Jeremy Beckwith: Keynesian theory would have worked well, taken as a whole

Before the 1930s, governments only borrowed money to pay for wars that they were unable or unwilling to finance via taxation. A peacetime budget deficit was an anathema and widely regarded as immoral.

Thus it was in the 1930s at the beginning of what turned out to be the Great Depression that, as tax revenues fell in line with the economy, so governments would cut their spending in order to balance the books.

It was not the job of the government to interfere in the management of the economy because, left to their own devices, markets would do that job for them. This is known as orthodox or "neo-classical" economics.

In 1936, John Maynard Keynes published his seminal work, demonstrating that left alone, markets could leave the economy in a perpetual state of very high unemployment. He showed that by temporary government spending measures, the economy could be brought to a new state of equilibrium with much lower levels of unemployment. Keynes argued that the deficits this spending created would be offset by surpluses when the economy had returned to a healthier state.

For vote-seeking politicians, Keynes's theory has been a godsend ever since. It gave them the legitimacy to spend money they didn't have in order to create more jobs (read: win votes).

Every time there was a recession, governments across the world raised spending and/or cut taxes. Of course, what they neglected was that in Keynes's mind these spending measures were intended as temporary, and to be reversed as economic recovery took hold.

Therefore, over time, the levels of government spending and taxation in western economies have risen steadily, and budget deficits have become the norm, rather than the exception intended for years of recession. This in turn has produced ever-higher levels of government debt, funded by the capital markets. Indeed, it is these levels of government debt that have now become the problem.

Keynes himself never imagined that peacetime government borrowing of more than 25 per cent of GDP would be necessary, and so funding his spending programmes was never a problem since the government's creditworthiness was never called into question.

By 2014, however, government debt across the US and Europe is expected to be around 90 per cent of GDP. The crisis in the peripheral European government bond markets this year is showing that, at such levels of debt to GDP, the capital markets are now questioning the creditworthiness of the governments as borrowers.

So it is that the western world now finds itself in a real mess. Decades of deficit spending and borrowing appear now to have reached their limit.

In order to retain sufficient credibility to finance their existing debt loads, governments are having to make substantial cuts in their spending programmes at a time when economic growth, particularly in the West, is weak. This is a complete reversal of the economic policy model that has been followed since 1936, and Keynes's theory tells us that it runs the risk of sending economies back into recession.

In the recent May general election here in the UK, the key difference between the programmes of the Conservative and Labour parties was one of economic theory. Labour said that spending cuts should be delayed in order to "secure the recovery", and the Conservatives said that spending cuts needed to start now to regain trust and credibility in the markets.

This was Keynesian versus orthodox economics in a nutshell. A hung parliament showed that voters were not provided with a clear answer. No-one thought to ask the economists – probably because they currently don't have an answer. Orthodox economists are unable to refute the charge that a market-led equilibrium might require substantial unemployment while the Keynesian model is not applicable at times of high government debt.

A new economic genius is required urgently to solve today's problems.

Jeremy Beckwith is chief investment officer for wealth managers Kleinwort Benson.