An Attack on Paul Krugman
By Michael Edesess
Source: Advisor Perspectives
A foundational principle of modern economics is that the creation of credit leads to economic growth. That precept underlies need for quantitative easing, and it is central to the question of what role monetary policy can and should play in stimulating a faster recovery from the Great Recession. It is also the subject of a debate between one of the world’s most prominent economic scholars, Paul Krugman, and a feisty Australian economist, Steve Keen.
Krugman is an unusually public figure for an academic. The Nobel Prize-winner and Princeton professor is also a widely-read New York Times columnist and prolific blogger, with the gift – unusual for someone in so wonky a profession – of clear and persuasive prose. He has earned a large and passionate audience, among them both ardent acolytes and rabid detractors. Krugman represents the mainstream of neoclassical economics, which believes that a combination of central bank monetary policy and government fiscal policy can moderate the business cycle.
Among the dissidents is Keen, the author of a provocative book, Debunking Economics. By his own admission, Keen is proudly out of the mainstream, but also able (“because of impediments like academic tenure,” he says in his book) to challenge it without fatal retribution. Keen thinks central bank controls are not as effective as Krugman believes, because private banks can create money in the form of debt through a process that is beyond the central bank’s control. Because of that, the economy will regularly experience “financial instability,” as advocated by Keynes’s disciple Hyman Minsky.
The debate in the blogosphere between those in the Krugman camp and those in the Keen camp has generated more heat than light; but the core of the debate is whether or not private banks can create money “out of thin air” to their heart’s content, by extending credit – leaving the central bank with no choice but to sanction this money creation.
Keen has taken aim at Krugman, and about a month ago Krugman, welcoming the challenge(at least initially), responded to Keen several times on his blog, setting off a furor in the economics blogosphere that has reverberated well beyond it.
I reviewed the exchange between Keen and Krugman, as well as much of the voluminous blog traffic of commenters weighing in, often to support one side or the other. I also conducted a personal phone interview with Keen. (I contacted Krugman through The New York Times to ask for an interview but did not receive a response.) These efforts shed new light for me on this debate, which I share below.
The crisis in economics
Economics is in a state of ferment; I would like to be able to say it is like physics before Einstein, but economics is not remotely comparable to Newtonian physics, and no Einstein-esque economist is going to perfect it.
The critical state of economic theory has been exacerbated by the financial crisis, and numerous heterodoxies today bedevil the neoclassical mainstream – Post-Keynesianism, followers of Hyman Minsky, Modern Monetary Theory, Austrian economics, even Marxist economics. These alternative ideasets have been chronicled in The Economist, and a partial cast of characters has been mapped in The Washington Post. Most of the debate goes on in the blogosphere, which is particularly prolix on this subject. I have noticed that virtually all of the bloggers are economists – they may or may not be academics, but they generally have economics degrees.
The volume of internet chatter among professional economists is staggering. A friend of mine was once chairman of the Federal Reserve Bank of Kansas City. He is not an economist but a businessman. (No, my friend is not Herman Cain.) He told me that when he arrived in the position, he found that there were 170 economists who reported to him – and he didn’t have the foggiest idea what they were all doing with their time. Now that I’ve read so much of the blogging on this subject, I think I could tell him. They are all kibitzing about Fed policy, reading charts and data and constructing models.
The bloggers are trying to determine what central bank policy should be. Some of the new schools of economics believe central banks like the Federal Reserve can create all the money they want without negative consequences. Others believe central banks shouldn’t exist at all. Some schools believe that, instead of trying to fine-tune a balance between inflation and GDP growth, the Fed should just target a constant rate of nominal GDP growth, to effect a balance of inflation and GDP growth all in one bang. And others still, believe the central bank has little to say about it because booms and busts will occur whatever it does (this is closest to the locus of the Keen-Krugman debate.)
The core of the dispute
The central question in the Keen-Krugman interchange is whether banks can create money with complete freedom, or whether they are effectively constrained by the actions of the central bank. The question at issue is whether banks can “create credit out of thin air,” a notion that seems to have been first advocated by the economist Joseph Schumpeter. Keen and others of his faction say they can; Krugman says they can’t.
But there are really two aspects to the debate. The first is the general charge that all of neoclassical economic theory is bankrupt because it is enthralled with equilibrium, and therefore it cannot model or understand the dynamic evolutionary economic process. That is to say, the essential nature of the economy is to be in disequilibrium, so theories obsessed with equilibrium cannot model it.
