposited with it, but, for every guilder for which it gives credit in its books, to keep in its repositories the value of a guilder either in money or bullion. …The city is guarantee that it should be so." [p.453]

This experiment with a system of full reserves for currency in circulation could not be sustained. For one thing, the temptation to issue bank notes in excess of hard money deposits promised bankers huge profits if they were able to navigate the difficult waters of economies that periodically crashed. With government backing, monetary systems were created based on fractional reserves of precious metals; and -- in the later years of the debates between Keynesians and Hayekians - currencies that could not be redeemed for a specific quantity of gold or silver. This form of paper currency I have come to describe as promises to pay nothing in particular. As Keynes would observe, the merging of the role of the deposit bank with that of a lending institution, combined with the issuance of bank notes and credit beyond the value of gold and silver reserves, significantly altered the operation of markets. Yet, he also believed:

"Convertibility into gold will not alter the fact that the value of gold itself depends on the policy of the Central Banks."p.25]

Well, not totally. The laws of a country might set a fixed price for gold or silver, but market forces frequently intervene to force governments to lift rescind impractical laws or regulations. It sometimes takes years or decades for government officials to face up to new realities, as was the case with allowing the exchange value of currencies to float against one another based on perceptions of those who acquired and held currencies as a result of trade or even for purely speculative purposes. What has proven to be true is that the volatility of a basket of currencies is far lower than any single currency.

Other powers granted to central banks over time also came with serious side-effects. Reducing interests rates in order to encourage borrowing as a strategy for economic expansion was criticized by the Austrians as unwarranted intervention. Ludwig von Mises "contended that when a central bank reduced interest rates, it interfered with the natural equilibrium between individuals' savings and the investment in capital goods." [p.42] It is worth noting that the current policy of the Federal Reserve board in the United States has dramatically reduced the interest income on savings of millions of retirees. The longer term impact on the nation's economy is not even considered by most economists.

Hayek also held little faith in the power of central banks as a stabilizing agent. "Hayek noted that there were some in the Fed who hoped to iron out the recurring booms and busts of business cycles. He concluded that while there might be ways of reducing to a small extent the wildest fluctuations of the cycle, the goal of ridding America of the business cycle was a fool's errand." [p41] My own brief survey of Hayek's writings on the business cycle indicates he paid almost no attention to the operation property markets, and no attention to the land markets that drive property markets - the taming of which would certainly calm if not bring an end to business cycles. Hayek apparently embraced the view expressed by Ludwig von Mises in Socialism: An Economic and Sociological Analysis (1969):

"The separation of 'Land' … owes its special position to the Classical theory of ground-rent. According to this theory, land is that requisite of production which, under certain assumptions, can yield a rent. …In modern imputation theory on the contrary, the grouping of the factors of production according to the scheme of the classical theory is no longer of any importance. What was formerly called the problem of distribution is now the problem of the formation of prices of goods of higher orders."[p.295]

Simple observation should have revealed to both Mises and Hayek that price does not clear the market for land in the same way it does for labor and capital goods. Rising land prices stimulate hoarding and speculation, reducing the supply of land made available (at any price) for development. What we are left to conclude, it seems, is that in order to appear modern, to describe the industrial rather an agrarian-based economic system, land and its rent had to be removed from the equation. Agrarian landlordism had been supplanted by capitalism as a theoretical model. The reality was rather different, what is more accurately described as agrarian, industrial and financial landlordism (i.e., a system that evolved from but did not displace its forerunner).

Keynes also ignored the role of property markets in his analysis of business cycles. Writing in 1923 on the "Social Consequences of Changes in the Value of Money," he describes the affects such changes have on distribution. He identifies the Investing Class, the Business Class, and the Earner, but says nothing about the Rentier. In the passage on the Earner, Keynes applauds the fact that since the end of the First World War:

"[I]mportant sections of labour were able to … not only to obtain money wages equivalent in purchasing power to what they had before, but to secure a real improvement, but to combine this with a diminution in their hours of work…"[Essays in Persuasion, 1931, p.96]

Keynes may have forgotten about the conclusions reached by the Land Enquiry Committee in their Urban Report of 1914, which revealed that "over three million people … are living under over-crowded conditions, with the great majority of the working classes dwell in long and featureless streets with no gardens or adequate playgrounds for the children."[Quoted in: Roy Douglas. Land, People & Politics, 1976, p.162] Keynes might have found reason to comment on the fact that after the war, a plan to construct new housing for those who had seen military service dissolved in the face of rising land costs. He did not.

As explained by Nicholas Wapshott, "Keynes suggested that the cause of the alternate booms and busts of the business cycle was the action of the banks, which also held the cure. …The level of savings and investment could be brought into line if a central bank were to carefully control the amount of credit it offered. The result would be stable prices." [p.55] Keynes would have been more accurate in his analysis if he had understood the effects of credit-fueled land speculation. He might have then argued (as Professor Mason Gaffney has today) for regulation prohibiting any financial institution that accepted government-insured deposits from extending credit for the purchase of land or the use of land a collateral for other borrowing. This one measure would have significantly protected the bankers from themselves and the taxpayers from the imprudent lending practices of the bankers. Even if property markets crashed, the depth of the resulting recession and its duration would have been less severe and less plagued by the failure of hundreds or thousands of banking institutions.

For the central bank to play the role envisioned by Keynes, a nation would have to abandon fixed exchange rates and the gold standard because "central banks would not be able to manage credit so that savings and investment were kept equal…" [p.55] As an alternative, Keynes suggested "it would be more equitable if currencies were aligned to a basket of sixty key internationally traded commodities and allowed to float annually up to 2 percent either side of their pegged value." [p.56] One of the great lessons we have learned since the establishment of the Bretton Woods system, it seems to me, is that the decisions made by political leaders in many countries are only inadvertently sound where economics is concerned. Unresolved, also, is the problem in every society of deeply rooted privilege and corruption. Keynes seemed to believe the establishment of a few international agencies could create a fair field with no favors where none had ever existed.

The Not-So Roaring Twenties

Britain at the end of the First World War was left with an intact industrial infrastructure but also with a huge national debt and a population expecting changes that would create more opportunity for all and less privilege for those who controlled Britain for centuries. The people increasingly put their hopes in the Labour Party, which replaced the Liberals as the dominant opposition to the Conservatives. Yet, when Labour failed to deliver on the promises of its leaders, power was handed back to the Conservatives, who were eager to return Britain to its pre-war position as the world's leading economic power. In this quest an endless serious of disastrous decisions were made and implemented. As Nicholas Wapshott writes:

"Churchill abandoned his instinctive opposition to the Treasury view and agreed to restore fixing the pound sterling to the price of gold - 'the gold standard' - at its prewar parity." [p.38]

The almost immediate result was to price British goods well above prices of goods coming from other countries. Export markets disappeared, unemployment climbed, and Britain sank into recession.

From the Austrian School: A Voice in the Wilderness

While Conservatives battled with Labour and the dwindling contingent of Liberals over political power and policy, Hayek arrived in England to share his perspectives with the economics professors at Cambridge. "[Hayek] insisted that measuring elements of the economy was no substitute for understanding how an economy worked. ...The true key to understanding economic activity, he argued, was the choices individuals made…" [p.73] He declared that to explain any economic phenomenon it was convenient to assume that over time an economy would reach a state of equilibrium in which all resources would be fully employed." [p.75] In short, Hayek had total faith in the price mechanism to return markets to a state of general equilibrium even after serious shocks. In his view:

"The only way permanently to 'mobilize' all available resources is … not to use artificial stimulants - whether during a crisis or thereafter - but to leave it to time to effect a permanent cure." [p.77]

Hayek somehow failed to acknowledge the observable reality that some level of structural unemployment exists even as an economy enters the strongest portion of the so-called business cycle. Under the socio-political arrangement and institutions existing in every modern nation there has never been true full employment. Hayek's introductory essay to the volume Capitalism and the Historians, published in 1954 by the University of Chicago Press, reveals his incomplete appreciation for economic history. He saw industrial expansion as providing the opportunity to lift the majority of people out of poverty:

"The very claims and ambitions of the working classes were and are the result of the enormous improvement of their position which capitalism brought about." [p.25]

Millions of people had been forced to leave the land. Some land had to be abandoned because of diminished productivity, often, but not always, caused by the absence of scientific farming techniques. A much larger area of still fertile land had been converted from the production of food crops to the grazing or sheep or cattle, leaving peasants with no recourse but to migrate. Remarkably, Hayek has nothing to say about the shift in economic power from rural to urban rentier owners of land. The vast migrations of peasants into the industrial towns in search of employment created the circumstances under which urban landed interests claimed in rent an ever-increasing share of the wages that came to propertyless workers. An argument can be made that what improved the living standards of millions of people was the combined efforts of progressive reformers, trades unions, the public funding of schools and the loss of workers who migrated to less populated parts of the globe.

To Intervene or Not To Intervene: An Anti-Depression Prescription

With his appointment in 1931 to the faculty of the London School of Economics, Hayek felt certain he would have a greater opportunity to introduce English economics students to Austrian theories. Lionel Robbins assigned to Hayek the task of preparing a detailed analysis of and response to Keynes's writings on monetary and capital theory. "Hayek's harsh review of Keynes's Treatise on Money invoked howls of rage from Keynes, who was offended at his opponent's failure to take into account that he was publishing ideas he had been assembling for nearly seven years and that he deemed a work in progress." [p.96] Keynes responded by "brutally assessing the arguments Hayek had presented in Prices and Production. He wrote:

"The book, as it stands, seems to me to be one of the most frightful muddles I have ever read, with scarcely a sound proposition in it …"[p.97]

Keynes then wrote directly to Hayek:

"In economics you cannot convict your opponent of error; you can only convince him of it. And, even if you are right, you cannot convince him, if there is a defect in your own powers of persuasion and exposition or if his head is already so filled with contrary notions that he cannot catch the clues to your thought which you are trying to throw to him." [p.107]

Keynes was, as Nicholas Wapshott observes, already coming to ideas that would later provide the basic theories of macroeconomics:

"[Keynes] was now fully occupied with developing an intellectually watertight explanation … for why raising public investment in place of absent private investment at a time of recession would put the jobless to work without prompting the crisis Hayek believed to be inevitable. The result would be his monumental General Theory of Employment, Interest and Money." [p113]

At the same time, he was absorbed by practical concerns and had little time for debates over what he viewed as minor theoretical refinements. He was writing almost daily regarding unfolding trends and offering his policy recommendations. The public paid close attention. He was, however, viewed by members of the government (most particularly, Labour's Chancellor of the Exchequer, Philip Snowden) as a thorn in their side.

As Britain fell into a deeper economic chasm, Keynes declared "that the government should reduce interest rates by issuing government bonds." [p.31] He also argued "that the government was duty-bound to directly employ workers in public works projects, such as building roads." [p.31] Perhaps most significantly, his reputation as an orthodox economist opened the door for even bolder proposals for government management of the economy by other economists:

"It is obvious that an individualist society left to itself does not work well or even tolerably. The more troublesome the times, the worse does a laissez-faire system work."[p.32] …It is not a correct deduction from the Principles of Economics that enlightened self interest always operates in the public interest.[p.35] …The important thing for Government is not to do things which individuals are doing already, and do them a little better or a little worse, but to do those things which at present are not done at all." [36]

Keynes attacked Snowden's plan to reduce unemployment benefits and make other budget cuts, and he again called for severing the pound sterling from gold. Finally, in September of 1931, Ramsey MacDonald "abandoned the gold standard."[p.86] The circumstances were succinctly described by historian Carroll Quigley in Tragedy and Hope: A History of The World in Our Time (1966):

"By 1931, the authorities in Britain saw clearly the futility of trying to stay on gold by raising the bank rate. …It was realized … that conditions had changed. For the first time, people began to realize that the two problems - domestic prosperity and stable exchanges - were quite separate problems and that the old orthodox practice of sacrificing the former to the latter must end. From this point on, one country after another began to seek domestic prosperity by managed prices and stable exchanges by exchange control."[p.346]

Yet, the new national coalition government followed through with a strategy of even greater austerity. As Carroll Quigley adds, British leaders decided the only course left to them was to create a trading block within the remnants of the British empire:

"The home market was set aside by the establishment of customs duties on imports into the United Kingdom. The empire was brought into closer economic ties by a group of eleven 'Imperial Preference', treaties made at Ottawa in August 1932."[p.347]

Keynes viewed these steps as counter-productive and unnecessary, if only the government would provide employment to the nation's idle workers:

"The fact that many workpeople who are now unemployed would be receiving wages instead of unemployment pay would mean an increase in effective purchasing power which would give a general stimulus to trade." [p.129]

In 1933, a collection of articles Keynes wrote for The Times was published with the title, The Means to Prosperity. Examining these articles today, Nicholas Wapshott concludes:

"It was the most cogent, disciplined, persuasive account of his imaginative ideas yet expressed, and contained all the elements that would come to be known as 'Keynesianism'." [p.133]

Among the practical measures advanced by Keynes to stabilize the economies of the world's major trading nation was "that the world's finance ministers should print money in concert, as if it were backed by gold."[p.136] This idea eventually developed into the post-Second World War system created at the Bretton Woods conference of 1944. Holding gold reserves would be replaced by accounts governments would establish in an International Clearing Union. When they ran short of another country's currency they would borrow as needed. When their exports brought surplus foreign currencies, these could be deposited. Without examining the specifics in this proposal, I have to wonder what means of enforcement he foresaw to prevent governments from seeking advantage in the implementation of this plan. One could argue that Bretton Woods worked only so long as nations rebuilding their infrastructure sacrificed domestic consumption in order to maintain a favorable balance of trade.

