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The Keynes Solution: The Path to Global Economic Prosperity

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This book is terrific. Like many investors, I am very wary of economic commentary because many commentators seem to be living in a parallel universe that has assumed away many of the practical realities that we see every day. Dr. Davidson's book not only discusses current economic issues in a pragmatic way, he also addresses the flaws and strained assumptions upon which policy makers have conducted economic policy. It takes someone who understands the flawed models of mainstream economics to illuminate these flaws for those of us who are merely observers.

Much more so than the Keynes solution itself, this book's greatest value comes from its insights into trade deficits, unemployment, the monetary system, and the realities of correcting trade imbalances. Many of the benefits of imports come at the cost of higher unemployment, and it is important to understand the real choices involved in addressing this situation.

Macroeconomic analysis can be frustratingly useless to investors. According to the famous investor Peter Lynch: "I've always said if you spend 13 minutes a year on economics, you've wasted 10 minutes." However, I sat down and read this book in one sitting, and I'd love to send it to Mr. Lynch, as it might just be the exception that proves his rule.

As a companion piece, I'd suggest Warren Buffett's 2003 article in Fortune magazine that originates Buffett's proposal of Import Certificates as a way to correct trade imbalances. Taken together, there is plenty of food for thought.

Paul Davidson has done a remarkable job of explaining John Maynard Keynes' key insights, most of which he first introduced to the world in his seminal 1936 "General Theory of Employment, Interest and Money." Unfortunately, for Keynes, that book is fairly impenetrable, so the general public is essentially unaware that the economics movement that bore his name (i.e., "Keynesian") is, in fact, a synthesis of the classical economics that Keynes rejected and Keynes' less controversial ideas. In other words, Keynes' own name was hijacked by what were, essentially, classical economists.

This book is an easy read and easy to understand because it uses the recent economic crisis to compare and contrast neoclassical economics (best exemplified by Milton Friedman and the Chicago School) to true Keynesian economics. If you really want to understand Keynes' insights in detail, pick up a used copy of Anatol Murad's "What Keynes Means," which is a fantastic primer.

If you are interested in reading other accessible economics books by heterodox economists, check out Steve Keen's "Debunking Economics." Like Davidson, Keen is a Post Keynesian economist.

This is an excellent book and should be required reading for anyone who has even the faintest interest in economics and finance. It will give those who have not had the intellectual gumption to digest The General Theory of Employment, Interest, and Money (which includes this reviewer and according to the author, Paul Samuelson)a reasonably clear picture of what Keynes was really trying to tell us. It also exposes some of the intellectual dishonesty that had pervaded economic theory in its quest to be considered a science. I will conclude this rant with the observation that this book is a fine counterpoise to all of the economic mumbo-jumbo we hear from most of our legislators as well as the majority of our CEOs

The Keynes Solution by Paul Davidson and Keynes: The Return of the Master by Robert Skidelsky

These two new books re-introduce John Maynard Keynes to current policy makers dealing with the failure of de-regulated financial markets. They also introduce Keynes to a new generation and provide excellent background information on how Keynes' legacy is being re-applied in today's fiscal and monetary policies, stimulus plans and debates at the G-20 on how to reform global finance (see my own proposals at [...]).

Both Skidelsky and Davidson offer similar and excellent policy advice based on Keynes' concepts and proposals. Both authors call for a re-instating of an updated Glass-Steagall law to again separate "plain vanilla" retail banking still insured by FDIC to protect depositors and disallowing investment banks from participating in any government insured access to financial bailouts or subsidized credit from Treasury or the Federal Reserve. We at Ethical Markets have advocated this since 2008, along with the levying of a 1% financial transactions tax by G-20 agreement; a Financial Crisis Insurance Fund assed on all excessive risk-taking financial firms; a "too-big-to-bail" statute to allow for orderly break-up of oversized banks that pose systemic risk; banning credit default swaps not cleared on regulated exchanges, and other provisions to downsize overgrown financial sectors that have become predatory on the real economies of "Main Street."

Neither Skidelsky or Davidson go this far, although both cite the need to tame finance and its unregulated global casino unleashed on the world in the 1980s by US President Ronald Reagan and British Prime Minister Margaret Thatcher. Neither author addresses the issues still outside most economic boxes: the devastation of the planet's ecosystems by 300 years of fossil-fueled extractive industrialization. The need is to internalize such devastation and social costs into prices, company balance sheets and national accounts. Nevertheless, both these books do shed light on the deficiencies of political reforms currently debated in Washington, London and other capitals of OECD and G-20 countries. Both authors offer ideas for restructuring and reforming global financial architecture but stop short of fundamental re-thinking of models of human development beyond economics and GDP-measured growth. Skidelsky is the deeper thinker and draws conclusions from Keynes' longer-term vision on how to break the hold of money-obsessed economic ideas of "progress." Skidelsky goes beyond Davidson's prescriptive policies and examines ethical and moral issues ignored by economics and calls for more inter-disciplinary approaches to social progress. Neither author touches on the pressing need to reform money-creation itself and the fractional reserve banking which turned money-creation over to private banks as backed only by debt on their loan books. The widespread movement to audit, reform and even fold the private US Federal Reserve System into the US Treasury are not mentioned by either author as proposed by the American Monetary Institute. Clearly, we must now move beyond Keynes, important as his reforms are, and re-integrate public policy using inter-disciplinary systems approaches that enfold, but go beyond economics - revealed again by both authors as a profession with few if any pretensions as science.

I found this book to be concise and convincing. It would be hard to find a fault with it. It is too easy to associate Keynes with only tax and spend policies, but this book effectively highlights the other areas of economics Keynes stressed, many of which have proved very relevant to recent events.

The first of these areas Keynes emphasised was the "neutral money axiom"/ liquidity preference. The argument is that free market economists fail to understand how people can choose to hold liquid money as a reaction to uncertainty, instead of investing which would be the rational free market assumption.

Secondly I found the discussion of the whole area of "market makers" very interesting and new to me. In my own personal free market type ignorance, I have never before appreciated exactly how financial markets benefit from liquidity and how this liquidity is not inherent, but has to be generated by organisations pro-actively willing to buy when the herd is selling, and sell when the herd is buying. The desirability of market makers and the liquidity they bring highlight another angle from which to observe the weakness and folly of many of the new hybrid financial products which played their toxic role in the recent troubles. Many of these new securitised investment products were sold as being very stable and very liquid. When the troubles came to these markets, many investors quickly learnt otherwise.

Thirdly the "ergodic axiom" (calculating future probabilities based on past data). More broadly this is the fallacy of confusing probabilistic risk which can be pooled, managed and tamed, with uncertainty which should be treated with more caution. From this book it is easy to assume Keynes would have also seen the inherent dangers of complex finacial products and practises, and the idiocy of institutions believing they had quantified the risks they were exposed to, when it was really unquantifiable uncertainty, which we are now all paying for. Keynes would also have recognised the delusional self congratulation of organisations employing ex-rocket scientists to design and manage their exposure to financial risk, when they really did not have a clue as to what was around the corner.

Also I thought I had little more to hear regarding critiques of free trade policies, but Davidson managed to include a few more gems. For example he explains in accessible language that the full benefits of comparative advantage assumes full employment in both countries in order for their to be reciprocating exports and imports, and also the theory assumes that the extra goods generated automatically are demanded and do not cause excess capacity.

But on a cautious note, much is made in this book and by other left orientated economists about the WWII spending of the US finally ending the last great depression. But consider America's position after WWII, finding itself one of the few undamaged industrialised countries remaining. Most of its old competition in Europe had reduced its capacity for manufacturing consumer goods, and Japan was in poor shape also. Of course America was going to enjoy a prosperous decade, its industrial capacity was experiencing high demand and scarce supply. Presently with an industrialising China and India, can America really have the same confidence that it can pay off a large Keynesian government debt over the next few decades? I would rather be 1950's America with any amount of debt, than today's America suffering from out-sourcing and off-shoring.

Also the proposition Davidson makes regarding not importing from countries with lower child labour / environmental / health and safety standards sounds simple enough, but it would open the way for endless complexity and subjective gaming by domestic interests. I advocate protectionism more strongly than anyone, but would be wary of a subjective basis for it such as described in this book.

A big strength of this book is that it identifies the correct target head on regarding America's problems: being the trade deficit with China and co, and the loss of jobs resulting. Davidson proposes a clearing house kind of international exchange system which would put the onus on creditor (export surplus) countries to reciprocate their stored up demand (export earnings), instead of saving it as presently is happening too much. A central part of Keynesian analysis was the way savings reduce aggregate demand, and on an international scale, this is now the issue. This question of China not importing as much as it exports is THE biggest question in world economics presently, and Davidson must be commended for proposing a plan which squarely tackles this issue. I am not able to fully comprehend or judge how good a plan it is, but I greatly respect the fact that he has one. Excellent read.

this book is especially important if we are to avoid another economic setback-- a so called "w" recovery.The Keynes Solution: The Path to Global Economic Prosperity.

Hopefully the leaders of the G-20 will read this and put off indefinitely their fear of government deficits that are needed to restore a prosperous economy Deficit hawks must be shown the error of their thoughts. Then we may start to restore prosperity for our children and grandchildren

America's seminal economist, Dr. Paul Davidson, has written the clearest vision of money and math mechanics, to date. Not since the 18th century's true mathematical logicians, De Morgan, Jevons, Clifford, Peirce and Veblen, have scientific ideas of logic, money and math mechanics been laid so clearly before our eyes. Mr. Davidson begins with a simple explanation of a true scientific method, any high school student can easily understand, then exposes the fallacies in relation to and of the classical economists' and mathematicians' mistakes, of economic model mis-applications and mis-interpretations of. He reveals his entire thesis in a simple dialectic method any gifted 5th grade student could understand, by keeping the technicalities to his other 22 published books, and some 200 articles. Never before, in the history of economics, has so much been revealed by such a simple, yet scientific, method.

As an example, Mr. Davidson, shows how the `universal' facts, habits and ambitions of money, control the `particular' events of all economic history. He does this by revealing Keynes' true vision of how all nations' balance of payments' imbalances and hoarding, actually starves the world of its productive employment potential. This is truly where all macro-economic theses should start, yet sadly almost all other classical macro-economists see not the forest for the trees. It's taken America's yet unrecognized genius, Paul Davidson, to point this very fact out. He further exposes this first and foremost generating problem, creating the other unrecognized problems' mechanics with and in `the ergodic theory', `the neutrality of money theory', `comparative advantage theory', `free-trade theory', `efficient market theory', `the incompatibility theory of mobile money and full employment', and all really generated from the fundamental `balance of payments' imbalances and hoarding theory and facts', just as Keynes originally stated and implied them, in his total works, published and unpublished, private and governmental letters, etc.

After clearly and succinctly showing the relationships between true Keynesian theories and facts, against classical mis-interpretations of the same theories and facts, Davidson easily explains his extended Keynesian solution, to the world's present problems. This is done through his recognition of the world's need for not only a new `re-regulation of financial markets and trade', but also his, as it was Keynes', call for a new `international financial architecture', to rebalance the world's prices, money and currency contracts. Davidson has updated Keynes' ideas to a 21st century feasible plan of fundamental economic and highly possible political actions, the world sorely needs.

Never before has an economic book impressed me as much as this little treatise, as I see it having the potential of reaching not only the academic economists, but most all political, academic and intellectual elites, along with many private citizens. This is what the nation and world really and truly needs__a clear and concise manual to explain and solve the world's massive problems. Davidson has succeeded as no other in accomplishing this job...

L.A.Gillespie
...autodidactic, polymathic economist, logician, etc...

"The Keynes Solution" by Paul Davidson is a great book - just out this week and very timely. The author clearly explains the factors that brought on the current economic crisis, and, using examples from previous successful economic recoveries, demonstrates how Keynes' economic philosophy can provide "The Path to Global Economic Prosperity".

