John Maynard’s Martingale

As usual in times of economic crises, Keynesian solutions are bandied about, and their supposed influence on Roosevelt’s New Deal is magnified. This fuels the old debate as to whether investment or consumption is best suited for public aid in climbing out of recession. It seems that Keynes has lost once again. The flood-gates of funds have opened for corporations instead of workers. So that the effective result of the alternative will remain a mystery. But, as inflation is the only solution to massive debt, why not get it over with right from the start? Why let things drag on endlessly while redundancies soar?

However, if Keynes became rich, famous and honoured (a peerage), it was less the consequence of his General Theory than of his stock exchange martingale. Having read Marx, and grasped the idea of an average return on capital investments, he realised that it applied to shares and bonds, and made a fortune through a strange twist of history. Marx had explained that capital moves around. And that, in the case of farm land, more productive acres are worth more than less productive ones, and the return on investment tends to balance out. Keynes looked at the varying prices of shares and bonds, and realised that… In fact no one knows how he went about it. But when the price of shares rises, the price of bonds tends to fall, an vice versa. This is due to their two forms of remuneration, dividends and interest. Dividends vary according to profits, and the interest paid is fixed.

$100 shares pay $5 in dividends (5%), and $100 bonds at 5% pay $5. If the dividends double to $10, the price of the shares also has to double ($200) to re-establish a 5% return, while the bonds have to lose half their price ($50) to bring a return of 10%. What would actually happen in such a simple case is that share prices would rise a bit ($133), and bond prices would fall a bit ($67), and the return on both would average out at 7.5%. Alternatively, if the dividends were to drop to $3, share prices would fall to $75, and bond prices would rise to $125, for an average return of 4%.

Of course, the real market was infinitely more complex than that, even when Keynes was piling up his stash. But the trends existed and still do to-day. So, what happens when profits are in free-fall? The price of bonds goes up. But the scale of government borrowing and the way it is financed may turn out to be inflationary. And inflation affects bonds the same as bank notes. So shares may be preferable after all. The world’s stock markets are hesitant and nervous. Prices rise and fall, suddenly and unexplainably. And many, dreaming perhaps of a return to metalism, still believe that gold can save them from the looming debacle. Which just goes to show how little influence Keynesian ideas have had on the general consciousness.

KENNETH COUESBOUC can be reached at: