Making sense of chaos: 1919-1923

The economic events of the immediate postwar years did nothing to weaken the view Keynes so forcefully expressed in The Economic Consequences of the Peace in 1919 that Europe had seen the end of the insti­tutional foundation of the old era of prosperity and now confronted the daunting challenge of constructing a new economic regime that could operate successfully in the changed environment.

From 1919 through most of 1922, Keynes was energetically engaged in efforts to more rationally implement the peace treaties, make possible the rebuilding of the war-torn economies of Europe, and eliminate the severe impediment to the reconstruction and reconstitution of a viable system of international finance and trade represented by reparations and war debts.

Starting in late 1922, however, Keynes increasingly turned his attention toward domestic economic problems and domestic policy. Four lectures delivered to the Institute of Bankers in November and December provide

Making sense of chaos: 1919-1923 35 insight into the status of his thinking at a time when the economy had hit its trough. Much of the substance of these lectures would reappear in his 1923 Tract on Monetary Reform, though in 1922 he had yet to come to the firm policy conclusion expressed in that manuscript.

Keynes focused on the expected return to the gold standard at the prewar par of $4.86 per pound. Appalled by the damage done to the domestic economy by the severe price instability of the recent past, Keynes at this point considered domestic price stability, not a return to gold, to be the sine qua non of a regime of persistent full employment. An expert on the mechanics of both the international and domestic banking systems, he believed that the monetary authorities now had both the tools and, for the first time, the knowledge (in part gained by the necessity to manage the value of sterling over the past few years) to enable them to control the cost and availability of credit. Deliberate control of the credit cycle in turn could be the means to permanent domestic price stability if that were to become the primary objective of monetary policy. But since 1920, both monetary and fiscal policy had been used not to pursue domestic price stability, but rather to pursue and achieve a savage deflation intended to slash wages and prices in order to improve Britain's trade balance as a precondition for a return to gold at prewar par.

With sterling still well below par, monetary policy would have to exert additional deflationary pressure by substantially raising interest rates. This would create a serious impediment to the restoration of full employ­ment and, Keynes believed, would strike a blow to distributive justice as well. In the lectures, Keynes argued that while the continental countries were in no condition to go back on the gold standard at prewar par or at any fixed rate of exchange, Britain could probably do so, but only if the rate was well below prewar par, as it had been two years earlier when the value of the pound was below $3.50.

[T]rade will never go ahead until people are certain [that prices] have touched bottom. They will never be certain that they have touched bottom until they see them going up a little; so that I am in favor of a moderate rise in prices as the only way of getting out of the present period of depression.

(CW 19-I, p. 65)

Further deflation, he argued, would also raise the burden of an already devastating internal, primarily war-induced debt shouldered by the British taxpayer. Keynes put the current yearly debt service at about 40 percent of total government spending, or 70 percent as large as all 36 The Economic Consequences... to The General Theory government spending other than debt service (CW 19-I, p. 63). As on many other occasions, he insisted here that the proper way to handle this kind of problem was through a substantial, one-time, progressive "capital levy" or wealth tax, which, when applied in an appropriate and timely way, is "the justest [sic] and wisest instrument, because you can make the burden fall in the right place" (CW 19-I, p. 48).¹

A return to gold at par would perhaps require an additional 7 per­cent decline in British prices when what was needed for a revival of the domestic economy was a price rise of about 15-20 percent, Keynes said. The standard way to push the pound up to par would be to use monetary policy to raise interest rates in order to "keep money in London for a very long period very dear - decidedly dearer than in New York" (CW 19-I, p. 71). Higher interest rates would be needed to reduce domestic demand by enough and for long enough to force domestic prices down, thereby eventually improving the trade balance, which would raise the value of sterling.