This charge seems wholly valid to me. In answer to the mainstream’s deficiencies, Keen said in my interview with him, “I want to eliminate the neoclassical mainstream and replace it with a Schumpeterian dynamic growth evolutionary mainstream.”
Schumpeter, you’ll recall, was the economist who coined the term “creative destruction” to characterize the capitalist economic process – a term beloved by nearly all economists, but of which it is difficult to find any trace in mainstream economic models. Says Keen, “Creative destruction doesn’t involve equilibrium, so they leave it out completely. It’s about how investment comes in pulses and waves … so you get an inherent explanation for the cyclicality of capitalism out of Schumpeter.”
The second aspect is a chicken-and-egg problem: Do banks take in deposits and then lend, or do they loan first, then use the proceeds of the loan to create deposits? It is not merely a chicken-and-egg question – those, like Keen, who say banks can create money out of thin air also say that the central bank must condone, willy-nilly, this so-called “endogenous” money creation. Krugman, on the other hand, says the central bank can control the process. That is, he believes money is created only “exogenously” by the central bank. Keen is a disciple of Hyman Minsky, who was a disciple of John Maynard Keynes but also of Schumpeter. Minsky believed that this process of banks creating money, in the form of debt, would inevitably lead to frequent financial bubbles and crises.
Judging from how much feverish blogging there has been surrounding the Keen-Krugman battle alone, this is a thorny question to resolve one way or the other. The amazing thing is that, in this debate, one side or the other will present what appears to be a very simple proof that they are right – and yet the other side is not persuaded in the least.
What really bothers me about the debate
It is difficult for a non-economist to decipher the debates, which revolve around esoteric terminology known only to the disputants – like “aggregate demand” and even “money.” Most people certainly don’t know what economists mean by “money.” A friend of mine told me he was at a meeting recently with a number of people, most of whom thought that when the central bank increased the money supply it actually physically printed currency – and all the people at the meeting were financial advisors.
As I said, almost all of the debates are among economists, bandying about terms that are, in principle, quantified aggregates of manifestly intangible, imprecisely defined theoretical objects like “aggregate demand,” “economic growth,” and “money” (not just currency), none of which can be measured very accurately, even if they are defined. Then they make stepwise arguments involving causality from one aggregate to another, like “an increase in money increases aggregate demand.” These feel to me like either verbally constructed tautologies, or oversimplifications of a more complex process.
For example in one of the most enlightening blog entries that I found discussing the Krugman-Keen debate, written by a University of Massachusetts graduate student named Josh Mason, Mason actually tries – I say “tries;” I do not think he succeeded – to clarify what “aggregate demand” really means. Is the orthodox view that aggregate demand is the same thing as aggregate income? Not quite, Mason says: “The question, as always, is which way causality runs. The term ‘aggregate demand’ is shorthand for the argument that causality runs from aggregate expenditure to aggregate income, whereas pre-Keynesian orthodoxy held that causality ran strictly from income to expenditure.”
But surely causality doesn’t only run one way. This was George Soros’s insight in the concept he calls “reflexivity;” in Soros’s application, this means that the price implied byprojected future earnings for an investment can also be a cause of those earnings. Causality runs both ways, complicating the relationship.
I am particularly baffled by these debates, because my background is in pure mathematics. Economics pretends to be mathematics, but it is not mathematics. There is a major difference. No mathematician uses a term in a formula, or a statement of a theorem, unless that term has first been defined with excruciating precision. Hence, there is no question of what the term means, let alone any debate that is carried on only because two disputants have different concepts of the meaning of their terms. As a result, a very simple proof of something will invariably persuade the other side. The cost of this, however, is that mathematics is strictly limited in what it can define and prove.
In economics, it is completely different. Terms are used in formulas without ever having been precisely defined. Economists may think they’ve defined them, but they should try reading some real mathematics to see what a precise definition truly is. The economists, I think, leave the work of definition to be inferred from the way the terms are used in the formulas. This, to me, is weird – but I suppose it could work, and it does work sometimes, but more often it leads to ridiculous debates that leave matters of real importance unexamined.