Pragmatic in his ideas of how to deal with systemic shocks, Keynes noted how ready a nation's political leaders were to borrow when at war and suggested that the Great Depression was very much equivalent to war:

"Some cynics, who … conclude that nothing except a war can bring a major slump to its conclusion. For hitherto war has been the only object of governmental loan-expenditure on a large scale which governments have considered respectable. In all the issues of peace they are timid, over-cautious, half-hearted, without perseverance or determination, thinking of a loan as a liability and not as a link in the transformation of the community's surplus resources, which will otherwise be wasted, into useful capital assets. I hope that our Government will show that this country can be energetic even in the tasks of peace." [p.137]

What history reveals all too clearly is the success of the wealthy in almost every case to avoid significant increases in taxation in order for government to respond as Keynes recommended. Rather, governments resort to the issuance of bonds that pay interest, and imposing taxes on the general population (most of whom have little or no disposable income to invest in bonds or anything else) to raise sufficient revenue to service the bonds. The United States was no exception.

As conditions worsened in the United States, the search for solutions brought attention to what Keynes had been advising to his own countrymen. As described by Arhur M. Schlesinger Jr.:

"The machinery for sheltering and feeding the unemployed was breaking down everywhere under the growing burden. …It was a matter of staving off violence, even (at least some thought) revolution." [p.157]

At the urging of Felix Frankfurter, Keynes responded with an open letter to Franklin Roosevelt, published in the New York Times on December 31, 1933. An advance copy was sent to Roosevelt by Frankfurter so that he would not be blindsided. What troubled Keynes was the emphasis on projects that took too long to plan and longer to get started. "The spending on hydroelectric dams, new highways, and national parks that Roosevelt favored was a slow business, funneling money into the economy many months, even years ahead." [p.159] "Keynes described the president's landmark National Industrial Recovery ACT (NIRA), passed into law in 1933, which allowed among other things private monopolies, the fixing of prices, and the setting up of the Public Works Administration to implement a public works program, as a mixed blessing." [p.158]

Marriner Eccles, the Mormon banker from Utah, who worked with Rexford Tugwell, Mordecai Ezekiel, Henry Wallace and George Dern to come up with the New Deal programs, later wrote:

"With the exception of Ezekiel and Tugwell, I doubt whether any of the men … had ever heard of John Maynard Keynes… At least none of them cited his writing to support his own case, and the concepts I formulated, which have been called 'Keynesian', were not abstracted from his books, which I had never read."[Marriner Eccles. Beckoning Frontiers, 1951, pp.131-132]

Keynes traveled to the United States in May 1934 and met with members of Roosevelt's brain trust and many others. He met with Roosevelt on May 28th. Marriner Eccles makes no mention of ever meeting with Keynes. Yet, Eccles was traveling down the same intellectual path as Keynes with regard to economics and public policy:

"The nineteenth century economics will no longer serve our purposes… The orthodox capitalistic system of uncontrolled individualism, with its free competition, will no longer serve our purpose." [p.165]

This system, often referred to as "the American System," was never characterized by free competition and never served the people as a whole, only those who enjoyed entrenched privilege created by the force of law. The concentration of wealth and income that exists today existed at nearly the same level in 1929. And, for the record, the existence of a class made wealthy by inheritance from landed privilege (deepened by generations of speculation in land in all its forms) existed from the early decades of the seventeen century. The historian Jackson Turner Main wrote, in The Social Structure of Revolutionary America (1965):

"Even before 1700 good land in some coastal regions was unobtainable except by purchase from individuals. The price of land near the cities and along major waterways rose very rapidly."[p.165]

"When the frontier stage had ended, and society become stable, the chance to rise diminished. All the land worth owning was now occupied, and land prices rose, so that the sons of pioneers and the newcomers could not so easily improve their positions. Mobility therefore diminished as the community grew older."[p.177]

As with Keynes and Hayek, neither Eccles nor the others on Roosevelt's advisory team gave any consideration to what political economists such as Henry George identified as the primary cause of business depressions - the private appropriation of the rents associated with land. One member of Roosevelt's early brain trust, Raymond Moley, was an exception; however, his position on the introduction of New Deal programs was more sympathetic to those held by Hayek than Keynes or Eccles. He would soon break with Roosevelt.

Depression and War Strike a Severe Blow to Laissez-Faire

Clearly, something had to be done to prevent widespread starvation, despair and violence during the Great Depression. Keynes and Eccles provided measures that would provide hope for a better future without, they believed, jeopardizing the reliance on individual choices Hayek embraced as essential to a market-driven economy. Keynes saw intervention as a humanitarian necessity to prevent the worst from happening:

"Our criticism of the accepted classical theory of economics has consisted not so much in finding logical flaws in its analysis as in pointing out that its tacit assumptions are seldom or never satisfied, with the result that it cannot solve the economic problems of the actual world." [p.151]

With laissez-faire politically abandoned, the door was now open for Keynes to create a new economic science, what would later be described as macroeconomics. And, he went to work on the book, published in 1936 with the title, The General Theory of Employment, Interest and Money. The book was directed to the members of his discipline. As Nicholas Wapshott details, Keynes agonized over many of the concepts he presented, putting them into final form only after constructive input from R.G. Hawtrey, Roy Harrod and Joan Robinson.

Almost immediately upon publication, The General Theory was studied and discussed in the colleges and universities where English was the first language. On this side of the Atlantic Ocean, Harvard University became the center of the Keynesian school. As James Tobin put it: "Harvard was becoming the beachhead for the Keynesian invasion of the New World." [p.167] John Kenneth Galbraith recalled that "[t]he old economics was still taught by day. But in the evening, and almost every evening from 1936 on, almost everyone discussed Keynes." [p.167] Back in England, Arthur Pigou was not particularly impressed with the accomplishment, writing:

"[Keynes's] argument is in places so obscure that the reader cannot be certain what precisely it is that he is intending to convey." [p.173]

However, even Pigou, "on rereading The General Theory, retracted his objections and fell in behind the long line of distinguished economists who came to applaud the work." [p.183]

And, for reasons Hayek tried to explain later in life, he made no effort to challenge anything in The General Theory. "[Hayek] suggested that it was too difficult to adequately express objections to Keynes's top-down approach to economics when his counterarguments assumed that the key to understanding economics was bottom-up." [pp.174-175] So, he decided to spend his time on theoretical issues relating to capital theory.