Keynes understood that organized labor had become much more powerful in Britain during and after the war and would fiercely resist any significant cut in nominal wages. He made an argument here that he would make throughout the interwar era: the attempt to force nom­inal wage deflation would not succeed in achieving a major reduction in real wages in the traditional export sectors. He estimated that the real hourly wage had risen about 20 percent from its prewar level in spite of the depression. However: "The business of forcing down certain levels of wages... into equilibrium is almost hopeless, or it will take a long time" (CW 19-I, p. 66).

Experience during this period thus led Keynes to reject a cornerstone of classical theory - that flexible money wages can be relied on to restore full employment in the event of a recession or depression. He continued until his death to attack the idea that market disequilibrium adjustment processes such as wage and price deflation could be relied on to cure unemployment. Chapters 2 and 19 of The General Theory were designed to demonstrate that deflation actually worsens unemployment. As Skidelsky put it:

Money wages had fallen by a third during the slump - the last example in British economic history of downward flexibility. Yet they had not fallen enough to restore equilibrium and for the rest of the 1920s remained rigid, despite further deflationary pressure. Keynes and the financial establishment drew different lessons from this experience. Keynes concluded that the deflation of 1920-1 had brought Britain to the 'verge of revolution,' and that, as a working assumption, wage rates should now be regarded as too rigid in the short period to adjust to the 'ebb and flow of international gold credit'... We have in these lectures an early clue as to what Keynes was to be saying in the years ahead.

(Skidelsky 1992, p. 134)

In stressing this point about wages, Keynes merely hints at (though he does not clearly theorize here) a contradiction between a return to the gold standard at any fixed rate and sustained full employment at home. If inflation is unjust and corrosive of thrift and deflation is economically dis­astrous, then the domestic and international requirements for monetary policy will frequently be in contradiction.

The general point is this: the severity of the disequilibrium deflationary processes of the past four years had convinced Keynes that, though many of the old verities may have remained true in some abstract, theoretical long run, the process of attempting to move between long-run equilib­riums under modern conditions could be long, path dependent, and enormously costly. The dysfunctional effects of supposedly short-run disequilibrium dynamics could affect the intermediate-run and even the long-run path of the economy, a point not acknowledged by supporters of the return to gold at par. They spent the entire interwar period arguing that the only long-run solution to Britain's unemployment was to deflate her way back to her prewar domination of export markets. They disdained short-run policies designed to directly raise domestic demand and lower unemployment, claiming that they only made the process of adjustment to the long-run solutions longer and costlier.

In reviewing these issues one year later in the Tract on Monetary Reform, Keynes made his oft-cited and oft-misunderstood observation that, in ser­iously troubled times, policy must focus on short- to intermediate-run problems or the hoped-for long-run return to full-employment equilib­rium will never come. This was not the good old days of the nineteenth century.

But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.

(CW 4, p. 65, emphasis in original)²

But the flexible exchange rate policy that Keynes now supported had its own problem, one that Keynes, as an inveterate foreign-exchange market gambler, knew all too well. With no assured center of gravity predetermined by policy, unregulated or fully flexible exchange rates can easily become the object of heavy speculation. This can transform moderate exchange rate cycles into periods of substantial instability. If there were to be flexible exchange rates, they would have to be managed by the government.³

In July of 1923, the Bank of England raised the interest rate it charged to commercial banks from 3 to 4 percent. The contradiction between domestic and international priorities in the use of monetary policy had now become clear to Keynes, and he had made up his mind about the dir­ection in which the contradiction should be resolved. High domestic pro­duction and employment must be the new objectives of monetary policy replacing exchange rate and trade balance targets.

The raising of the Bank rate to 4 per cent is one of the most mis­guided movements of that indicator which have ever occurred. Trade is discouraged and declining; prices are falling slightly; employment is very bad; and the political situation is such as to damp down enterprise and hold back everyone from entering into new business... There is no necessary reason why disturbances on the Continent need cause a million or two of Englishmen to stand idle. Our job is to do our best to free ourselves from the psycho­logical reactions of foreign politics. and resolutely to keep our own business going as best we can. What is the explanation?. There is not much doubt that the explanation is to be found in the fall of the dollar exchange (not at all unusual at this time of year). That is to say, the Bank of England thinks it more important to raise the dollar exchange a few points than to encourage flagging [domestic] trade.