That seems to be the case in the Keen-Krugman faceoff. The most central terms – inflation and GDP – are so riddled with measurement problems that they are almost arbitrary fictions, a reality with which no one ever grapples. There is never so much as a nod to the fact that a large body of intelligent people believe that economic growth, by mathematical necessity, cannot continue forever, or even for long – yet efforts to define clearly enough what “economic growth” means in order to close the gap with this external (and sometimes internal) body of thought are rarely seen in debates among economists.
Understanding Minsky in common-sense terms
I think economics often becomes clearer if you disdain the abstractions and think in more ordinary terms.
The economist Randall Wray, a disciple of Minsky, makes things a little clearer by pointing out that Minsky said that anybody can create money out of thin air, by loaning to someone else. That at least gets us to stop thinking that we can only discuss aggregates of ill-defined monetary units mediated by institutions.
As an experiment, I tried thinking about it this way. Suppose there is a community in which some particularly well-respected person – let’s call her Ms. X – is not only held to have high credibility, but is also assumed to have a significant wealth, or access thereto.
Ms. X lends her credibility – not to say, sometimes, explicitly her credit – to numerous people in the community in whom she believes. Her honor and sense of responsibility are of such a high order that she tends to command these same qualities in others. Hence, her credibility and/or credit tend to rub off on, and to be extended to, anyone for whom she vouches – and she vouches for many people.
Hence, for example, an innovative writer of children’s books wishes to try creating a line of books using specialized expertise that can be provided by an arts and crafts supplier in the community. Ms. X recommends the book writer to the arts and crafts supplier, vouching that the book writer is someone whom Ms. X esteems and stands behind. The book writer asks the supplier to provide certain materials and expertise to facilitate her innovation.
These agreements or collaborations can be cemented through loan agreements, with Ms. X as countersigner or extender of credit, or merely through a tacit underlying presumption of Ms. X as guarantor, in cash or in kind. After all, aren’t all exchanges and collaborations some combination of extensions both of credit in strict monetary terms, as well as in the broader sense – the sense meaning trust or expectations of eventual compensatory treatment?
The point is that, with the general level of credit extended by Ms. X to many people, economic activity will no doubt increase. “Aggregate demand” will increase. “Money” will increase. These statements are true not because they are true in some quantitative sense, but because they are true qualitatively – the degree to which the economic activity, the aggregate demand, and even the “money” all increase could probably be measured, after a fashion, but it would be very approximate.
The source of all the confusion, in my view, is the idea that if you can’t measure something and model it mathematically, it has no meaning. There is too much mathematics used and expected in economics, and too much of it is of poor quality and distorts the ideas it is meant to undergird. Keen agrees. “If you’re actually aware of the limitations of mathematics, you say, ‘Well, this is a guide, but I could have missed something,’” he told me. “So there’s more modesty in a proper non-equilibrium dynamic modeling approach than you’ll ever get out of neoclassical equilibrium modeling.”
To go on with the Ms. X analogy, the economic growth that her spreading trust engenders is delicate. If she overextends – if she stands behind more people than she can actually back up, or if she has miscalculated the trustworthiness or credibility of some of her mentees – her own credibility – and through her, theirs – may suffer erosion. You can see how things could collapse quickly. This is, I believe, a simple version of the Minsky financial instability hypothesis.
This simple narrative confirms that creating “credit” in the broad sense – trust and confidence in your trading partners and collaborators – can help spawn economic activity, though it can also create a credit bubble that can break. But if the sole and entire purpose of this exercise were to get it put into formulas, you can see how you might lose a lot of the texture. Perhaps it’s possible, but if you do it too soon, and too imprecisely, you’ll create a Babel in which people fight over the formulas, instead of over what’s actually going on.
Michael Edesess is an accomplished mathematician and economist with experience in the investment, energy, environment and sustainable development fields. He is a Visiting Fellow at the Hong Kong Advanced Institute for Cross-Disciplinary Studies, as well as a partner and chief investment officer of Denver-based Fair Advisors. In 2007, he authored a book about the investment services industry titled The Big Investment Lie, published by Berrett-Koehler.
Michael Edesess is someone who is in love with theory, with what Hannah Arendt called “ideological scientificality.” To be in love with theory means that when theory collides with fact, it is fact that must be sacrificed.
Edesess tells us, for instance, that
Unfortunately for Edesess and his fellow orthodox economists, however, the “foundational principle of modern economics” is hardly borne out by the facts.
