Sounding Off: Boom and bust cycle is familiar

In a typical business cycle, there are four steps:

?Boom

?Crash

?Recession and Depression

?Recovery

In regard to the business cycle, there are two authors who have historically attracted wide followings: Karl Marx and Maynard Keynes.

Other economists, Nobel Prize winner Milton Friedman for example, developed followers but they never obtained mass support such as the theories of Marx and Keynes.

Marx developed theories that are the basis for Communism and socialism. Concerning the business cycle, Marx’s Theory of Surplus Value holds that, because of profits going to the business owners (the capitalists), labor cannot buy back all the goods that labor produces: Thus at the top of the boom, there will be a surplus of products that cannot be sold.

This overproduction forces manufacturers to lay off workers “” why produce more when you can’t sell what you already have? Witness the automobile industry today. Another example: real estate developers who are stuck with houses that can’t be sold. Build more? No. The first thing “” lay off the workers.

As each worker is laid off, the worker loses purchasing power. This starts a snowball effect because each laid-off worker can’t buy the products he normally would buy and, bingo, other workers are laid off.

Multiply this scenario by thousands and millions and a crash is followed by a recession and a depression and high unemployment takes place. Thousands of laid off workers can not go to a restaurant. So, fewer waiters, cooks, busboys, cashiers, bartenders “” the list goes on and on “” are needed. And more purchasing power is lost.

Every industry will be subjected to this “snowball.”

People in general get a feeling of depression and the entire population lacks confidence in the future.

Marx believed that the seeds of destruction of capitalism were within the system itself. The business cycle could eventually get in such a king-sized depression that the workers would rely on violence to overthrow the system and class warfare would result. Marx was writing around 1850 and he had no plan, nor did he want one, to save capitalism or the Russian czar.

Enter John Maynard Keynes (1883 ““ 1946). Keynes, frequently referred to as Maynard Keynes, was a highly educated member of the upper class in England. He was an out-of-the-closet homosexual who was friendly with many famous writers, artists and intellectuals of England in the first decades of the 20th century. He was a speculator of the highest order. And a brilliant economist.

He made a fortune, lost it, then made it again. Lying in bed each morning, he studied the stock market “” and raked in money by buying and selling stocks. As an avid fine art fancier he compiled one of the world’s finest collections, including works by Picasso, Degas, Modigliani, Cezanne, Seurat and others.

Keynes theorized that the business cycle could be managed “” the ups and downs could be minimized. Start with the boom “” don’t let it get out of control.

Using taxation and other measures, the factory owners could be forced to cut production, thus mitigating over-production.

As soon as a crash started, or was about to start, the government could stop unemployment by hiring thousands of workers for government projects: streets and roads, government buildings, police forces, schools, bridges, flood control, forests, etc.

Keynesian economics was central to the administration of Franklin Delano Roosevelt, who died in 1945 while in his fourth term as president. Roosevelt’s New Deal, which was designed to get the country out of the Great Depression (which started with the stock market crash of October 1929), was based primarily on reducing unemployment by hiring millions to work for the government. Roosevelt gambled on this massive hiring by using government credit to pay the workers. The result was an unbelievable increase in the national debt.

Roosevelt developed numerous government agencies to handle this huge labor force:

?Works Progress Administration: for highways and schools

?Civilian Conservation Corps: planted trees, forests, worked with soil erosion

?National Youth Administration: Students assisted schools and colleges in research, recreation

?National Recovery Act: handled business and industry regulations, later declared unconstitutional

?Securities and Exchange Commission: regulated stock and bond transactions

Does all this sound familiar? It should, because the Barack Obama stimulus proposals are leaning heavily on Keynesian economic theory. And the huge deficit will surely strain our national debt.

Did Keynesian economics and FDR save the capitalist system? This question can not really be answered. The U.S. economic system was making some progress from 1934 to 1939 but not sufficiently to say that Keynesian economics was a plus or a minus. What changed the U.S. economy was World War II.

An enormous demand for products made in the U.S. came from our Allies and from our own armed forces. Jobs were plentiful. Employment was at an all-time high. We entered into a boom stage “” but was this an artificial boom due to the war? Or were we simply continuing the business cycle by going from recovery to boom?

These questions must remain unanswered. But what we do know is that the Russian dream of equality for everyone failed. Russia now has millionaires.

What about other theories? Friedman believed the free market with limited government interference should be the path to follow. But the financial community, mainly the banks without proper regulation, made loans to persons who were not credit worthy. That’s why so many homes are now being foreclosed. And that’s why scam artists like Bernie Madoff could “make money” without proper regulation.

Other Nobel winners, including Paul Samuelson and Clive Granger, had access to computers and huge data banks to develop theories of macroeconomics and microeconomics to predict the business future. These theories were too far advanced in mathematics and econometric models to get a following among the common people. But people can understand Marx and Keynes.

So, of the two understandable economic theories, Keynesianism must be our choice unless a better theory is proposed.

Keynesianism is the path President Obama is taking even though it will mean more government regulation, higher taxes and government ownership. But don’t dismay. Even President Nixon was forced into deficit spending to reduce unemployment and said, “Now I am a Keynesian.”

And we might add, at the moment, “We are all Keynesians.”

EUGENE AUERBACH is president of Diversal Ltd. Inc. in Laguna Beach.