By the time war again came, diverting the resources of the warring nations, Keynes was already giving thought to prevention of a post-war recession. "In 'War Potential and War Finance', …Keynes [proposed that] earnings would be subject to a levy that combined progressive taxation with compulsory savings, 'deferred pay' credited to interest-bearing accounts to be cashed once the war was won. Keynes believed the accumulated money spent after the war would counter … a slump once war expenditures came to an end." [p.191] "Hayek suggested instead that the deferred pay should be invested in shares." [p.192] In the United States, a full employment economy combined with the shift in production to munitions to achieve the desired effect: a vast pool of individual savings was accumulated to jump-start a return to a peacetime economy.

Hayek as Philosopher of Freedom

Economics might have been Hayeks's chosen profession, but the ideas he is most revered for come out of his deep concern for individual freedom and fear of the centralized power of the nation-state. His response, The Road to Serfdom, was published in Britain in March, 1944 and soon thereafter by the University of Chicago Press. "[Hayek] asserted that the common perception that the extremes of Left and Right were polar opposites was a misapprehension, for both, by replacing market forces with comprehensive state planning, assaulted individual liberties." [p.194]

At the same time, Hayek was not a defender of the status quo. He "condemns the 'wooden' advocates of free-market solutions, while rejecting conservatism, a devotion to existing institutions." [p.197] Hayek acknowledged the need for government to provide for the basic needs of its citizens, particularly where private arrangements proved to be insufficient:

"There can be no doubt that some minimum of food, shelter, and clothing, sufficient to preserve health and the capacity to work, can be assured to everybody. Where, as in the case of sickness and accident, neither the desire to avoid such calamities nor the efforts to overcome their consequences are as a rule weakened by the provision of assistance -- where, in short, we deal with genuinely insurable risks -- the case for the state's helping to organize a comprehensive system of social insurance is very strong." [p.200]

What should have occurred to Hayek is whether the very fact that what passed for free-market capitalism never generated full employment or came close to eliminating poverty was a clear indication of the need for systemic reforms. From Locke, Hayek might have found reason to consider the distinction between liberty and licence, and the extent to which privilege existed as a consequence of government-created licences granted to some at the expense of others.

Reactions to The Road to Serfdom varied, of course. Keynes wrote to Hayek:

"In my opinion it is a grand book. … You will not expect me to accept quite all the economic dicta in it. But morally and philosophically I find myself in agreement with virtually the whole of it; and not only in agreement with it, but in a deeply moved agreement." [p.198]

George Orwell expressed his deep concern over the book's fundamental message, writing that "Professor Hayek does not see, or will not admit, that a return to 'free' competition means for the great mass of people a tyranny probably worse, because more irresponsible, than that of the State." [p.202]

And, from Frank Knight, who one might assume would applaud Hayek's principles, came this:

"The work is essentially negative. It hardly considers the problems of alternatives, and inadequately recognizes the necessity, as well as political inevitability, of a wide range of governmental activity in relation to economic life in future. It deals only with simpler fallacies, unreasonable demands and romantic prejudices which underlie the popular clamor for governmental control in place of free enterprise." [p.201]

To Frank Knight and most Americans, the ongoing involvement of citizens in the affairs of their communities and governments, generally, provided a fundamental safeguard against state tyranny. Elected officials were public servants, chosen for a limited period to act in the best interests of their constituents. As T.V. Smith, a professor at the University of Chicago wrote:

"The greatest success of the Constitution … is that in a century and a half it has won the people from an ancient distrust of government to an acceptance of it as their friend. A democratic government is the people themselves incorporated." [p.204]

In effect, Hayek had written a manifesto embraced by a small number of individuals who occupied a corner of the intellectual and political wilderness. "It soon became clear that … The Road to Freedom was a defining work that not only divided the Left and the Right but also the Right from the Ultra-Right." [p.205] As Hayek lamented:

"I discredited myself with most of my fellow economists by writing The Road to Serfdom, which is disliked so much. So not only did my theoretical influence decline, most of the departments [at the London School of Economics] came to dislike me." [p.209]

Yet, the deep concerns felt by Hayek were shared by others, in knowing circles referred to as the Remnant, who held on to their principles of anti-statist individualism. This was far from a cohesive group, but they all now felt like outsiders in their societies. The majority of their fellow citizens accepted or embraced the expanded role of government in the management of economies and in the pursuit of social democracy. Clinton Rossiter, in his Conservatism in America: The Thankless Persuasion (1962), attaches to the American wing of the Remnant "their common antipathy, strong to the point of loathing, for the New Economy and the New Internationalism." With this in mind, it is somewhat remarkable how Hayek emerged as one of the philosophical leaders of this group.

Hayek decided to create a formal environment where the Remnant could gather to provide encouragement to one another. He "proposed a summit in the most literal sense, a ten-day conference in April 1947 … near Vevey in Switzerland." [p.211] Financing came from various individuals and conservative groups, including Leonard Read's New York-based Foundation for Economic Education. With some leaving and others joining, annual meetings were held every year thereafter until 1961, when dissention caused Hayek stay away.

Hayek's assessment of what The Road to Serfdom cost him was quite accurate. He eventually came to join the faculty of the University of Chicago in 1950, but not as a professor of economics. Rather, with encouragement from Robert M. Hutchins and "at the suggestion of [John] Nef [chairman of Chicago's Committee on Social Thought], Hayek became professor of social and moral science." [pp.217-218] This cemented Hayek's role as a philosopher and essentially eliminated his influence among economists. "Over the next nine years he worked on an off on a book that would explain why the rule of law is the best way to safeguard individual liberties from governments." [p.218] And, as a proponent of constant self-examination Hayek declared himself to be a liberal rather than a conservative:

"One of the fundamental traits of the conservative attitude is a fear of change, a timid distrust of the new, while the liberal position is based on courage and confidence, on a preparedness to let change run its course even if we cannot predict where it will lead. The conservative position rests on the belief that in any society there are recognizably superior persons whose inherited standards and values and position ought to be protected and who should have a greater influence on public affairs than others. The liberal, of course, does not deny that there are some superior people - he is not an egalitarian - but he denies that anyone has authority to decide who these superior people are." [p.220]

Liberals in Britain, after all, had championed the free trade policies that had contributed to the rise of Britain's industrial might. However, critics pointed to serious flaws in Hayeks' principles. Hayek attacked labor unions but not cartels. He attacked progressive taxation in favor of a flat tax, even though progressive taxation left the wealth still very wealthy and a flat tax was potentially regressive. Hayek contradicted himself by advocating for a limited welfare state, for universal health care and for state-provided basic housing. As I noted above, if these were goods the free market would provide to all, then there had to be systemic impediments preventing the free market from achieving its full potential. This, even Lionel Robbins came to see. "Robbins argued, like Keynes, that state intervention in aid of the public good is only as bad as the society in which it takes place." [p.223] What none of these leading lights could see, however, was the essential need to ride societies of land monopoly and rent-seeking if markets were ever to meet the needs of all people.