The United States Federal Reserve Board used to publish a paper called “Profits and Balance Sheet Developments at U.S. Commercial Banks.” The report for 2009, the latest year I could find, can be found here: http://www.federalreserve.gov/pubs/bulletin/2010/articles/profit/default.htm
This paper demonstrates that the method used by the Fed to ease monetary policy in the wake of the GFC did not “lead to economic growth.” In fact, about the only thing the Fed’s manipulation of monetary policy achieved was to enhance bank profits.
Between 2007 and 2009 there was an increase in the bank’s net interest margin or net interest spread. The interest rate the ten largest banks paid on interest-bearing deposits (such as those of my 90 year-old mother) dropped by 79% from 3.30% to 0.79%. The interest rate the banks paid on federal funds dropped by 90% from 5.15% to 0.54%. The interest rates the banks charged their customers, however, did not fall so precipitously. So while everybody else is getting murdered, the banks’ net interest margin actually increased by 14%, from 3.46% to 3.96%.
But the manufacture of an artifically high net interest spread isn’t the Fed’s greatest crime, for as the Fed is seeing to it that almost interest-free money is being lavished on the banks, the banks are drastically cutting back on the amount of money lent to households and businesses. Loans and leases drop from making up 53.21% of bank assets in 2007 to only 46.99% in 2009.
So unless Edesess can explain how increasing the banks’ net interest margin while at the same time greatly cutting back on the amount of money lent to households and businesses “leads to economic growth,” there seems to be a flaw in his “foundational principle of modern economics.”
The orthodox or neoclassical economist is the quintessential rationalist. Rationalist ideology can be traced back to Classical Civilization and the Pythagorean rationalists such as Pythagoras himself, Socrates, Plato, or the early Aristotle.
Early Christianity dealt a significant blow to the rationalists. Early Christianity was informed by nominalism, and in opposition to the long and convoluted rationalizations crafted by the rationalists, expressed itself in such well-known scriptures as “by their fruits ye shall know them.”
As Christianity morphed into the official religion of the Roman Empire, however, rationalism once again came to dominate Christianity and we see the medieval scholastics arguing endlessly over questions such as: “How many angels can dance on the head of a pin?”
Nominalism experienced a revival as a result of William of Occam’s nominalist revolution of the early 14th century. The science wars, which pit rationalism against nominalism and empiricism, have raged ever since.
When I saw the mini-documentary that was screened on one of the final days at the recent Institute of New Economics Thinking (INET) conference held in Berlin (published on this blog), I came away with the impression that the dissident economists’ (such as Keen’s) challenge to the neoclassicists was much more fundamental than arguing over “how many angels can dance on the head of a pin.”
Neoclassical economic theory, because it assumes a vast, sweeping generalization known as homo economicus, is the epitome of rationalist thinking. And if the totalitarian movements of the early 20th century taught us anything, it is just how unrealistic this caricature of man is. As Hannah Arendt observes in The Origins of Totalitarianism:
Besides its unreality, neoclassical economics is also imbued with a healthy dose of mysticism. As Michael Allen Gillespie put it in The Theological Origins of Modernity, according to orthodox economic theory “the social world is governed by an ‘invisible hand’ that almost miraculously produces a rational distribution of goods and services.”
The evolutionary biologist David Sloan Wilson put it this way:
Wilson goes on to explain just how unrealistic this mystically-based assumption is.
But we didn’t need empiricists like Wilson to tell us this. Anybody who had been watching knew from the experience of the totalitarian movements the horrors that the unbridled pursuit of individual material self-interest can produce. To quote Hannah Arendt again from The Origins of Totalitarianism:
Michael is correct in stating that complex systems [or any system, for that matter] can not be distilled into mathematical formulas, not only because we can not understand the system [its variability], but because mathematics is its own system which has little to do with reality.
If you desire mathematics to define your system, then you must first convert your system into mathematical language, something impossible to do [at this point in economics]. Eventually, this will be possible, and you will simply have another of layer of obfuscation [albeit, a well-accepted one].
No matter how opaque the economics community wishes to makes its science, it will always remain a human relationship between producer and consumer, one laced with infinite variability and therefore protected against grotesque hyper-intellectualism.
What is needed is to fuse the rationalism of the monetary and economic systems with the human and individual sensitivities of the various wisdom traditions thus a mutual temperance of mindset.
There can be no progress in a science when the multiple practitioners of that
discipline cannot agree about the definition of fundamental quantities which
the science itself is concerned. In economics, that quantity is “money”.