(CW 19-I, pp. 100-101, emphasis in original)⁴

Though Keynes remained unsure about precisely how to solve all of the serious problems confronting Britain at this point in time, he was quite clear that there would have to be a qualitative increase in the economic responsibilities and powers of the state in the postwar era. In January 1923, in the introduction to the last segment of an influential series of art­icles on European reconstruction published in the Manchester Guardian, he made the following observation, cited by Skidelsky:

In our present confusion of aims, is there enough clear-sighted public spirit left to preserve the balance and complicated organisation by which we live? Communism is discredited by events; socialism [as embodied in the Soviet-style plans of the Labour Party], in its old- fashioned interpretation, no longer interests the world; capitalism has lost its self-confidence. Unless men are united by a common aim or moved by objective principles, each one's hand will be against the rest and the unregulated pursuit of individual advantage may soon des­troy the whole.

(Skidelsky 1992, p. 121)

Skidelsky notes that, at this point, "Keynesianism is already a gleam in his eye - not as an economic theory, but as the vision of an enlightened Middle Way" (Skidelsky 1992, p. 122).

A Tract on Monetary Reform (1923)

Many important theoretical ideas and concepts we associate with the mature Keynes of The General Theory played an important role in the Tract. They include the central role given to uncertainty, expectations, conventions, business "psychology" as a key influence on production and investment, and the "regime of money contract" (CW 4, p. 33). The regime of money contract refers to a crucial characteristic of post-WWI capitalism. The total value of contractual obligations (mostly credit contracts) stated in nominal terms was so large relative to the size of the economy that substantial deflation could trigger a wave of defaults and even a financial crisis. To use Hyman Minsky's famous phrase, a "regime of money con­tract" is subject to "financial fragility." In such a regime, the condition of balance sheets can have a huge impact on economic performance. This insight would have a profound influence on Keynes's understanding of the causes of the Great Depression of the 1930s, though, surprisingly, it is mentioned - see chapters 19 and 22 - but not consistently stressed in The General Theory. For Keynes in the interwar years, the state of balance sheets is a crucial determinant of economic performance: balance sheets matter.

Keynes argued that stabilization of the aggregate price level was the key to reducing uncertainty and preventing expectations from becoming dysfunctional. Though his theory of "aggregate demand" was not yet fully developed, Keynes made the argument that excessive instability of the general or economy-wide price level (as distinguished from relative prices) reduced economy-wide spending, raised unemployment, and mal- distributed income. Capitalist markets:

cannot work properly if the money, which [individual savers and businessmen] assume as a stable measuring rod, is undependable. Unemployment, the precarious life of the worker, the disappointment of expectation, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer - all proceed, in large measure, from the instability of the standard of value... [R]isk... is one of the heaviest, and the perhaps the most avoidable, burden on production. This element of risk is greatly aggravated by the instability of the standard of value.

(CW 4, p. xiv)

The first chapter of the book dealt with the economic and social consequences of price instability. The term "social" is very important

40 The Economic Consequences... to The General Theory because Keynes is thinking here, as in The Economic Consequences of the Peace, in terms of the broad sweep of events taking place in the twentieth century as they relate to the social, cultural, institutional, and political preconditions for the efficient functioning of domestic and global capit­alism. Though known as the most influential macroeconomist in history, Keynes, as we will see, also emphasized the influence of micro and meso (or industry) conditions as well as the psychology of individuals and groups on macroeconomic outcomes.

He began the book by restating one of his 1919 themes: that unstable price movements since 1914 had destroyed many of the preconditions for the successful reproduction of the prewar system.

