Sunday, July 21, 2013

The New Theory Of Economics

World War 1 made an indelible impact on this nation. From an isolationist country we emerged with much more of a global mentality. Certainly that was true where economics was concerned. The devastation of Europe presented unparalleled opportunity for Americans to expand their businesses. With the industrial revolution in full swing, American businesses export automobiles telephones, food, and technology worldwide

Unfortunately, what American business schools imported was an idea that had just begun to take root in Europe: socialism. Professor John Maynard Keynes, a British economist, and an avowed socialist, had succeeded in establishing his doctrine of government intervention in private business throughout European academics.

Simple put, Dr. Keynes believed that it was the roll of governments to manipulate the economies of their countries so as to lessen the effects of economic cycles. He taught that during good economics times a government should confiscate funds from the economy and used them to promote social mandated programs such as health care, shelter, jobs, and such: the Robin Hood syndrome, if you will.

Then during economic downturns the government would supply capital as needed to stimulate growth and economic recovery. (The difficulty arises when the social programs expand during bad times and the government is enticed to borrow to continue their operations.)

In poorer nations, where the economies were already controlled by the governments, this concept was adopted wholeheartedly, but they lacked the resources to give the theory a platform from which to experiment. So what better place to experiment than in America, where free market economics, based on biblical heritage, had built the strongest economy in the world with tremendous surpluses available to pilfer.

Keynesian economics swept the world. From it was born the International Monetary Fund and the World Bank. In America came the Federal Reserve System, the Job Corps program, the Farm Bank, the Federal Depositors Insurance Corporation, and on and on it went. The real impetus to adopt Keynesian economics came during the Great Depression of the 1930s. In reality the Great Depression was exacerbated by President Hoover's ill advised decision to raised taxes on consumer goods to feed the government's growing need for funds, and the incredible nearsighted move to establish import quotes on foreign goods, which triggered a worldwide protectionist movement.

Herbert Hoover was booted out of office and Franklin Roosevelt was voted in with a mandate to implement Keynesian economics at every level of government. Adding momentum to these social changes was America's entry into World War II, during this period the checks and balances of the constitution were suspended in favor of almost dictatorial powers for the President. Coming out of the war the expanded role of the central government grew until it touched the lives of virtually every American.

What we see and accept as normal today would have sparked a revolution in any generation prior to the century. When the federal income tax system was first suggested in 1912 it was promoted as a "voluntary" system because the supporters were fearful that the electorate would revolt if the government tried to force compliance. When congress voted to accept the voluntary tax system, it was argued that a 1.5 percent cap should be placed on what the federal government could raise in income taxes. The resolution was soundly defeated on the basis that Americans would never allow their government to take such large sums from their wages. It was argued that if the congress approved such a limit some future politician might be tempted to seek that outrageous amount.

From those humble beginnings we have evolved into a full blown Keynesian-run economy. Nothing happens that does not in some way involve the federal government in everyday business affairs. The average American now believes it is the duty of our government to control our economy.

The difficulty with government manipulation of the economy is that each action creates a greater reaction and requires more manipulation. Lowering interest rates and producing credit out of thin air definitely stimulates the economy. But the laws of supply and demand swing into play, and with more people competing for the available product, prices go up and we have inflation.

The point I am trying to make here is that the economy has a direct effect on everyone's investment philosophy, whether we want it to or not. So understanding something about economy is essential to long term saving. The shorter the time period, the more difficult it is to project the direction of an economy. What knowledgeable investor must do is look at trends. Trends often develop over the years, not months, and certainly not weeks.

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