Ludwig Wittgenstein observed, “If a lion could talk, we would not understand
him.” In the same manner, when an economist refers to “money”, we have no
idea, from within the consensus of the discipline itself, as to what is meant.
In order for the possibility of progress to be achieved in understanding the
role of “money” in an economy, it must first be accurately defined, to the
mutual acceptance of all participants. Otherwise, economists will continue
to talk PAST each other, rather than with each other.
A quote from the 19th century writer Walter Bagehot is illustrative of the
current dilemma. “The businessmen of London are disturbed about the
currency question. They cannot define what money is. How to count they
know. What to count, they do not know.”
I have neither the time nor inclination to express what, in fact, money IS,
when a far better job than I could accomplish has already been done. For
those few of you who care to look, the blog FOFOA has a very lengthy post
entitled “Moneyness” which gets to the heart of the matter. For those who
don’t, the following definition(s) have been helpful to me.
Money is a word, representing a human invention, which has multiple
manifestations (3) in number. They are, the unit of account, the medium of
exchange, and the store of value. Each manifestation is a “function” of the
invention of the money concept. Each is potentially independent of the
others. Do you know how many lemons you would exchange for a dozen
eggs? For a loaf of bread? Do you need to refer back to some arbitrary
neutral unit to arrive at such determinations? If you don’t, then you
already have the idea of the shared notion of value inherent in things in
and of themselves, without reference to an artificial reference point. In the
course of time, as more “things” could be exchanged, it became simpler
to refer to some base unit to which all could be compared. That is the
unit of account “function” of “money”.
An arbitrary token, serving as the unit of account, and expiring without
value at the end of a period of exchange, has a long history in economic
exchange, going back to the medieval fairs at Lyon and Seville. Here, the
unit of account and the medium of exchange were one and the same, but
because they expired at the end of the fair, they had no purpose as a
store of value beyond the event. Only for those who got more in value
that they gave, or vice versa, was a “settlement medium” needed. It
could have been anything mutually acceptable, but over time gold or silver,
having been used in prior historical periods, evolved into this final settlement
function. It was not money, simply something that finalized settlement of
any imbalances which remained.
The greatest conflict in understanding, as well as the greatest possible
source for mischief and suffering, occurs when the first two functions,
the mental “unit of account” and token “medium of exchange” become
a “store of value”. To understand why this is so, one needs to understand
the fundamental nature of banking. But, anybody who has read Steve’s
work already has a good grasp of that, right?
The discussion about the difficulty of explaining the creation of credit reminded me of an old joke:
It is a slow day in a damp little Irish town.
The rain is beating down harshly, and all the streets are deserted.
Times are tough, everybody is in debt and everybody lives on credit.
…On this particular day a rich German tourist is driving through the town, stops at the local hotel and lays a €100 note on the desk, telling the hotel owner he wants to inspect the rooms upstairs in order to pick one to spend the night.
The owner gives him some room-keys and, as soon as the visitor has walked upstairs, the hotelier grabs the €100 note and runs next door to pay his debt to the butcher.
The butcher takes the €100 note and rushes down the street to repay his debt to the pig farmer.
The pig farmer takes the €100 note and heads off to pay his bill at the supplier of animal feed and fuel.
The guy at the Farmers’ Co-op takes the €100 note and runs to pay his drinks bill at the friendly neighbourhood pub.
The pub owner slips the money along to the local prostitute drinking at the bar – who, in spite of facing hard times, has always gladly offered him her ‘services’ on credit.
The hooker then rushes over to the hotel and pays off her room bill to the hotel owner with the €100 note.
The hotel proprietor quietly replaces the €100 note back on the counter, so that the rich traveller will not suspect anything.
At that moment the traveller comes down the stairs, states that none of the rooms are satisfactory, picks up the €100 note, pockets it and leaves town.
…No one has produced anything.
No one has earned anything.
However, the whole town is now out of debt and looking to the future with a lot more optimism.