Demand Management: An Overconfidence in Fiscal and Monetary Manipulation

Nicholas Wapshott captures the post-Second World War atmosphere quite well. He reminds the reader that those who survived the Great Depression and fought to save their countries from fascism expected, in return, a fairer distribution of wealth and income than had been the norm in earlier times. Keynesians were determined to deliver on this promise. Hayek recorded that in Britain, "[Nicholas] Kaldor, through the Beveridge Report, has done more to spread Keynesian thinking than almost anybody else." [p.227]

Across the Atlantic in the United States, "the Keynesian high priest John Kenneth Galbraith was made State Department adviser on economic policy in the occupied countries." [p.228] "The management of the American economy was to be overseen by the newly created Council of Economic Advisers matched by the Joint Economic Committee of Congress." [p.229] Liberals and Progressives pressed for a commitment to a full employment society.

Now economics professors had a permanent seat at the table. A growing number of young people began to choose economics as a discipline, certain they would find rewarding employment in government, in business, with a research institute, or in a college or university classroom. More than ever before, the validity of their theoretical models of the economy became a determining factor in their value to society. However, urging caution against claiming too much for demand management interventions, Harvard professor, Gottfried Haberler warned:

"If the unemployed are concentrated in certain 'depressed' areas and industries, while there is full employment elsewhere, a general increase in expenditure would serve only to drive prices up in the full employment area, without having much effect on the depressed industries. Then the paradox of depression and unemployment in the midst of inflation would be experienced." [pp.229-230]

Haberler was proven right by the failure of state and federal programs to achieve renewal of distressed urban communities. Britain experienced similar economic imbalances between its regions. By the time the United States government began to channel funding to the depressed areas the problems were far too entrenched to be effectively mitigated. Dick Netzer, in Economics and Urban Problems (1970), reminded readers why so many sections of our major cities fell into ruin:

"[M]uch of the loss of substandard and even standard housing in the central cities has been the result of a relatively new phenomenon that first become visible in the 1960s - the large-scale abandonment of rental housing by its owners. An increase in the total supply of housing during the 1950s and 1960s, together with a large-scale decline in central-city populations and, during the late 1960s, in the flow of minority-group immigrants into the cities set the stage for abandonment. In such an environment, owners have found that rents for lower-quality housing located in the most unattractive parts of the ghettos were often insufficient to offset rising taxes, insurance, interest, and maintenance costs. So they cut back on the one cost item they could control, namely, spending for maintenance and repairs."[pp.43-44]

Not surprisingly, the one contributing factor Keynesians ignored in their proposals for urban revitalization was the structure of property taxation. They essentially ignored the economic effects of taxation practices by local communities as outside the concerns of macroeconomics. Dick Netzer was more personally affected by what he observed each day as he commuted to his office at New York University's School of Public Administration. And so, near the end of his analysis of the origins of urban problems, he made his case for moving to a land-only property tax base:

"The land-value tax is the economist's ideal: it is equitable; it is neutral in its economic effects; and it is positively desirable as a replacement for the conventional property tax with its many bad economic effects. …Landowners would generally be under pressure to better utilize their land or to sell out to others willing and able to better use the site."[pp.256-257]

Although events were to demonstrate the weaknesses in demand management theory, few economists in or out of the Keynesian camp could explain what was going wrong. The answers were right in front of them, but the theories they embraced prevented them from identifying fundamental causes and then coming to real solutions. Nicholas Wapshott provides this remarkable statement by Paul Samuelson:

"I don't care who writes a nation's laws if I can write its economics textbooks." [p.232]

To his credit, Paul Samuelson at least continued to devote a few pages of each edition of his introductory textbook on economics to land as a distinct factor of production, including a brief discussion on rent as an appropriate form of income to be captured to pay for public goods and services. Most other economics textbooks no longer included land in their index.

One could argue that what prevented a return to recession or depression following the end of the Second World War were two circumstances: (1) the accumulated savings of workers during the full employment war-time economy; and (2) the aggressive behavior of the Soviet Union under Joseph Stalin. The pool of savings helped to jump start the construction of suburban housing, which accelerated after President Eisenhower obtained approval to begin construction of the interstate highway system, which he argued was necessary for national defense. Few expressed concern that "spending on defense eclipsed all that was spent to fight the Second World War."

By 1954, the pool of accumulated savings was long gone and the United States economy slid into recession. Eisenhower appointed Arthur Burns to head his Council of Economic Advisers and approved a $7 billion tax cut that was forecasted to cause a budget deficit. Despite such interventions, the United States economy was found still to be prone to cycles of boom-to-bust. Yet another recessionary downturn in 1960 opened the door to John F. Kennedy, "who for the first time openly acknowledged he would employ Keynesian countermeasures not merely at the bottom of the cycle but as a general policy tool to boost the nation's productivity." [p.235] John Kenneth Galbraith, Kennedy's top adviser on economic policy, moved on to become Ambassador to India. Walter Heller came on to chair the Council of Economic Advisers. "Heller … Kermit Gordon and James Tobin [were] convinced they could deliver full employment - which they defined as a 4 percent unemployment rate - without inflation." [p.236]

Their continuing exposure to error is traced to the fact that they paid no attention whatsoever to rising land prices and the effect this had on the costs of living or the profitability of commerce. The Keynesians and most other economists were content to offset rising land prices by bringing down interest rates. What they failed to see, as one aspect of the economic equation, was that the window of greater affordability to potential buyers of real estate - whether residential or otherwise -- quickly closed, as the savings created by lower interest costs was capitalized into higher land prices. If the rate of homeownership was to increase, additional subsidies (e.g., reduced down payment requirements) had to be introduced. But, the added subsidies were then capitalized into higher land prices. Only by a matching increase in household incomes to keep ahead of the increase in land prices could recession be forestalled. Businesses had to somehow generate increased revenues if they were to pay the demanded higher rents for offices, warehouses or manufacturing facilities and also maintain acceptable profit margins.

In the face of yet another recessionary downturn, a downturn that could not be stalled even with the administration's acceleration of spending on the military and space exploration, the government took a page out of the supply-side arguments made by Keynes. At the end of 1962, Kennedy announced:

"It is a paradoxical truth that tax rates are too high today and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now." [p.238]

Had I occupied a seat on his Council of Economic Advisers, I would have directed the discussion to the economics of taxation and which taxes ought to be cut. Galbraith and some other Keynesians opposed the tax cuts arguing for more government spending in targeted areas. "By formulating policy according to the Phillips curve, Heller believed he had found a way to provide full employment without provoking higher prices." [p.239] Action on changes in fiscal policy finally occurred under Lynson Johnson, who pushed through the tax cuts in 1964, "reducing the top level from 91 percent to 65 percent." [p.239]

To the surprise of many economists, Federal tax revenue actually increased, the output of goods and services grew and unemployment fell. Demographics surely had something to do with this, as the first of the baby-boom generation were completing their high school education and either moving on to college, specialized training, the military or entering the work force. Without a clear understanding of the broader dynamics at work, the effect provided the analytical fuel for a later generation of supply-side policy proponents. Optimism about the economy also opened the door for changes in social policy embraced by Lyndon Johnson. He "embarked on a vast public spending spree. …He extended civil rights to African-Americans, embarked on a 'war on poverty' through federal entitlements, and instituted Medicare to give health care to everyone over age sixty-five and Medicaid for those who could not afford health insurance." [p.240] The impact on people, notes Nicholas Wapshott, was rather different than that anticipated by members of the Remnant:

"Far from introducing creeping authoritarianism, as Hayek had predicted, the new wealth that Keynesian planning produced offered new freedoms." [p.241]

However, as we now know, a society that attempts sustained military adventurism while expanding the social welfare capacity of the state will in the long run experience serious side-effects. The individual liberty exchanged for a greater sense of security exposes what in his 1980 book, Cracks in the Constitution, Ferdinand Lundberg traced to the long history of entrench privilege plaguing the people of the United States:

"All along, on the economic front, there has been creeping monopoly more or less winked at by the government and indeed constitutionally protected and politically sponsored."[p.30]

The disputes between Keynes and Hayek seem mild in comparison to the ideological divide that emerged between the far Right and virtually everyone else. Lundberg's assessment of the political situation in 1980 was quite prophetic:

"As matters now stand, nobody knows precisely what is going on in the Presidency or elsewhere in the government. The President can, and does, spring one surprise after the other on the country. Discussions, if any, have been had only with his cronies and personally selected advisers, all members of the palace guard. Without telling anyone of his intensions, no even Congress, the President may be maneuvering the country into a wasting war or ruinous financial straits."[p.294]

If Lyndon Johnson put his foot on the accelerator for reasons of conviction, Richard Nixon pushed down even harder to sustain himself in the Presidency. Initially, Nixon promised to cut back Federal spending and dutifully recruited a more conservative economic team. Paul McCracken left his teaching position at the University of Michigan to become chair of Nixon's Council of Economic Advisers. McCracken was by this time strongly influenced by Milton Friedman's work on monetary theory and policy. So were a growing number of other economists. Yet, even though economists had access to greater amounts of data than ever before, few predicted the recession that hit the United States at the end of 1969. Milton Friedman was no better than other economists. "[H]is performance as a forecaster was abysmal," wrote Alfred Alfred L. Malabre, Jr., economics editor of the Wall Street Journal, in his book, Lost Prophets: An Insider's History of the Modern Economists (1994, p.119).

Facing recession and rising unemployment, "Nixon switched tracks, saying he wanted 'a full employment budget, a budget designed to be in balance if the economy were operating at its peak potential." [p.242] Then came Nixon's famous pronouncement in January of 1971: "Now I am a Keynesian in economics." [p.242] Economists were surprised when consumers chose to save rather than spend. To economists this behavior was counterintuitive. If people expected future increases in prices of goods they needed, the time to make these purchases was today. But, people were insecure about the future and felt the need to put money aside in the event they faced prolonged unemployment down the road. Banks, also concerned about inflation, raised interest rates. The result, writes Malabre was that "the sharp rise in interest rates both discouraged consumer borrowing and encouraged consumer saving."[Malabre, p.130] And, in an observation that escaped the attention of most economists, Malabre writes:

"Even homeownership costs, up more than 20% in a decade, reflected rising land prices more than rising construction costs. The average land cost for a new home soared more than 70% between 1958 and 1968, and yet the average weekly earnings of workers who were building new homes increased roughly 50%."[Malabre, p.134]

Here, for anyone to see not blinded by an ideological adherence to orthodoxy was a key issue to be addressed by economists and policymakers: how to stabilize and even reduce the cost of land that so stressed an economy. Nixon reacted to the situation by ordering wage-and-price controls. He further "approved the devaluation of the dollar followed by the removal of the dollar from the gold standard; a financial stimulus of lower taxes and increased spending that plunged the federal budget into a $40 billion deficit. …Later, free trade was abandoned and a 10 percent import levy imposed." [p.243]

Little noticed was the next step in deregulation of the financial services sector -- the signing of legislation authorizing the first money market funds in competition with the nation's local savings institutions. Thus, there is considerable irony in Milton Friedman's charge that "Nixon was the most socialist of the presidents of the United States in the twentieth century." [p242] If this was so, Nixon's appointment of Alan Greenspan to head the Council of Economic Advisers was a decision he might have regretted had he continued in office. As it turned out, Greenspan's presence had little effect on the economy during Gerald Ford's remaining two years. The world's major economies now faced the most potent land cartel in history: OPEC, which controlled the world's largest supplies of crude oil at a moment in history when neither conservation was pursued nor substitutes were available. When OPEC increased its prices and cut back on supply, the global economy quickly contracted. Economists coined the term stagflation to describe their predicament. Moreover, "the Keynesians' belief that it was impossible for unemployment and inflation to rise simultaneously was shown to be false and undermined confidence in much of the rest of their theories." [p.245]

In the United States, the problems were now those of Jimmy Carter, who "reached the White House on the Keynesian pledge of returning America to full employment." [p.245] Failing to recognize the nation's land markets as the key drivers in the business cycle, "Carter's approach could not counter OPEC and stagflation, so he shifted to a program of austerity and "tax breaks for industry." [p.246] He appointed Paul Volcker chairman of the Federal Reserve, "with a mission to raise interest rates to choke off the demand that was thought to be the root of inflation." [p.246]

