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Keynes’s Last Stand

With no antibiotics, Keynes was given a regime of bed rest. After three months of this, he went home to his country house at Tilton in Sussex; and for the next eighteen months he led the life of an invalid. It was only in the early spring of 1939 that he discovered—nobody knows how—an extraordinary Hungarian doctor named Janos Plesch. Keynes regarded him as “something between a genius and a quack,” but found him a kindred spirit. His first step was to give Keynes one of the new sulfa drugs; this cured the streptococcal infection in his throat but could not cure the infection in his heart. All the same, the effect was immediate; with the lesser evil cured, Keynes was no longer fighting infections in his throat and chest, and could function for as long as his heart held out. With care he could live and work for another decade. As he recovered his strength, the British went to war with Nazi Germany.


Keynes was neither a pacifist nor an appeaser. But as the author of The Economic Consequences of the Peace, he was a world-famous critic of the Versailles settlement after World War I. He had hoped that if Germany’s real grievances against the postwar settlement were met, peace could be preserved in Europe. Hitler, on the other hand, presented a distinctive problem; negotiation was impossible. He would not keep agreements, and regarded any attempt to make agreements with him as a sign of weakness. Neville Chamberlain’s wish for something clear-cut was the last thing needed in 1938; Keynes favored the line pursued by Anthony Eden—to make friends with the Soviet Union and the US, while keeping the German and Italian dictators guessing. It was a faint hope. In a letter of July 1937 to Kingsley Martin, the editor of the New Statesman, Keynes argued that a natural sympathy between dictators made it easy for Hitler and Stalin to become allies, and he predicted the Nazi–Soviet pact.

Keynes’s overriding thought was that no government should sacrifice its own people unless they were actively in support of war. He would not have gone to war just to save Poland or Czechoslovakia; but once public sentiment was clear that Nazi Germany had to be stopped from swallowing Europe piecemeal, Keynes was for war. “Some sort of die had been cast,” Skidelsky writes. “It was not one he would have cast. Britain had gone to war for an object he did not think worth fighting for—and without the United States. But he accepted the conflict as inevitable. The British people had forced the hand of their rulers. Keynes’s most important test for going to war had been met.”

Keynes’s war work now began. From the British declaration of war on September 3, 1939, until the American entry into the war two years and three months later, he was engrossed in financing the war. His first contribution was a series of articles that were worked up into a pamphlet, How to Pay for the War, which Samuel Brittan recently described as a high point of Keynesian thought, and relevant once more in a world where the United States will be spending vast sums on war and preparations for war.2 Robert Skidelsky agrees about the merits of How to Pay for the War: “It engaged all the qualities of his complex nature. The union of theory and practice, the linking of economic doctrine to political philosophy here achieved its most compelling artistic expression.” It was a dazzling theoretical performance, and the economic imagination it displayed was extraordinary. It also displayed Keynes’s attachment to the liberalism of his Edwardian youth quite strikingly.

Keynes wanted the war to be fought without totalitarian controls over everyday life in Britain. This was a lost cause, partly for practical reasons but also because Churchill—probably rightly—thought that anything less than total mobilization would have been unintelligible to the British people. British society was closer to being completely mobilized than any other belligerent, and content to be so. On the question of how to fight a war without economic disaster, Keynes had more success. Everyone agreed that in wartime, civilian consumption was a “residual,” whatever could be afforded after the war had been paid for. And economists agreed that the great danger was inflation. War would cure the unemployment of the pre-war years, but the problem in war was excess, not inadequate, demand. The question was how to divert the necessary resources into war and away from consumption. In World War I, Britain had done this by inflation. In the seven years between 1913 and 1920, the price level rose two and a half times, while working-class wages lagged behind prices. The “hard-faced men” did well out of the war, since profits and dividends were buoyant; their employees suffered. The burden of paying for the war had been unequally borne by the least well-off members of society, and it could not safely be done a second time.

The argument lay between “fiscal” and “totalitarian” planning. Keynes liked fiscal planning because it used the price mechanism in flexible ways and avoided the creation of a despotic bureaucracy. Keynes’s favored device was a system of compulsory savings, taking away the extra incomes generated by the wartime economy for the duration of the war and returning them afterward. Meanwhile the money would be available to finance the war. The government shrank from this as much as from the inflation-driven devices of World War I, and feared that compulsory savings would erode the interest paid for voluntary savings of those who had something to save. Sir John Simon, the chancellor of the exchequer, turned Keynes’s scheme down in his budget for 1940, though he had grace enough to write that Keynes’s plan was the best of all solutions, but politically impossible. The budget of April 1940 was followed within three weeks by the German invasion of the Low Countries and France, and the arrival of Winston Churchill as prime minister.