Yes the store of value aspect of money is the one that has been most problematic, and that plays into the more corruptible aspects of the economic and monetary systems. The other two aspects are akin to money as ticket for the distribution of production. Even the store of value aspect however could be made much less difficult to maintain if we’d take effective measures to actually control the monetary system. We don’t do that now, and we justify it by resorting to delusional orthodoxy (Its not free market! Its central planning!) or, consciously or unconsciously, to obscure undeserved privilege (the ability to loan/distribute financial credit when a cultural heritage of productive potential that is owned by all is the major {and unrecognized} reason why such financial credit is able to be distributed so widely and voluminously at all) and sanction financial greed and rapaciousness ( casino capitalism with unregulated derivative creation/trading and naked shorting etc.)
Consider: Is a dividend to every individual citizen and a general not an individual or selective price discount based on changing monthly statistics a command economy run by pointy headed bureaucrats or is it the humane prescription for a modern high tech economy which in actual fact ushers in the first truly free market by providing needed liquidity to the individual and STABLY CREATING AND MAINTAINING MARKET CONDITIONS WHILE PREVENTING INFLATION? I think the latter and here’s why.
There IS an inherent gap in purchasing power, and no matter how much or how little credit is re-circulated it must go back through the cost accounting cycle which currently enforces that gap before it can liquidate another price thus prices are sticky and overhead charges and debt must accumulate. Supplementing purchasing power from a truly independent and non-interest bearing source approximates that gap with many positive effects resulting, and the monthly discount catches any cost push, demand pull and even speculative inflationary effects (inflated appraisals on housing loans for instance are discounted the same way the price of bread is). And this discounting occurs by the way, OUTSIDE OF OR AFTER the normal business cycle of production through retail sale and so there is no interference in price discovery at all.
Consider: Is a dividend a free lunch or an equitable and completely legitimate payment for one’s share of the value of a heritage of progress that is being usurped by the Banking system asserting a privilege? As stated above it is the latter. Why? Because there is no market for an automotive plant for domestic consumption in Papua New Guinea due to there being no cultural heritage of productiveness there. This heritage is the ultimate unacknowledged financial value and externality that is taken from us all by the assumption of it by the Banking system.
Robert,
The association of economics to science can falsely imply that there is a consistent set of governing laws which determine the behaviour of the system. The study of economics is the study of the interactive behaviour of individuals, who to varying degrees of freedom make decisions which influence the outcome as observed via poorly collected economic variables. Economist like to think that there is an ‘invisible mechanism’ which deterministically drives the system. It’s a convenient but false way of understanding the economy.
The Keen v Krugman argument is not argument about reality, it’s an argument about whose invisible mechanism is more correct. You don’t have dig too deep to realise that in the context of reality both approaches are narrowly focused theoretical views from 2 different angles.
TruthIsThereIsNoTruth,
I agree wholeheartedly that economics is not a science, and that models of almost any orthodox theoretical base fail to capture all variables.
However, is the system perfect or immutable in any structural way?
If we made it more free for the vast majority by actually controlling it via mechanisms that used its creditary nature of issuance and cancellation….how could it be any less free for doing so?
And we need to always keep the following questions in our minds in regard economics.
Are its underlying basic ideas, values and psychology likewise perfect and immutable?
Are the systems we have or we craft made for Man, or is Man being manipulated for the sake of those systems?
@ Robert K May 17, 2012 at 9:03 am
Spot on. At least you have defined money. Good that you made the effort to enlighten the need for discipline.
Many on this blog (and even professional economists) simply invent (“out of thin air”) what they think is “commonsense”, without bothering to research or verify that they might have re-invented a square wheel. They also arrogantly assert that only their simple ideas are correct.
Economics has not been practised as a science (to what extent it can be is debatable). It may explain why economics has made little progress.
@ Robert K May 17, 2012 at 9:03 am
The money question is one of the great unsolved political problems of Western Civilization, so I doubt you’re going to get much agreement on it.
Up until the establishment of the Bank of England in 1694, money was in the form of specie. There could be no close relation between the volume of money available and the economic need for money as a medium of savings and exchange. The volume of money was strictly related to the supply of bullion. We have seen that the supply increased too rapidly in the three centuries 1000-1300, then increased far too slowly (because of exhaustion of existing mines within the framework of existing technology) for the next century and a half (1300-1450), then was expanded in a spectacular and accidental way, quite out of relationship to economic need, by Spanish access to the bullion stores of Mexico and Peru (1520-1650).
