The One-Arm Contrarian

by Mark Skousen

I call John Maynard Keynes the one-armed contrarian. Keynes was a British Don, a Cambridge economist, and today we live in the “Age of Keynes.” It was his idea that we need to increase government spending to keep the economy growing. He is the father of the welfare state, and he argues for big government. Not totalitarian government, he despised the Marxist and the Communists, but he was suspicious of laissez-faire and the invisible hand. He believed more in the visible hand of government.

Keynes was a speculator par excellence. He would speculate on currencies, commodities and stocks. He met the Swiss banker, Felix Somary and was begging Somary to give him some great stock picks. When Somery said he couldn’t recommend any stocks right now because he was expecting a crash, Keynes responded infamously, “We will not see another crash in our lifetimes.”

Keynes was fully invested in 1929, and failed to see the crash, just like Irving Fischer. So here we have the two great establishment economists, along with the Harvard Economic Service – the mainstream economics profession, the Monetarists and the Keynesians of the day – all telling the world the stock market is fine. The 1929 Farmer’s Almanac has the forecast that was written in 1928 expecting to see a continuing bull market in 1929. No one, except the Austrians and the hard money crowd expected a problem, and Keynes believed in the same thing as Fischer. He believed in the new era of the 1920s; he believed in the Federal Reserve, and the ability of government to protect us. And although he was wiped out in the 1929 crash, Keynes is still known as a speculator par excellence.

The fact of the matter is that he knew his limitations. He never had the ability to get out at the top. However, we call him a one-arm contrarian. He did have the unique ability to buy at the bottom. Some people can’t just get out at the top. They just don’t know where the top is, but they’re really good at buying at the bottom and knowing that this is a bargain. And that was Keynes, so in 1932 he started buying stocks and utilities yielding 15%. He started buying gold stocks, even though he hated gold.But Keynes was smart enough to ignore his personal economic philosophy and bought what he knew were bargains in the 1930s.He bought gold stocks and managed money for insurance companies and became spectacularly wealthy as a result. He died worth almost over 600,000 pounds sterling, even though he was completely wiped out in 1929 and then again in 1937. He lost three-quarters of his net worth during the recession in 1937 because he was always buying on margins at the bottom and adding to his positions. So Keynes was a very clever one-arm contrarian.

There was an issue of the American Economic Review, the premier publication by economists, and that had come out with a special study in the late 1980s. They reasoned that today we have all of these modern econometric methods to predict the future, so why not go back with the data from the 1920s to see if our modern methods could predict the 1929 crash and the Great Depression. When they ran the regression and did their analysis and do you know what their result was? They figured that the Great Depression and the 1929 crash were “unforecastable.”They had a model that couldn’t predict the crash.

But this is the amazing thing; this is really scary; because it tells you that today the top economists who work for President Bush don’t have a clue of any possible next Great Depression or crash. They can’t predict it and they’re proud of that fact. Instead of saying they have the wrong model, they say there is no model that can predict a future depression or crash.Therefore, they gave Irving Fischer, John Maynard Keynes, and the Harvard Economic Service high marks, even though they failed miserably to predict the Crash and Great Depression.Amazing.Irving Fischer lost his entire net worth, John Maynard Keynes was wiped out by the 1929 crash, so there’s a little bit of hubris, and arrogant elitism, still among my colleagues in the economics profession.

Why did the stock market crash in 1929? Well, we’ve had other crashes, the ’87 crash; and of course the slower crash over a several year period just a couple years ago. The basic argument that I favor is what the Austrians, Mises and Hayek, were talking about. They said the problem with Fischer and Keynes was that they took too macro a point-of-view when they said that commodity, whole, and consumer prices are basically stable.But what they failed to see was structural imbalances in the economy, and what these structural imbalances were manufacturing was moving up much more rapidly than other businesses, and where the stock market was growing five times faster than the underlying economy. They failed to see the stock market and the manufacturing sector, and even real estate to some extent, getting over-extended. It’s not much different from the asset bubbles that we are now experiencing.

In fact, I’ve argued that the consumer price index is not an accurate price of living; you need to look at other assets classes, like real estate. What’s the true value that should be included in a price index to find out what is really occurring?We have this happening to some extent today. Look at the economy. Do you have asset bubbles developing, and are those the sources of a potential crash? The 1929 stock market crash, in my opinion, was largely due to excesses. The Fed had manufactured artificially low interest rates. And why did they do that?Because they were trying to help England out with their gold flow problem, so they artificially lowered the interest rate, far lower low than what you would get in a normal recession.Does a lot of this sound familiar? Yes, the Federal Reserve has been engaged in a low interest rate scenario for a very long period of time, and it has created some asset bubbles and real estate is one of them.

To some extent, the stock market can have certain areas of asset bubbles. Now why did it turn from a recession into a stock market crash? A recession alone is not a precursor to another Great Depression, after all we had a crash in 1987 and that did not result in a major depression. That is because the Federal Reserve acted in a perverse manner and did not become a lender of last resort. They were under a doctrine known as the Real Bills Doctrine. The idea of the time was that if the economy is sliding, you should provide less credit since credit isn’t needed for commercial purposes. So, they failed to bail out the banking situation and the banks collapsed.

We don’t make that mistake today; instead, we go overboard the other way and we rescue banks at the drop of a hat. As a result, we suffer from a gradual inflation; which is a constant problem with propping up debt and constantly bailing out banks and companies that go under. If the banks and companies at risk are large, the government steps in and relieves them right away. It’s a very dangerous game that you always have to be alert to. I always err on inflation that government is very pro inflation, and market forces are deflationary. I ask my students to name me one example of a government service or a government product that has reduced its price in the last 20 years. Nothing – stamps, subways, tolls, they can never think of any.But in the private sector, they are constantly looking for ways to lower prices. The market forces are cost cutting, deflationary, and it’s very positive. The only things that the government cuts prices on are taxes, even then, it’s just certain kinds of taxes. The income tax, and the average tax you pay is going up, the margin rate is going down, but the average tax is going up.

There are many factors that are hurting the vibrancy of our economy. There’s the constant threat of more terrorist attacks and the cost of government. The deficits that we’re running are rising, and we’re losing control of them, which are danger signs on the macroeconomic scale. It’s a balancing act, but overall I’m cautiously optimistic, and I think the stock market is going higher.