The book covers all the financial terms that you hear on TV or read in the news in a way that is easy for even a layperson to understand. Highly recommended.

In an attempt to present my students with diverse perspectives on the current housing and financial crisis I decided to find two simple books on the subject coming from different perspectives. For the right I am quite happy with Meltdown by Thomas Woods. I picked this book up to see if it could serve as the view from the left. However, the economics of it are so ridiculous that I can not, in good conscious, allow my students to read it. Just to cite a few of the absurdities:

- He completely discounts the relationship between the money supply and inflation. "There is, of course, this old wives' tale - propagated even by Nobel Prize economists such as Milton Friedman - that when the money supply increases as government "prints" money to spend, rapid inflation is inevitable." Of course the impact of inflation comes with a lag - especially when the economy is in recession (which is his argument). But he ignores the reality that, all else equal, a greater money supply WILL lead to inflation. He is perfectly content to remain in his short-run world and ignore long-run consequences.

- As he wants to blame everything on the free market he completely ignores government interventions that clearly contributed to the crisis (Fed policy, government implicit guarantees to holders of Fannie Mae and Freddie Mac debt, government policies explicitly designed to lower lending standards to increase home ownership rates, the government history of bailouts to large institutions).

- He argues that China, by running a trade balance with the US and buying US government debt, is destroying US jobs. Here is the logic: "... the $10 billion the Chinese saved is $10 billion that cannot be earned by businesses located in the United States and by American workers." Is it really so hard to realize make the connection that when China buys US government debt they are funding the government expenditures that he claims are so stimulative to the US economy?

- He argues (as did Keynes) that international "rules of the game" should be structured such that the onus of correcting trade imbalances should be on the surplus countries. So, in the case of the US, our trade deficits are to be corrected by forcing China and others to consume more of our output. This is silly. If I borrow $10,000 from you... by this logic the way out of this imbalance is not to have me restrict future consumption in order to pay you back - rather it is to force YOU to buy more of my output so that I can pay you back. It is the savers fault!

- He argues that countries with low wages are "unfair" and that trade inevitably lowers wages in the developed world. "Do we really want to reduce the wages of American workers to less than a dollar per hour and simultaneously permit American children to work in factories, as Chinese children do, so that the family can earn enough to avoid starvation?" Really? Is this what he thinks will happen with free trade? What is his solution? "... (P)rohibit imports from any factory that did not, at least, meet all the conditions that our labor laws impose on American enterprises." So, let's get this straight, we say to Bangladesh, a very poor country, "Sorry... you are being unfair by paying your workers 40 cents per hour. If you just pay them $10 per hour then we will trade with you." Does he not understand that low wages come from poverty... not trade? Do we really want to penalize them for being poor?

I guess I will stop here. Please do not buy this book unless you want to see how ridiculous some of the Keynesian logic is. For a more balanced left-wing perspective on the recent crisis I recommend Freefall by Joseph Stiglitz.

This book has major errors in it regarding Keynes's application of his weight of the evidence variable w, where w was defined on the unit interval [0,1], from the A Treatise on Probability (1921) which he called uncertainty in the General Theory (1936).It is simple to see that uncertainty is a negative function of the weight of the evidence,w.Define U to equal uncertainty.Define w to equal the weight of the evidence.Let U=f(w).If w increases then U decreases and if w decreases then U increases.It is as simple as that.Keynes defined a w=0 to be a situation of ignorance or complete or total uncertainty in the TP,as opposed to a w=1 which would be a necessary and sufficient condition to use a unique probability distribution.Neoclassical economists assume both a w=1 and linear probability preferences .Davidson,like Shackle and the Post Keynesians,Institutionalists,and Cambridge Keynesian school, assumes a w=0.It is not possible to calculate any kind of probability relation,be it cardinal,ordinal,or interval,if w=0.This situation arises in a dynamic economic context over time when one is considering scientific invention that leads to the promise of predictable, positive technological change,innovation, and advance in future kinds of capital goods, as well as creating a severe, potential threat to businessmen, due to the decay and obsolescence of their current stock of capital goods which would occur if these future breakthroughs did occur.The problem is that the timing and the particular forms or types of successful technological breakthroughs can't be predicted.This is obviously a non stationary process.Now non stationarity is a necessary condition for non ergodicity.But non stationary processes can certainly be ergodic.Davidson is simply confused here.Keynes recognized that the world was made up of both ergodic and non ergodic processes.Unfortunately,Davidson applies his non ergodicity assumption to the wrong market.Davidson applies it to financial markets.There is a long 400-500 year history that demonstrates repeatedly, time and time again, that past and current speculation always leads to some kind of future economic problem.

Keynes recognized that financial markets ,for the last 400-500 years since the introduction of modern,fractional reserve banking,exhibited the same speculative pattern over and over and over and over again.This pattern was recognized 3,000 years ago by the ancient Hebrew,Israelite Old Testa- ment prophets,with respect to markets for land and property,as well as by Jesus Christ in the New Testament,Aristotle and Plato in Greece,Augustine and Aquinas,and by Adam Smith.The purpose of the 7th year and 50th year Jubilee year celebrations,which were never instituted by Israel's leaders,was to break the back of the speculative cycles in land and property that led to poverty and destitution among Israel's people.

THe pattern is already at work right now.Obama,Bernanke,and Geithner have bailed out the Wall Street speculator crowd again, just as they were bailed out in the early to late 1980's by Paul Volcker and late 1990's-early 2000's by Alan Greenspan .The result is that another bubble in the stock markets is being created.These financiual bubbles are ergodic because the same pattern repeats again and again.New types of financial assets and financing are created by the banking industry.In the 1920's,for example,these new financial assets were balloon payments for houses and margin account financing for stocks.The creation of these new types of assets is called securitization.The next step is debt leveraging.This allows speculators and speculating bankers to maximize their speculative debt financing.The growing bubble is fed by herding and copycat behavior that automatically leads to the creation of a larger and larger bubble.The next stage occurs as the bubble leads to a mania ,which leads to a panic,which inevitably leads to a crash,which always leads to an economic downturn,recession,or depression of some sort.These kinds of events are stationary because they keep repeating over and over again.Their ultimate collapse can be predicted with a probabiity approaching 1.However,they are not Normally distributed.One can't use the Normal distribution to describe the time series data in financial markets .The underlying processes are given by the Cauchy distribution.Davidson vaguely realizes that they are not normally distributed,but fails egregiously to recognize that they are Cauchy.Davidson has failed to take into account the vast,overwhelming empirical evidence that has accumulated over the last 50 years establishing the correctness of Mandelbrot's pathbreaking work on financial markets.
Mandelbrot ,like Keynes before him,recognized that the speculation problem kept reoccurring over and over again.Only the timing of when the bubble will deflate is not known.

Smith and Keynes,like the Old and New Testament prophets,knew how to stop these highly repetitive events from taking place.Both Smith and Keynes realized that a policy of low interest rates for productive entrepreneurs combined with a policy of credit restiction would put a stop to the financial market's constant generation of bubbles.

One can summarize this book as a worthwhile read for the non specialist who does not need to be able to follow the advances made by Keynes in the TP on the weight of the evidence index and in the GT on uncertainty,where uncertainty can be mild ,moderate,severe ,acute or total, or by Mandelbrot's work,since the early 1960's concerning speculation in financial markets as a private, stationary market process that can be controlled .Davidson's view of the speculative nature of financial markets as being nonstationary and non predictable, based on the past behavior of financial markets for the last 500 years ,is simply wrong and had nothing to do with Keynes's views.

Davidson is correct in his criticisms of the neoclassical school's use of a particular distribution,the normal distribution,in financial markets.Unfortunately,he is unable to specify correctly why this is erroneous.It has little to do with non ergodicity and everything to do with the fact that w,the weight of the evidence that represents the amount and quality of the evidence that underlies probability calculations is usually < 1.Only if w=1 can one specific probability distribution be singled out as the correct one to apply in the future to data from the past that is being analyzed today.