This inadequacy of specie-based money began to be remedied at the very end of the seventeenth century, notably by the establishment of the Bank of England in 1694. This remedy rested on the use of banknotes backed to only a fractional part of their value by specie reserves. This was a partial solution of the problem of money for two reasons: (1) it permitted a great increase in the volume of money when the supply of bullion was increasingly inadequate and (2) it permitted the volume of money to fluctuate to some extent in response to changing needs for money in the economy. It also ushered in the era of money manipulation.
The importance of the money question can scarcely be exaggerated. How money was created, and on what basis it circulated, defined in critical ways the relationship of farmers, workers, and commercial participants in the industrial state that emerged beginning in the late 19th century. The answers go a long way toward determining who controlled the rules of credit and commerce, who shared in the fruits of increasing production, and, ultimately, how many people obtained that minimum of income necessary to ensure that they lived lives of some dignity. With the stakes so high, all questions about the currency were clearly not of equal weight. One of the weightiest concerned the origin of money. Whether the government issued money, or whether private bankers did, shaped the precise forms of finance capitalism to a telling degree.
Needless to say, the money questions became moral, social and political questions, and those with the greatest political influence strove to dictate monetary policy.
In the United States, the Federal Reserve Bank was established in order to de-politicize the money question. It is a regime faithful to the progressive vision derived from the philosophies of Fichte and Hegel that the scientific managers of society should be given the necessary power and can be counted on to act with it in “the public interest.” Of course this has proven to be nothing but a Utopian pipe dream. The technocrat has proven to be no more immune than anyone else to what Thomas Hobbes termed “the continual competition for honor and dignity.” He is not immune to the ethnic and cultural loyalties which qualify a consistent economic rationalism; nor the deep and complex motives in the human psyche which express themselves in the desire for “power and glory.”
@ Glen Stehle,
Well said. The mind of Man has been beset by orthodoxy of one stripe or another since forever. And still is in many ways in spite his pretensions to science. I believe it comes down to the will to power versus the will to freedom, specifically the will to freedom for the individual. The one constant that runs through your short history is the control of matters by the oligarchy. If this is changed and is accompanied by actual wisdom in the acculturation process we have the chance to evolve. If not, history has a large bias toward extinction.
“The money question is one of the great unsolved political problems of Western Civilization, so I doubt you’re going to get much agreement on it.
Agree on getting agreement on it. I have read various views on money. For me the only one that makes sense is that money is today and has always been credit. Always backed by debt.
Metal has been used to try and stop counterfeiting. Or to limit the amount of credit that banks or Govt can issue.
But gold or silver etc has never been money. It has only been a token to represent credit. As notes and coins are today.
“But gold or silver etc has never been money. It has only been a token to represent credit. As notes and coins are today.”
RJ you keep repeating this falsehood.
At least read David Graeber’s book. We haven’t always lived in a credit system.
“At least read David Graeber’s book. We haven’t always lived in a credit system.”
I didn’t interpret like that. I don’t think there ever has been a time when humans didn’t do favours for each other in expectation of future repayment.
It’s in our nature to be like that. It’s in our nature to give credit.
Money expands by one or more of it’s creation vectors into rising belief that its creation will be of benefit, until that belief is contradicted by reality, reality experienced by a group with the power to prevent its printing to the extent that it will contract.
@NeilW
That really cuts to the chase. It alludes to another one of the vast, sweeping generalizations assumed by neoclassical economics, a theory which “only recognizes self-interested behavior.” (Herbert Gintis, Samuel Bowles, Robert Boyd and Ernst Fehr) Or as Amitai Etzioni put it in The Moral Dimension, the “fact is that neoclassicists have labored long and hard to show that practically all behavior is driven by pleasure and self-interest.”
We see the assumption stated more explicitly in Edesess’ post:
The phenomenon that NeilW and Edesess are describing is known as “reciprocity.” And undoubtedly “expectations of eventual compensatory treatment” play a role in many exchanges and collaborations. But do they motivate all exchanges and collaborations, as Edesess asserts?
The empirical evidence in support of Edesess’ theory (neoclassical theory) is all but non-existent. As Gintis, Bowles, Boyd and Fehr go on to explain:
Gintis et al go on to cite a great deal of evidence and numerous studies which debunk neoclassical mythology. (And I use the term “mythology” here because when experience, observation and evidence show a hypothesis to be untrue, and yet the hypothesis is still believed in, it ceases to be science and becomes religion or mythology.)
