Hayek, Keynes and How to Prevent Economic Crises: Sylvia Nasar

Sept. 13 (Bloomberg) -- Unlike the movies, life rarely permits second takes. But the Second World War gave John Maynard Keynes, the patron saint of government activism, and Friedrich Hayek, the Cassandra who warned of the state’s destructive potential, just such opportunities.

During the Blitz, this odd couple was said to have shared fire-warden duty atop the soaring roof of Kings College’s chapel, an apogee of Gothic architecture that stood in the crosshairs of Nazi bombers. The story is likely apocryphal but its symbolism holds true. Despite their differences, both men were committed to the defense of Western civilization, and both were determined that the West would do better than it had last time in laying the foundations of a lasting peace.

When Hitler launched his mad world conquest, Keynes was no longer the slim young civil servant he had been 20 years earlier, someone who could poke fun at his superiors but was too remote from power to persuade them. Middle-aged and paunchy now, saddled with a “wonky” heart, he had become Britain’s de facto wartime treasurer and postwar planner and was in a position to influence the economic future.

Bretton Woods

In July 1944, 10 months before Germany’s surrender and 15 before Japan’s, Keynes was in a resort in the White Mountains of New Hampshire. The purpose of the Bretton Woods conference was to revive world trade when the war ended, stabilize currencies and deal with war debts and frozen credit markets. The war would leave much of the world significantly poorer, and countries would need to be able to earn their way back to prosperity. In the broadest sense, salvage meant rebuilding and reconstruction, moving back toward pre-1913 globalization, but without reviving the pre-World War I assumption that the world’s economic machinery worked automatically.

For the West, Bretton Woods meant avoiding the mistakes of the interwar era -- the very lesson that Marxists claimed capitalists could never learn -- and restoring lost moral and material credibility. Economic chaos after World War I had convinced Keynes that economic stability was a key to political stability, and economic growth was a necessary if not sufficient condition for the long-run survival of the West. Modern societies could not endure economic breakdowns any more than great cities could run without electricity or water.

By 1943, it was obvious to Keynes that the U.S. and Britain would design the postwar economic order together, but that America’s financial strength and Britain’s weakness meant that the U.S. would have the last word on all important matters. Determined to deploy his intellectual capital as a counterweight to American financial clout, he drafted the British proposal and got it out first.

International Monetary Fund

Keynes envisioned a United Nations of international finance that would provide a framework for cooperation as global lender of last resort and arbiter of trade disputes. It would operate according to agreed-upon rules and procedures to avert financial crises, trade wars and depressions such as those in the interwar era. By marshalling international cooperation to deal with postwar debts and stabilize currencies, the West would not be driven, as it had been between the wars, to embrace the beggar-thy-neighbor policies that had exacerbated the Great Depression. On the sea journey to the U.S., Keynes drew up blueprints for the International Monetary Fund and the World Bank.

Unlike British thinkers in the Victorian era who championed free trade, Keynes and his American counterpart, Harry Dexter White, the U.S. Treasury’s second in command (and a KGB agent), no longer believed that the world naturally tends toward peace and progress. International cooperation was required. The alternative was unthinkable.

Allied political leaders had also learned from experience that peace depended on economic revival. As President Franklin Roosevelt put it, “Economic diseases are highly communicable. It follows therefore that the economic health of every country is a proper matter of concern to all its neighbors, near and distant.”

The Bretton Woods conference was Keynes’s idea, but White chose the Mount Washington Hotel. When the conference got under way with delegates from 44 countries, Keynes and White were in charge. Keynes took little trouble to disguise the fact that he was ramming his views down the throats of the banking committee that he chaired. The U.S. Treasury Secretary Henry Morgenthau had to go around to Keynes’s suite and ask him to “please go slow and talk louder and have his papers in better arrangement.”

Keynes, typically, was more efficient than democratic. He had accomplished what he had wished to accomplish as a much younger man, and now he was exhausted and eager to get away. When he arrived at the banquet to give the final speech, everyone stood up, silently, until he made his way to the dais.

Reading Hayek

En route to the Bretton Woods conference, on the Queen Mary, Keynes had lounged in his deck chair devouring, among other books, “The Road to Serfdom” -- written by Friedrich Hayek at Keynes’s old college in Cambridge.

Although just 40, Hayek too was feeling his age, and was troubled by deafness and a sense of uselessness. His emigre status had shut him out of any active role in Britain’s fight against fascism.

During World War I, he had been a corporal in the Austro-Hungarian army and, in the cold, dark, hungry years that followed, a university student in Vienna. A moderate socialist who was repelled by his family’s enthusiasm for German imperialism and anti-Semitism, Hayek grew disillusioned with central planning when he witnessed the new Austrian state and hyperinflation destroy the middle class’s faith in democracy.

