Podcast

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Steve Keen: The Deliberate Blindness Of Our Central Planners

Choosing to ignore the largest risks
Sunday, March 29, 2015, 12:20 PM

The models we use for decision making determine the outcomes we experience. So, if our models are faulty or flawed, we make bad decisions and suffer bad outcomes.

Professor, author and deflationist Steve Keen joins us this week to discuss the broken models our central planners are using to chart the future of the world economy.

How broken are they? Well for starters, the models major central banks like the Federal Reserve use don't take into account outstanding debt, or absolute levels of money supply. It's why they were completely blindsided by the 2008 crash, and will be similarly gob-smacked when the next financial crisis manifests.

And within this week's podcast is a hidden treat. Steve's character exposition on Greek Financial Minister Yanis Varoufakis. Steve has known Varoufakis personally for over 25 years, and is able to offer a window into his constitution, how his mind thinks, and what he's currently going through in his battle with the Troika for Greece's future.

Click the play button below to listen to Chris' interview with Steve Keen (46m:13s)

Transcript: 

Chris Martenson: Welcome to this Peak Prosperity podcast. I am your host Chris Martenson. Well, as of today, world's central banks are out of fresh ideas—as if they had any to begin with. I mean look, after seven years of printing and mispricing money and fostering a massive surge in the levels of debt, all they’ve got to show for their efforts are low to non-existent to in some cases negative rates of economic growth and an enormous largest ever, wealth gap. And, some nice, high equity prices. Hardly the sort of inspirational outcome they were really hoping for. So they keep doing more of the same in the hope it will all turn around soon enough. But what if their basic models are wrong? What if the core tenants of the economists running the monetary show are simply wrong?

Well if they have all this wrong, then a very large financial catastrophe is not only a possible outcome, but I consider it a likely outcome, which means there’s literally nothing quite as important to your financial future—or heck, your future in general—is understanding if the central banks have a snowball’s chance in August of achieving their aims of delivering a smooth and prosperous future.

Today’s guest is the perfect individual to help us sort out what’s going on and what the true risks really are in the story. Steve Keen is an Australian, an economist and author. He considers himself a Post Keynesian, criticizing neo-classical economists as inconsistent, unscientific and empirically unsupported. He’s the author of the book Debunking Economics, an excellent book by the way, and the popular blog DebtDeflation.com. Welcome Steve.

Steve Keen: Thank you Chris.

Chris Martenson: Well it’s really good to have you here, so let’s dive right in. What have the mainstream economists got wrong?

Steve Keen: Well the thing which is very hard for people who haven’t studied economics to actually get their head around is that mainstream economists developed reasons why they thought you could model capitalism without including the existence of banks, debt or money. I know that sounds like an outrageous statement, but in fact if you go and search on Paul Krugman’s blog you’ll see regular statements that you don’t need to consider the banks or money or indeed private debt, most of the time on the latter point. When you’re modeling the economy you can do perfectly well by ignoring them.

Now that is to my way of thinking, a bit like saying well you can be on the Serengeti Plains and you can perfectly ignore the approaching hill herd of Wildebeest. It’s just beyond belief that they can start from that point of view but that’s where they actually start from. And that’s the fundamental reason why they didn’t see this crisis coming, why they had no idea why it happened and why the attempts to cure it so far have been generally extremely unsuccessful except for the capacity to inflate asset prices and quite a bit of a wash over into the real economy. And why when they get back into trying to manage it again when they think they’re back to normal they actually got themselves back to abnormal but they don’t know what abnormal is.

Chris Martenson: So I need some help here because Steve this is -- it’s inconceivable to me that you could just somehow think you can ignore debt in this story. I just -- I don’t even understand that. So, take their position; how would they argue that you can safely ignore debt?

Steve Keen: Well they start -- the simplest one they do is when they drive this into the heads of first year students at universities is what they call the money illusion. And they tell students “Well here’s a little model of how you behave” involving what they call indifference curves and budget lines. Work out the consumption level and then double all incomes and double all prices what happens? And the student says "nothing sir," and then they say, “That’s the point you see” it’s not the absolute level of prices and absolute level of money that matters; it’s relative prices and relative—they don't talk about relative incomes, it’s relative prices is all that matter. And therefore we can ignore money when we model how people behave at the micro level. That’s stage one in the level of delusion they’ve built up.

Second level is when they get to talking about the banking system at all, they develop a model they call loanable funds. And loanable funds like everything else in economics—economic theory—tries to reduce economics to a pair of intersecting supply and demand curves. And on the demand curve they talk about people’s demand for money being sacrificing liquidity for yield. If you have a high interest rate you’re willing to sacrifice liquidity and therefore not have money in liquid form, a lower interest rate, you want to have high demand for money. [Inaudible 00:04:47] the downward sloping demand curve that they like to have. The supply curve they effectively say supply is under the control of the central bank, but they add to that an argument that the extent to which people are willing to provide money depends upon the rate of return they get for it. So a high rate of interest they’re willing to supply more. In other words they treat money just like the market for apples, like the market for printers, like the market for cars, etc., etc; so it’s no different to any other market.