The fluctuations in the value of money since 1914 have been on a scale so great as to constitute, with all that they involve, one of the most significant events in the economic history of the modern world. The fluctuation of the standard... has not only been of unprecedented violence, but has been visited on a society of which the economic organisation is more dependent than that of any earlier epoch on the assumption that the standard of value would be moderately stable.

(CW 4, pp. 1-2)

Changes of this magnitude "are producing now the vastest social consequences" (CW 4, p. 1).

His first point is that over the nineteenth century there evolved a separation of "the management of property from its ownership," with fixed-income securities - "mortgages, bonds, debentures, and preference shares" - becoming increasingly important sources of financial capital (CW 4, p. 5).⁵ In this historically specific form of capitalism, the high savings of the affluent rentier class were provided to the entrepreneurs of the day without substantial managerial interference, to be converted almost auto­matically into capital accumulation because the return on capital was high and because in this prosperous environment businessmen invested not on the basis of a careful calculation of expected profits, but almost as "a way of life" (CW 7, p. 150). The system was very successful, but such a rentier­based "regime of money contract" could not have persisted without the unusual price stability that occurred between the Napoleonic Wars (1803­1815) and the start of WWI.⁶

For a hundred years the system worked, throughout Europe, with an extraordinary success and facilitated the growth of wealth on an unprecedented scale. The morals, the politics, the literature, and the religion of the age joined in a grand conspiracy for the promotion of saving. But amidst the general enjoyment of ease and progress, the extent to which the system depended on the stability of the money to

Making sense of chaos: 1919-1923 41 which the investing classes had committed their fortunes was gener­ally overlooked.

(CW 4, p. 6) Anticipating the stress placed on "conventional" expectation formation in The General Theory, Keynes noted that belief in the permanent stability of the value of money was not rooted in any careful study of the broad sweep of history, for such a study would have shown recurrent outbursts of instability around a long-run trend of moderately rising prices. There existed, rather, merely a "conventional belief in the stability and safety of a money contract" (CW 4, p. 7, emphasis added). "Custom and favour­able experience had acquired for such investments an unimpeachable reputation for security" (CW 4, p. 12). Thus, the enormous inflation of prices during the war and for two years thereafter mortally injured the old system connecting rentiers and businessmen - or saving and the demand for capital investment - by nearly destroying the European rentier class itself and by making the conventional belief in price stability untenable. A system substantially based on a large volume of long-term nominal debt contracts was simply incompatible with substantial price instability.

The monetary events which have accompanied and have followed the war have taken from [rentiers] about one-half their real value in England, seven-tenths in France, eleven-twelfths in Italy, and virtually the whole in Germany and the succession states of Austria-Hungary and Russia... Nor can it be doubted that this experience must modify social psychology towards the practice of saving and investing.

(CW 4, pp. 12, 16)

The theory Keynes presented to explain why and how price instability caused production and employment to fluctuate is as follows: "It has long been recognized, by the business world and economists alike, that a period of rising prices acts as a stimulus to enterprise and is benefi­cial to business men" - and vice versa (CW 4, p. 17). Since output prices tend to respond more quickly to changes in final demand than input prices (including wages), rising prices bring what Keynes called "wind­fall profits" to the businessman. Inflation helps him in two ways. First, it reduces the burden of his existing debt, and since, in Keynes's view, nominal interest rates rarely catch up to the pace of inflation, it lowers the cost of new credit as well. Second, since production and marketing take time, inflation raises his selling price relative to the prices paid for inputs. This stimulates output and employment. In a deflationary period, everything works in reverse. The burden of debt is increased, and not only for business borrowings: "in these days of huge national debts. the burden of taxation becomes intolerable on the productive classes of

the community" (CW 4, p. 30). In current conditions, Keynes argued, the market system left to itself is incapable of preventing destabilizing, large-scale price movements that raise unemployment. Therefore, the state must take direct responsibility for the maintenance of domestic price stability. There is also the suggestion that the destructive influ­ence of uncertainty (here called risk) on economic instability through the medium of expectations is becoming stronger as economic relations grow more complex and the time between the decision to undertake produc­tion and the receipt of revenues from production lengthens.⁷ The causes of this problem arise:

to a certain extent out of the character of the social organisation described above, but [are] aggravated by the technical methods of present-day productive processes. With the development of inter­national trade, involving great distances between the place of ori­ginal production and the place of final consumption, and with the increased complication of the technical processes of manufacturing, the amount of risk which attaches to the undertaking of production and the length of time through which this risk must be carried are much greater than they would be in a comparatively small self­contained community.

