There was one preeminent economist during the course of the 20th century and that was John Maynard Keynes, the "Cambridge Don," as some would call him. And every time there is a discussion in this country about budget deficits, inevitably the brilliant British thinker's name comes up.

Keynes lived from 1883-1946 and was a dominant figure in many of the cataclysmic events of the century, particularly in the case of the Versailles Peace Treaty following World War I, as well as economic thought during the Great Depression.

Regarding the former, around the time of Versailles, Keynes wrote the influential "The Economic Consequences of the Peace" and was Britain's leading financial representative at the Paris talks. But he resigned from his delegation in disgust, labeling the Versailles outcome a disaster. He was right.

Keynes's main issue was that the victors required Germany to pay reparations that it could not possibly hope to pay, which he thought could lead to despair and revolution that would destroy Germany and other countries. At the time many criticized him for being too friendly to Germany, but look what happened in the era which led to the rise of Hitler.

At the time of the Crash of 1929, Keynes was prominent in his pronouncements on Americans and the market. [He lost a mini-fortune himself during the market plunge.] And he argued at the time that the Crash had the benefit of liquidating unsound positions, with the money previously used for speculation now being turned toward more productive enterprises.

Author Edward Chancellor quotes Keynes on investing as follows. "(The game of investment is) intolerably boring and over-exacting to any one who is entirely exempt from the gambling instinct; whilst he who has it must pay to this propensity the appropriate toll." As Chancellor notes, how appropriate a statement for today, just as it was centuries ago.

Keynes defined speculation as the attempt to forecast changes in the psychology of the market and, with the release of his landmark "The General Theory of Employment, Interest and Money," he attacked the earlier prominence given to speculators and the stock market in the allocation of capital resources. Keynes asserted that "There is no clear evidence from (recent) experience that the investment policy which is socially advantageous coincides with that which is most profitable."

"Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes a bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill done."

Well…hope this rings a bell…sounds awful familiar to me.

Keynes also promoted the theory that if one could not predict the future with any degree of certainty, when it came to the stock market what really mattered was the state of confidence, or what is better known today as investor sentiment, which is the result of the "mass psychology of a large number of ignorant individuals."

Keynes's comments about Americans and investing still hold true today.

"Even outside the field of finance, Americans are apt to be unduly interested in discovering what average opinion believes average opinion to be; and this national weakness finds its nemesis in the stock market."

And when you look at your confirmation slip and notice a little transaction fee or two, thank John Maynard Keynes who suggested that a transaction tax be levied on U.S. share purchases on the grounds that "casinos should, in the public interest, be inaccessible and expensive."

But it was during the Depression that Keynes really rose in prominence as he became forever known for recommending an increase in government spending, even if it meant creating large deficits, as the only way to stimulate consumer demand by reducing unemployment. To Keynes, deflationary measures, such as cutting government spending, or encouraging companies to limit production and thus keep prices artificially high were counterproductive. This would only prolong the Depression by reducing the demand for goods. The only way to break the cycle was to spend, spend, spend.

In "The General Theory…," Keynes established the foundation of modern macroeconomics. And it became one of the treatises by which future arguments between "monetarists" and "Keynesians" would be waged. So I turn to noted economist Henry Kaufman to explain the chief difference between the two.

The monetarists' central tenet "is that inflation is caused by an overabundance of money, and that control of the money supply rests with the Federal Reserve."

While Keynesians "argue that inflation often is caused by nonmonetary developments such as wage increases and high import prices. They advocate a flexible approach to fiscal measures such as taxation and government spending to achieve sustainable economic growth. They believe, in other words, that demand for goods and services can be managed through flexible fiscal policies."

Armed with his philosophy, Keynes implored President Roosevelt to spend his way out of the Depression. But this was at a time in America when running a deficit just wasn't acceptable to most Americans. Folks were struggling to meet their own meager budgets, how could the government spend like a drunken sailor?

But Keynes continued to argue that easy money wasn't enough. [And it's important to remember that short interest rates in America during the Depression were in the neighborhood of 1.5% for years…as measured by the Federal discount rate.] While during a mild recession lower interest rates might be enough to jumpstart the economy, during a deep slump easier credit was not enough; business confidence was often too low to take advantage of cheaper money. [Again, think of today's environment, with the Fed's aggressive action having little benefit thus far.]

As Keynes put it, relying on easier money in a slump was "like trying to get fat by buying a bigger belt." And government had an obligation to directly intervene to replace the lost purchasing power of the unemployed by cutting taxes, and, more importantly, through substantial spending on public works and welfare.

[Keynes is more known for his stance on spending, as opposed to tax cutting, but he was just as aggressive in his theories on the latter, only that during his era few Americans were required to pay taxes, so 'spending' became the key part of the equation.]

Despite Keynes's pleas, however, FDR really didn't spend like legend would have it. Sure, there were programs like the PWA and WPA, but they weren't enough. Yes, it was the war that pulled the nation out of the depths and it was only during WW II that employment reached pre-1929 levels. The heavy governmental spending during the war years seemed to confirm the arguments of Keynesians. And the flip side was that by the end of 1945, the national debt was 6 times larger than at the time of Pearl Harbor.

Of course, over the decades Keynes has been associated with liberalism and heavy government spending. But the political argument gets distorted. For example, during the Reagan years the president advocated reducing the size of government and cutting taxes, but the reality was that government spending soared due to the large increase in the defense budget. It really was a pseudo-Keynesian policy, and while deficits soared, the economy boomed. [I'm not taking this issue any further. No arguments today.]

Following are some of the better known quotes from Keynes.

[Keynes hated Woodrow Wilson] "Like Odysseus, the President looked wiser when he was seated."

"In the long run we are all dead."

"Capitalism, wisely managed, can probably be made more efficient for attaining economic ends than any alternative system yet in sight, but…in itself it is in many ways extremely objectionable."

"The important thing for Government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all."

[Of Lloyd George, another target] "This extraordinary figure of our time, this siren, this goat-footed bard, this half-human visitor to our age from the hag-ridden magic and enchanted woods of Celtic antiquity."

"It is better that a man should tyrannize over his bank balance than over his fellow-citizens."

[Explaining why he performed badly in the Civil Service examinations] "I evidently knew more about economics than my examiners."

We will have far more on Keynes in future pieces, particularly his leading role in the formation of the International Monetary Fund and the World Bank.

Sources:

"Wall Street: A History," Charles Geisst
"America: A Narrative History," Tindall and Shi
"Devil Take the Hindmost," Edward Chancellor
"The Bear Book," John Rothchild
"On Money and Markets," Henry Kaufman
"A History of Modern Europe," John Merriman
"One World Divisible," David Reynolds
"The American Century," Harold Evans

Brian Trumbore