The dire straits into which Britain was plunged by the fall of France meant that Keynes was brought back into the Treasury to play a central part in thinking through the taxation and borrowing needs of a wartime government, and then in securing the overseas finance needed to pay for imports. Keynes got some of his ideas through and failed with others. As better national income statistics were compiled, the tax authorities became reconciled to treating a small part of income tax as a withholding tax to be repaid in due course. Once he saw that the Labour Party could not be budged from their support for a system of subsidies for the necessities of the working class, he settled down to devise one. The visible egalitarianism implied in a comprehensive rationing system was the price of political unity.

Keynes reentered the Treasury in installments, beginning in August 1940. First set to work on exchange controls, he soon began to prepare memoranda on the way the government could close the gap between its war expenditure and the funds it had available, and in the same vein, on what, by means of taxation, it must withdraw from consumption to control inflation. Between the autumn of 1940 and the spring of 1941, Keynes worked for thirteen hours a day trying to get plausible estimates of the size of the problem and trying to persuade his skeptical critics in the Treasury, the Revenue, and the Bank of England that some version of his compulsory savings surcharge was a workable option. In the process, he provoked other people to provide for the first time accurate estimates of national income and expenditure.

What was Keynes’s impact? On the one hand, he had to swallow the truth that his most imaginative ideas were politically unacceptable; but the broad shape of wartime taxation—with the top rate of income tax set at 97.5 percent—owed almost everything to him. In the long term, the government’s failure to appreciate Keynes’s favorite ideas was bad for postwar Britain. Compulsory savings meant a wartime surcharge to be returned in installments after the war, and implied a return to a low-tax regime after the war. Instead, the top rate of income tax stayed above 80 percent for thirty-five years, which was good news for the creators of the British welfare state but bad news for growth and innovation. The game of “what would Keynes have thought?” is irresistible but unfruitful.


Keynes assumed from the beginning of the war that Britain would have to fight the war with the help of the United States. This was not a universal view. Indeed, there was no universal view, since nobody knew quite what to expect. In November 1939 Keynes composed a letter to Roosevelt that he (probably wisely) never sent. In it he urged Roosevelt to extend war credits to Allied governments, and use the postwar repayments for a fund for the reconstruction of Europe in order to save it from communism. He described what amounted to a premature Marshall Plan as an indemnity “paid by the victor to the vanquished.” But Keynes had no more insight than anyone else in the British political elite into what American policy in fact would be. Skidelsky comments wisely that

Like most liberal Englishmen, Keynes overestimated support for Britain in the United States. British expectations of assistance concentrated on the President, ignored Congress and assumed that the (largely Republican) east-coast WASP elite represented US public opinion.

In particular, he never understood that Roosevelt actively loathed the British Empire, disliked British aristocrats, and thought the pre-war Foreign Office had been pro-fascist in its sympathies. As to wider public opinion, it was not obvious to Americans that the British were entitled to hang on to India by force but that Germany was not entitled to march into the Rhineland or the Sudetenland, or unite Germany and Austria in the 1938 Anschluss. At a less principled level, Americans had less at stake in Europe than many Europeans assumed. This fact dictated relations in the immediate aftermath of the war, too. Only when the specter of a Soviet takeover of Europe seized the American imagination did that change.

As to the pre-1939 economic conduct of the British, Americans had plenty to complain about—whether justly or not. The British had repudiated government debts incurred in World War I; they had devalued the pound when the American economy was in recession; and the system of Imperial Preference shut American goods out of markets that American manufacturers wanted to enter. Fighting the war together improved relations; but even after Pearl Harbor, the American attitude to Britain combined admiration for British resistance to Hitler with skepticism about nearly everything else.

Keynes’s interest lay in the fate of Britain’s foreign currency reserves. The problem was simple enough. Anyone who had the chance to convert sterling into dollars had every reason to do it; the United States had no intention of getting into the war, was a huge creditor, and was in no danger of devaluing its currency. Britain ran an elaborate system of exchange controls to stop sterling leaking into dollars, but it had many holes in it. Nonresidents could sell sterling-denominated securities for dollars; and the licensing system allowed nonessential dollar imports to come into Britain.

  1. 2

    Samuel Brittan, “How to Pay for the War,” Financial Times, October 11, 2001.

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