(CW 4, p. 32, emphasis in original) Keynes believed that this problem of uncertainty was both increasingly dangerous and very difficult to resolve. "The provision of adequate facil­ities for the carrying of this risk at a moderate cost is one of the greatest of the problems of modern economic life, and one of those which so far have been least satisfactorily solved" (CW 4, p. 33). His main insight here is that as the average time involved in the processes of production and distri­bution lengthens, production becomes increasingly and inherently specu­lative, a problem that will eventually be dominated in his thinking by a focus on the inherently speculative nature of the process of capital invest­ment. Unexpected changes in relative prices are one part of the problem, but unexpected changes in the average price level are more dangerous yet, especially if they are large. The latter concern is incompatible with the classical dictum that changes in the average price level that leave relative prices unaffected have no impact on the economy.

A considerable part of the risk arises out of fluctuations in the relative value of a commodity compared with that of commodities in general during the interval which must elapse between the commencement of production and the time of consumption.. But there is also a con­siderable risk directly arising out of instability in the value of money. During the lengthy process of production the business world is incur­ring outgoings in terms of money - paying out in money for wages

Making sense of chaos: 1919-1923 43 and other expenses of production - in the expectation of recouping this outlay by disposing of the product for money at a later date. That is to say, the business world as a whole must always be in a position where it stands to gain by a rise of price and to lose by a fall of price. Whether he likes it or not, the technique of production under a regime of money contract forces the business world to carry a big speculative position; and if it is reluctant to carry this position, the productive pro­cess must be slackened.

(CW 4, p. 33, emphasis in original)⁸

Keynes seemed to be suggesting in this chapter not only that production and employment have become increasingly elastic with respect to abso­lute price instability, but also that increasing uncertainty about future price movements itself was adversely affecting the incentive to save and the incentive to accumulate real capital. That is, not only has the amp­litude and length of the production-employment cycle been affected by institutional change and price instability, but the trend around which this cycle takes place may have been impacted as well.⁹

Finally, Keynes argues that the inflation-deflation cycle of the past decade has had profound social and political as well as economic consequences. His main concern is that price instability of this magnitude violates social justice as he defines it by creating an arbitrary and undeserved substan­tial redistribution of income and wealth among and within the three great classes of society: rentiers, businessmen, and workers.¹⁰ It has often been said that Keynes did not concern himself with the issue of social justice, but this assertion is at best misleading.

On average, rentiers were devastated by inflation, while businessmen and workers were enriched. "Throughout the continent the pre-war savings of the middle class, so far as they were invested in bonds, mortgages, or bank deposits, have been largely or entirely wiped out" (CW 4, p. 16). During the inflation phase, businessmen reaped large, speculative, and undeserved gains, and many sectors of labor were able to use the greater bargaining power they achieved during the war "to take advantage of the situation not only to obtain money wages equivalent to what they had before, but to secure a real improvement [and] to combine this with a diminution in their hours of work" (CW 4, p. 26). Since no important aspect of this substantial redistribution reflected changes in the economic contributions to society of the classes, its "most striking consequence is its injustice," especially to middle-class savers (CW 4, p. 29). Deflation, on the other hand:

means impoverishment to labour and to enterprise by leading entrepreneurs to restrict production, in their endeavour to avoid loss to themselves; and is therefore disastrous to employment... Of the two perhaps deflation is. the worse, because it is worse, in an 44 The Economic Consequences... to The General Theory impoverished world, to provoke unemployment than to disappoint the rentier.

(CW 4, pp. 35-36)

Keynes finds this cycle of redistribution through inflation-deflation to be not only morally repugnant, but economically and politically dan­gerous because it destroys belief in the efficiency and fairness of economic institutions, a precondition for economic and social stability. In particular, it changes the image of the businessman from creative entrepreneur to speculator and "profiteer," destroys the incentive to save in the inflation phase, and causes depression and financial distress in the deflation stage.

Keynes's policy conclusion is simple: either the state must be given unprecedented responsibility for maintaining a relatively stable domestic aggregate price index in an environment of managed but flexible exchange rates or the conditions under which savings are made available for capital accumulation can no longer be left to individuals and the market but must be ceded to the state.

In a speech summarizing the key points made in the Tract at the time of its publication, Keynes stressed the seriousness of the consequences that would follow from rejection of his advice and a continuation of the eco­nomic policies appropriate to the prewar regime. It reflects a consistent theme in his attempts to sway elite public opinion to his approach to policy: my reforms will not look so radical and unattractive, he argues, if you compare them with the disastrous alternative.¹¹

But I should like to warn the gentlemen of the City and of High Finance that if they do not listen in time to the voice of reason their days may be numbered. I speak to this great City as Jonah spoke to Nineveh that great city. I prophesy that unless they embrace Wisdom in good time, the system upon which they live will work so very ill that they will be overwhelmed by irresistible things which they hate much more that the mild and limited remedies offered them now.

(CW 19-I, p. 162)

Skidelsky ended his discussion of the Tract with the following observation (keep in mind that Skidelsky tended to underemphasize the radical nature of Keynes's policies):

Beneath both the technical and the ironic drapery of the Tract were a series of connected propositions which were to inspire Keynes's economic work for the rest of his life. Economic health was too important to be left to laissez-faire. Economic management, which had already started, must become part of the modern science of government, not the tool of vested interests. The war had vastly increased the dangers of social upheaval. To preserve the core of

Making sense of chaos: 1919-1923 45 an individualist society from revolutionary danger some of the outerworks had to be sacrificed.

(Skidelsky 1992, p. 160, emphasis in original)

It may be helpful at this point to recapitulate the anti-classical policy con­clusion Keynes developed by 1923: Britain should switch from the gold standard to managed flexibility in the exchange rate and devote monetary policy to controlling the creation of credit in pursuit of stability and thus predictability in the domestic price level rather than in defense of the fixed value of the exchange rate under the gold standard.

The cumulative effect of Keynes's shifts in theoretical perspective in these few years is impressive. By 1923, Keynes had uncovered many flaws in classical theory as it applied to modern capitalism and had developed intuitions about many of the building blocks he would later use to con­struct The General Theory. Institutional rigidities had developed in the postwar economy that are absent from the assumption set of classical theory. One is a lack of downward flexibility in the nominal wage in the face of high unemployment, especially in Britain. This removed one of the two main disequilibrium processes in classical theory that eliminate unemployment. In a direct attack on classical theory, Keynes argued that unemployment would rise, not fall, under serious wage and price defla- tion.¹² Therefore, as he argued in The General Theory, downward rigidity in nominal wages is actually a good thing.¹³ Another is the "regime of money contract": bankruptcies may erupt and financial markets may even implode in the face of serious deflation if firm and bank balance sheets are fragile. This problem is also unaccounted for in classical theory. Keynes suggested that the decisions that determine the proportions of society's income that were saved and that were invested in capital goods in the nineteenth century depended on "unstable psychological conditions" that had not carried over to the interwar period (CW 4, p. 21). He also emphasized the increasing importance of uncertainty in modern econ­omies and therefore the importance of expectations formation under uncertainty in determining the economic trajectory of the country. Since, ceteris paribus, increasing risk or uncertainty would permanently lower the level of capital investment, it would, of necessity, reinforce Keynes's emer­ging belief that Britain had entered an era of permanently sluggish growth. Keynes also hinted at an incipient theory of expectations formation based on social and behavioral heuristics or, as he put it, on "conventions." This obviously foreshadows the centrality of uncertainty and the necessity of a behavioral theory of conventional expectations formation that is at the heart of The General Theory.