In a sense, this strategy had merit. Rising interest rates on 30-year fixed rate mortgage loans dramatically reduced affordability and, hence, demand for residential property. The asking prices of existing residential properties fell back and the inventory of newly-constructed homes grew even as new construction was stopped in its tracks. However, rather than sell land at the new price level, landowners simply withdrew and waited for the land price cycle to climb back upward. Had the nation's local communities been taxing the annual rental value of land and not property improvements, land would have been brought to the market at prices people and businesses could afford - even when faced with the higher costs of fossil fuels. Keynesian economists had no answers to offer. "It was time for the radical reassessment of economic theory that Hayek and his allies had long been plotting." [p.246]

This was also a time when a strong and consistent voice coming from an established think tank with its intellectual origins traced to the political economy of Henry George could have redirected economic policy. The one entity created to pursue this path, Edward Harwood's American Institute for Economic Research, remained obscure and with no real influence. Harwood had little patience with Keynesians, as exhibited in this passage from his 1955 tract, Reconstruction of Economics:

"The Keynesians generally have followed the outmoded procedure of judging the usefulness of a theory by its plausibility instead of by checking its implications against measured economic changes. In the realm of science, theory is controlled by the facts. When scientists find facts at variance with theory, that theory is discarded; but many Keynesian economists do not even bother to seek the measurements of changes implied by their theory."[p.30]

Harwood was far more appreciative of the contributions of Ludwig von Mises. However, reviewing Human Action, A Treatise on Economics, Harwood warned:

"As for von Mises' assertion that economists must rely on 'cognition and analysis of our own purposeful behavior', this is the thoroughly discredited mode of knowing by introspection. Moreover, how can even the method of introspection be used if the knowledge praxeology provides is 'a priori' is 'not subject to verification or falsification on the ground of experience and facts'? If we find neither experience nor facts when we 'analyze our own purposeful behavior', do we find anything at all?"[p.40]

Harwood's criticism of von Mises reminds us, we should always remember that even great minds are fallible in logic and even objectivity.

A great opportunity for the study of business cycles was also lost when funds bequeathed by John C. Lincoln went into the foundation that carries his name. Lincoln was a confirmed supporter of Henry George's analysis and system of political economy. Unfortunately, his deep commitment did not translate into advocacy or the bringing together of sympathetic, credentialed economists to develop a coherent model of the economy. After this death, the board of the Lincoln Foundation (dominated by his children) pulled resources from further development of political economy as a science in an effort to achieve a degree of acceptance within the mainstream community of academic researchers. By these decisions, valuable resources were diverted from what might have evolved as political econometrics that recognized the underlying strength of Henry George's analysis of property markets as the key driver of business cycles.

As Keynesian economists were being pushed out of the public limelight by the monetarists, the accepted explanations for past recessionary downturns and even depressions were challenged. Friedman, for example, declared:

"Keynes … believed that the Great Contraction … occurred despite aggressive expansionary policies by the monetary authorities. The facts are precisely the reverse. …The Great Contraction is tragic testimony to the power of monetary policy." [p.249]

Friedman detailed the failure of the Federal Reserve to act as lender of last resort when the loss of public confidence caused the run on the nation's banks. The subsequent contraction of credit denied businesses the ability to do business based on bank-provided lines of credit. Farmers suffered as well as commodity prices fell and they could not repay outstanding loans our of revenue from crop sales. The issue is whether a recession will always be magnified into a full-blown depression when the central bank and the government increases the cost of credit and otherwise reduces access.

On the eve of the Reagan Revolution, the then Governor of California sought Milton Friedman's advice. "Reagan knew of Friedman from his 1962 book Capitalism and Freedom, and he recruited him to help reduce the size of California's government." [p.254] In Britain, Margaret Thatcher sought out Hayek for assistance, meeting him at the Institute of Economic Affairs in London in 1976. Periodically thereafter, Thatcher met with both Hayek and Friedman to gain their input on economic policy. As Prime Minister, she was determined to move the nation in the direction sought by these two free-market economists. When things did not go quite as planned, Friedman was called in to meet with members of Thatcher's cabinet, and he "blamed the initial failure of monetarism in Britain on the 'gyrations' in money supply that had been allowed to occur." [p.260]

Reagan defeated Carter in 1980, and Reagan invited Friedman to join his new Economic Policy Advisory Board, with George Schultz at its head.

Determined to win the war against inflation, "Volcker had started imposing a tight money policy by sharply raising interest rates halfway through Carter's presidency, causing thousands of jobs to be shed from businesses that depended on borrowing. …With Reagan in the White House, Friedman and Shultz agreed with Volcker that the remedy for inflation was to deepen the recession." [p.261]

Enter Arthur Laffer, a member of the Economic Policy Advisory Board, and the Reagan tax cuts were introduced with the expectation that investment by businesses would increase. Laffer actually credited Keynes as the source for his ideas on lowering tax rates to a level that would increase both economic output and public revenue. However, as in Britain, things did not work out quite as forecasted. Inflation fell but unemployment soared to its highest level since the 1930s. Government revenue failed to increase, so Reagan rescinded tax cuts on the highest incomes to counter a rising budget deficit. Looking at the longer term effects of Reaganomics, Milton Friedman declared his satisfaction:

"Those actions of Reagan, lowering tax rates plus his emphasis on deregulating, unleashed the basic constructive forces of the free market." [p.264]

Well, not exactly. The tax cuts actually made available a huge reserve of financial investment dollars for purely speculation purposes. Investment managers seek opportunities to maximize returns with little or no regard for whether the investments stimulate wealth production or merely shift financial assets from the clients of others to their own clients. At the same time, Reagan committed the United States to a level of spending on defense that made it impossible to balance the federal budget without significant increases on the revenue side. "Public debt grew from a third of GDP in 1980 to more than half of GDP by the end of 1988, from $900 billion to $2.8 trillion.'

Some years ago I exchanged correspondence with Arthur Laffer, who lamented that the dramatic increase in federal spending prevented the supply-side benefits of tax cuts from operating as he was convinced they would. Laffer actually believed his ideas regarding taxation were based on the theoretical work of Henry George. Clearly, Laffer had never really studied Henry George's writings in any detail to reach such an opinion. Every reduction in the rate of taxation on income flows and on financial assets made their way through the economy and were capitalized into high prices for land. An actual reduction in the tax rate applied to gains on capital goods would have achieved nothing, inasmuch as capital goods rarely, if ever, resell for more than their depreciated value. The supply-siders never understood any of these nuances; or, if they did, they were not prepared to go public with these insights.