Keynes had been Hayek’s hero since “The Economic Consequences of the Peace” was published in German in 1920. But like many young men who seek immortality in economics, Hayek launched his career by attacking the reigning king, beginning when he was an impecunious graduate student on a Rockefeller fellowship at New York University. When he met the great man in person at a conference in London, in 1927, he picked a fight about interest rates. And when he started Vienna’s first economic forecasting institute, Hayek ridiculed the confidence of Keynes and Irving Fisher that the next recession, whenever it came, would be mild, thanks to managed money and the Federal Reserve. In February 1929, in his monthly forecast newsletter, he predicted instead that the American boom would result in a crash.

Great Depression Debate

This strategy succeeded brilliantly, snagging Hayek an invitation to Beatrice and Sidney Webb’s London School of Economics, which a group of young Turks were itching to turn into a libertarian antipode of interventionist Cambridge, where Keynes’s disciples were. With Hayek on the LSE team, young economists everywhere followed the furious debate that ensued with the passion and partisanship of soccer fans.

As the Depression deepened, Hayek held that it was “due to monetary mismanagement and state intervention operating in a milieu in which the essential strength of capitalism had already been sapped by war and by policy.” Overinvestment during the boom -- not underinvestment, as Keynes contended -- had produced the slump. Consequently, what was needed was “time to effect a permanent cure.”

“The creation of artificial demand,” Hayek argued, would only lead to another burst of inflation and another downturn. Like most American economists -- as well as President Herbert Hoover and his political rival, Roosevelt -- Hayek opposed going off the gold standard, and favored spending cuts and tax increases to balance the budget. Give the economy time to heal.

When “nature’s cure” failed to end the Great Depression, Hayek’s star hurtled to earth. As Beatrice Webb wrote in her diary of Hayek and his allies in 1936, “They and their credo are sidetracked, without influence or even relevance to the present state of the world.” According to Nicholas Wapshott’s new book about the Keynes-Hayek disagreement, Hayek was so discouraged that he essentially gave up economics and turned instead to philosophy.

History Repeating Itself

After Britain declared war on Germany, Hayek found himself shut out of war work on account of his alien status, despite having become a British citizen. His contribution, he decided, would be to write a book warning Western intellectuals that -- as he had concluded from his own country’s history in the 1920s and 1930s -- the road to totalitarianism, whether of Hitlerian or Stalinist variety (Stalin then being Hitler’s ally), started on the slippery slope of well-intentioned government interference in the private sector. Exiled to Cambridge, where the LSE had been evacuated, he had plenty of peace in which to write. Generous as always, Keynes got him rooms and high-table privileges at Kings College, but discussions between the two men were confined to the antiquarian manuscripts they both collected.

On shipboard, after reading “The Road to Serfdom,” Keynes wrote to Hayek, “Morally and philosophically, I find myself in agreement with virtually the whole of it; and not only in agreement but deeply moved agreement.” Hayek might not have succeeded in drawing “the line between freedom and planning satisfactorily,” and therefore might not have created a useful guide through the “middle way” of actual policy making, Keynes wrote, but he had articulated values essential “for living a good life.”

One year after Bretton Woods, the Cold War had started, “The Road to Serfdom” was on American best-seller lists, and Hayek went on a wildly successful book tour around the U.S. Along the way, to the annoyance of his conservative sponsors, he spoke up in favor of the Bretton Woods treaty and the framework of international government cooperation that Keynes had done so much to bring about.

History of Economics

The grand pursuit of economic geniuses began in the 1840s with an act of imagination and turned into a quest for instruments of mastery, to borrow a phrase from the poet Muriel Rukeyser. Their aim was to create the special kind of knowledge needed to nurture a society marked by material well-being, liberty and security, and not staggering on the verge of moral and material collapse.

Hayek made the point that no one invented markets or private property or the rule of law, but that understanding how they functioned has been vital to these institutions’ survival.

Keynes was a balletomane, collector and intimate of Virginia Woolf, but he took up a calling that he once compared with dentistry. Artists were responsible for civilization, but economic thinkers had invented and continually improved an “apparatus of the mind” that made civilization possible.

Each economic genius not only looked at the world through his own window, but also stood on the shoulders of predecessors. It all began with the idea, born in Victorian London, that humanity might now, after millenniums in which most were condemned to drudge through life in poverty, ignorance and fear, seize its own fate and mold its material circumstances.

(Sylvia Nasar, a former New York Times economics reporter and the author of “A Beautiful Mind,” teaches journalism at Columbia University. This is the last in a five-part excerpt of her new book, “Grand Pursuit: The Story of Economic Genius,” to be published today by Simon & Schuster.)

To contact the writer of this article: Sylvia Nasar at

To contact the editor responsible for this article: Mary Duenwald at

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