Finally, Keynes insisted that movements in the average price level cause movements in economic activity that the market economy by itself cannot prevent. Cycles of inflation and deflation are related to cycles of credit creation and cause economic and social instability. Keynes clearly

had begun the struggle that culminated in the 1930s with the theory of the effect of "aggregate demand" on income and employment with which he is associated.

Notes

1 See also his discussion of the capital levy on pages 62-64.

2 The "In the long run we are all dead" part of this quotation is almost always taken out of context and interpreted to mean that Keynes was not interested in the long run. Nothing could be further from the truth.

3 Keynes was especially concerned that the seasonal nature of much of Britain's trade in food and raw materials would, in an unregulated system, inevit­ably cause seasonal exchange-rate fluctuations that would be magnified by speculation.

4 Keynes put the argument that Britain should be prepared to control its eco­nomic destiny relatively independently of the performance of the rest of Europe in a more provocative from in his important 1933 article "National Self-Sufficiency," discussed in Chapter 11.

5 The issue of common stocks was not an important source of funding for capital investment in the nineteenth century.

6 Trouble for the rentier class had actually begun before the war. "Between 1896 and 1914... the capital value of [an] annuity had fallen by about a third" (CW 4, p. 14). But this decline merely gave up gains achieved in the previous decade or so.

7 He will return to this idea in chapters3 and 5 of The General Theory.

8 In an earlier version of this discussion about the problems caused by time and uncertainty in a regime of money contract (published in The Nation in August 1923), Keynes argued that when individuals and businesses expect falling prices, "They put off their purchases, not because they lack purchasing power, but because their demand is capable of postponement and may, they think, be satisfied at a lower price later on. It is these postponements which are at the root of remediable unemployment" (CW 19-I, pp. 115-116). Keynes would later make this a central distinction between a "cooperative" or barter economy and a "money-wage or entrepreneur economy." In the latter but not the former, agents can flee commodities and flock to money in times of uncertainty or of certain deflation; thus, Say's Law is invalid in a money-wage economy. This general argument also appears in chapter19 of The General Theory.

9 A similar argument is made in The General Theory where the culprit is volatile expectations of the profit rate.

10 Keynes believed that any change in the class distribution of income not associated with a similar change in the economic contributions of the classes to the production of national output was unjust.

11 As we will see, this is the position Keynes also took in the final chapter of The General Theory. In that chapter, he first listed a series of very radical proposals for changing Britain's political economy. He then suggested that his policy proposals were really not as radical as they might appear to be in order not to scare his more conservative readers. But he exited the chapter with this warning to Britain's elites. If you - the economists, government officials, and

Making sense of chaos: 1919-1923 47 influential bankers and businessmen who control British politics - do not adopt the program I have developed in this book, all hell will break loose. "It is certain the world will not much longer tolerate the unemployment which, apart from brief periods of excitement, is associated - and in my opinion inev­itably associated - with present day capitalistic individualism" (CW 7, p. 381). In other words, join my policy revolution or the working class will undertake a revolution of their own that you will not like at all.

12 He would later argue that even when money wages are downwardly flexible, as in the USA in the early 1930s, the real wage will not fall because prices can fall by as much as or more than wages; see chapters 2 and 19 in The General Theory, in which Keynes insists that wage and price deflation are destructive processes.

13 "The chief result of [flexible wages] would be to cause a great instability of prices, so violent perhaps as to make business calculations futile in an eco­nomic society functioning after the manner of that in which we live. To suppose that a flexible wage policy is a right and proper adjunct of a system which on the whole is laissez-faire, is the opposite of the truth" (CW 7, p. 269).

4