Once Paul Volcker was confident that inflation had been purged from the economy and credit began to flow again, interest rates fell, and land prices climbed even higher. As early as 1983, Fred Harrison predicted as much in The Power in the Land:

"People who receive large salaries or income from investments have a high propensity to save, rather than to spend all their post-tax income on current consumption needs. Because of this, then, we would have expected an increase in the flow of money into assets. Unfortunately, ...if the prospects of making speculative gains were still present - that is, if the income tax cuts were not simultaneously offset by an increase in the tax on land values - then it paid to buy land."[p.127]

Reaganomics and Thatcherism trusted individuals to behave as though Adam Smith's invisible hand was actually operating. Instead, wholesale deregulation created enormous opportunities for the unscrupulous to prosper in an atmosphere of greatly reduced scrutiny. Reagan then made what is possibly - in hindsight - one of his worst decisions, recruiting Alan Greenspan to replace Paul Volcker at head of the Federal Reserve. Greenspan (on the eve of the new Great Recession) reflected on himself as the choice:

"As close as I was to Arthur Burns, the Fed had always been a black box to me. Having watched him struggle, I did not feel equipped to do the job; setting interest rates for an entire economy seemed to involve so much more than I knew. The job seemed amorphous, the type of task in which it is very easy to be wrong even if you have virtually full knowledge."[Alan Greenspan. The Age of Turbulence (2007) , p.99]

Greenspan adds that he and others at the Fed became increasingly concerned after 2002 that a "real estate crash" was coming. "As the boom rolled on," he writes, "the evidence of speculation became hard to miss."[Greenspan, p.230] Yet, he apparently saw nothing in the explosion of subprime mortgage lending to justify intervention. As he wrote in 2007:

"Poor performance of … two-fifths of originations has induced a significant tightening of credit availability, with a noticeable impact on home sales. …But I believed then, as now, that the benefits of broadened home ownership are worth the risk. Protection of property rights, so critical to a market economy, requires a critical mass of owners to sustain political support."[Greenspan, p.233]

What should have alerted the nation's chief bank regulator was the dramatic increase in reported fraud associated with the subprime mortgage business. Higher fees paid by banks pooling these loans in private label mortgage-backed securities, with minimum or no examination of borrower creditworthiness, pulled market share away from the conventional and FHA markets, which was a clear indication to market participants that criminal activity had become easy and enormously profitable. It may be somewhat of an exaggeration to say, as Nicholas Wapshott does, that "the individual who bound together the whole of this period … was Alan Greenspan." [pp.270-271] However, Greenspan's role in the setting of Federal Reserve policy sent a signal to players in the market that no one was on guard to protect the public interest.

Alan Greenspan remained at the helm of the Federal Reserve until 2006. He was there when the wrong-headed deregulation and speculation-driven pseudo-expansion of the Reagan years brought on the property market crash of the late 1980s. George H.W. Bush came into the Presidency facing not only recession but a rising national debt. Bush went along with the Democratic congress and raised taxes. The U.S. economy continued to struggle throughout his Presidency, and William Clinton was elected after campaigning in 1992 on a platform of a balanced budget and paying down the national debt. In office he pushed for middle-class tax cuts, higher taxes on the wealthy and the North American Free Trade Agreement. "Greenspan hailed Clinton as 'the best Republican president we've had in a while." [p.275] Which was fortunate for Clinton, since the Republicans held the majority in both houses of the Congress.

Clinton then demonstrated he was more of an Eisenhower Republican than a Johnson Democract when it came to regulation of the financial markets. "In a move favored by Treasury Secretary Robert Rubin, and strongly endorsed by Greenspan, in 1999 [Clinton] approved the Gramm-Leach-Biley Act, abandoning the rules on banking, insurance, and financial companies that Franklin Roosevelt set during the Great Depression. For the first time in sixty years, investment banks were allowed to merge with depository banks." [p.275] Importantly as it turned out, derivatives remained unregulated. We are today dealing with the consequences; however, few analysts point to Clinton's role in bringing us forward on the road to economic crisis.

For reasons that still elude me, Americans voted in almost sufficient numbers to turn the Presidency over to George Bush, who compliantly to the wishes of his wealthy supporters decided to cut taxes rather than try pay off the national debt. Another downturn reduced projected federal revenue and the debt began to skyrocket. Events then spiraled out of control. After the World Trade Center attack, Bush and the Congress approved massive new federal spending on homeland security. Greenspan dropped interest rates down to 1 percent in an effort to spur business borrowing, and President Bush pushed for a 50 percent cut in the tax rate on stock dividends.

Federal spending continued to climb, and Treasury Secretary Paul O'Neill resigned in protest over the rising deficits. The warnings and concerns of conservative economists, such as Herbert Stein, were ignored: "The radical conservative revolution is the dream of conservatives out of office," wrote Stein, "but not the practice of conservatives in office." [p.278] For many officeholders, getting re-elected or carving out a future role as lobbyist for special interests overrode principle or the broad public good. Yet, despite record spending by candidates, in 2006 the Democrats took back both houses of the Congress.

The long process of deregulation that provided much of the impetus for a shift from a goods producing to a financial instrument transactions economy finally imploded. Another strand of Hayekian thinking, that the free market, left to its own devices, would correct its own mistakes and ensure prosperity for all, suffered a near mortal blow in the summer of 2007. Fearful at the dubious value of bundled debt containing high-risk 'subprime' mortgages on homes that had sharply lost their value, banks began seizing up, incapable or unwilling to lend even to other banks." [pp.278-279] Greenspan awoke from his long sleep, announcing:

"I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms." [p.279]

Bush turned to a Keynesian-like stimulus package and tax reductions to try to stop the bleeding. The U.S. Treasury bailed out the banks, buying $700 billion in troubled assets. In mid-December, Ben Bernacke had the Fed reduce interest rates to zero, and upon entering the Presidency, Barack Obama expanded on the Keynesian policies with a new stimulus bill. Economists soon realized the multiplier effect was not kicking in because businesses hoarded cash to prop up balance sheets and meet reserve requirements, and consumers were paying off existing debt and trying to put income away - even at almost no return of interest - in order to have something to fall back on. "Meanwhile, the Federal Reserve continued buying back government bonds to keep long-term interest rates low, causing the dollar's value to diminish. Adding to the nation's supply of money when companies were already awash with cash only confirmed the admonition by Marriner Eccles … about the impotence of monetary policy as a stimulus." [p.284]

Where this leaves us and where we are heading Nicholas Wapshott does not attempt to predict. The story he tells reveals how desperately needed is a far more complete understanding of the causes of economic cycles than Neo-Classical theorists, Keynesians, Austrians, Monetarists or Supply-Siders have provided. Land and land markets must be brought back into the equation as distinct from the markets for labor, for capital goods, and for credit. Absent this, history is doomed to keep repeating itself every twenty years.