But I think the ones who have really taken a wrecking bar to the neoclassical mytholgy which holds all humans to be strictly self-regarding are the neuro scientists, such as the following:
http://thesciencenetwork.org/programs/beyond-belief-candles-in-the-dark/paul-zak
http://thesciencenetwork.org/programs/beyond-belief-candles-in-the-dark/v-s-ramachandran-1
http://thesciencenetwork.org/programs/beyond-belief-candles-in-the-dark/marco-iacoboni
Oops! Somehow when I quoted Edesess I misquoted him as follows:
After all, aren’t exchanges and collaborations some combination of extensions both of credit in strict monetary terms, as well as in the broader sense – the sense meaning trust or expectations of eventual compensatory treatment?
When what he actually said was:
After all, aren’t all exchanges and collaborations some combination of extensions both of credit in strict monetary terms, as well as in the broader sense – the sense meaning trust or expectations of eventual compensatory treatment?
It is that qualifying word “all” which carries his declaration deep into the territory of distortion, partial truth and being only verisimilar.
This is a very clear summary in plain English of the main aspects of the discussion between Krugman, Keen, the MMTers, and others. It is an excellent article for making this discussion understandable to the non specialist public, precisely the people who need to understand the workings of the monetary system and real economy. And its written by a mathematician and economist who is able to get beyond the standard jargon.
Congratulations to David Lawson
For some reason the name of the original author of this piece doesn’t seem to appear here.
Congratulations should go to the author, Michael Edesess.
My eyesight fails me again. I see that both the poster and original author of the piece appear here.
Congratulations to both of you.
cyrusp
May 18, 2012 at 6:02 pm | #
“But gold or silver etc has never been money. It has only been a token to represent credit. As notes and coins are today.”
RJ you keep repeating this falsehood.
At least read David Graeber’s book. We haven’t always lived in a credit system.”
You can continue to believe the gold as money myth if you want to. But I have read both sides and then applied common sense and logic. Money for me is credit and has always been credit.
If gold is used its either barter (one real asset exchanged for another one) or gold as a token for credit. Where the credit link is key not the true gold value.
The Science Network lectures, while interesting and unfortunately necessary in order to counter the largely negative propaganda and mindset of neo-classical economics and the culture of capitalism, are still science lectures and hence once removed from the experiences being talked about.
Its a reminder of the story of the monk who was asked what was the difference between how he saw things now and how he saw them before his study. His answer was before he embarked upon study he saw mountains and streams as mountains and streams, and after his studies he still saw mountains and streams, but he saw them wisely. The difference of course is the difference between being unconscious and possessing the philosopher’s stone, the difference between being unconscious of self and realizing that “the kingdom of heaven is within.” Its another reminder of how important it is to re-balance our society by changing the psychology which undegerds it because its frenetic”ness” takes up so much of our time and attention and so inhibits almost any kind of actually contemplative activity.
I agree with RJ Gold is… an element, a metal, a token to represent credit. Gold is not money. Money is a credit/deposit binary (a tally stick) where the deposit is created by the credit and the bifurcation of the two allows the circulation of the deposit as money whereas the credit generally remains out of circulation as an asset of ‘banks’. A modern feature of deposit money is it is homogenious (every dollar of money deposit is indistinguishable (unlike tally sticks) and equally able to destroy a defined debt. Money can be destroyed = the reunion of the binary deposit destroys credit. Gold does not get destroyed. The ratio of gold price to money as a token of exchange, long term, has a relationship that seems to track the inflation of deposit money (depreciation… worthlessness of money as a store of long term value). Gold does not inflate… depreciate, wheareas debts can be inflated away.
The owner of an asset is rarely best placed to use it productively.
Lending it allows it to be placed under the control of someone more motivated and more qualified to produce with it than the owner.
Intermediation (credit and the financial system) makes lending efficient, and early in the cycle credit does allow the economy to grow.
However over time intermediation between ultimate owner and ultimate borrower grows and becomes inefficient.
As the inefficiencies grow, the price of lending – the interest rate – becomes corrupted beyond recognition. When this occurs assets are no longer able to be efficiently placed under the control of those motivated and qualified to make best use of them.
Purging of the intermediation structures is needed to start the cycle anew.
In bygone times, these structures were purged naturally and frequently. In modern times there are repeated attempts to artificially prop up these structures (often by the very people who benefit from the structures). As a result they are now more inefficient than ever before, and the eventual unavoidable purge will be more painful than ever before.