And when it comes to explaining why this is done at the macro level the implication of loanable funds is that loanable funds involves Chris Martenson lending to Steve Keen. It doesn’t involve the bank of Martenson -- the Martenson Bank lending to Steve Keen the individual. And they didn’t say that well if Chris Martenson lends to Steve Keen, Chris has to allocate some money that he was going to spend to a flow of money to lend to Steve; therefore Chris' spending falls by the amount of the flow that he’s lending to Steve. Whereas Steve can go out and shop with the money that Chris is lending him with of course and interest rate bill coming along as well. With that flow of money Steve has to spend more; so Chris spends as a lender spends less. Steve as a lender spends more. The two pretty much cancel themselves out unless I’m much more of a spendthrift than you, which by the way I probably am, and therefore it’s a second order effect. You can ignore it at the first order level.

Now that completely ignores the fact that when you lend me money you don’t create any money. But if a bank lends me money it does create money.

Chris Martenson: Right.

Steve Keen: This creation process of money lending is ignored and derided and satirized and ridiculed by the mainstream, which has people like myself pulling my hair out in exasperation. And finally the world -- the Bank of England joined me in exasperation and published a beautiful little paper beginning of last year called "Money Creation in the Modern Economy" and pointed out that when an individual lends to another individual there’s no net money creation and there is an offsetting decrease in demand by the lender, increase in demand by the borrower.

But when you look at it from the bank's point of view, when a bank makes a loan to an individual it records an additional asset for its own, the loan, which means its assets rise and its liabilities rise which is deposits -- it puts money in the person's account. The person then spends that money and you therefore get a generation of demand out of the creation of debt. Now that is -- that’s the analysis that I take. It’s the analysis that the Bank of England is onto. The Federal Reserve is still off in cloud cookoo land, believing the stuff that Krugman spouts in his column in The New York Times. And consequently they ignore the role of the creation of money by banks as a creation of demand, and equally importantly, when debt is paid down and people deleverage as they did during the financial crisis that deleveraging is a destruction of demand. So they’re ignoring the major factor that’s causing the ups and downs to global economy.

Chris Martenson: Is this what you meant when you wrote recently you said, “You shouldn’t just ignore what you cannot explain”? It feels to me like the central banks, at least the Federal Reserve, they’re ignoring this debt function.

Steve Keen: They’re completely ignoring it and it’s what -- what it’s actually beautiful described by Kahneman in his book, Thinking, Fast and Slow, is theory induced blindness. Because it’s -- as you said it’s hard for you to even imagine people trying to model the economy without including banks, debt and money in it. But they have this theory induced blindness that says banks, debt and money don’t matter. So they don’t even look at the data to begin with. But when you show the data to them, their theory gets in the way of them even perceiving it. They say, "well, I want to see—you've got correlation there, what’s the causation?" Or, "I want to see panel data rather than just one country," and I show them 20 countries and they give the same response, ignoring it. It is just a blindness to the whole issue.

Chris Martenson: Well you know it’s interesting, I read that same paper you did when the Bank of England came out and I was shocked for two reasons. One, that it took them that long to figure that out, and I think they also kind of concluded that bank reserves are not essential to the whole process of loaning, that in fact loans come first and the bank will make a loan if it’s got a good loan; it’ll find the reserves later if it needs to. And so they figured that part out too. But I’ve been reading for over a decade when I became aware of it, but I can find books that go back a very long ways that understand the money creation mechanism and its role on demand.

Steve Keen: Yeah I mean you go back to before the 1930s, you find it was common place to understand this. It’s really just a recent fetish coming out of the American mainstream economists, largely beginning with Tobin back in the 1950’s. Tobin himself actually effectively ended up disowning the concept that he helped to bring in that banks didn’t matter. In his later work he became a good friend of Stephanie Colton who is one of the leading thinkers in endogenous money these days. And now thankfully working in the United States, I think Congress office as an advisor. So her intelligence is turning up in the Congress.

But this belief that banks, debt and money don’t matter to macro economics really was a fetish of what I call the Samuel Sonian approach to economics which evolved in America, called itself Keynesian but had bugger all to do with Keynes. And the more extreme right wing version of that being what Milton Freedman developed and gave rise to what they now call new classical economics. They’re even more strident at ignoring the role of virtually everything apart from indifference curves and -- which are fictitious and marginal cost curves which are equally fictitious. So it’s an American thing, and it’s not just -- the intriguing thing is you look back on the 1930’s and so on, before the 1930’s, it wasn’t just progressive economists like it is today who make this case. It was quite conservative economists who also saw it. For example if you read the general theory, you’ll find Keynes counter posing his views to Pigou and seeing Pigou as being the expression of the conservatives. Pigou had a book called Industrial Fluctuations, written I think in 1927 where he correlated the change in level of private debt to the rate of unemployment and made the case that the change in debt generated demand and this is a major part of why there was a correlation between it and the level of unemployment.

So even somebody that Keynes regarded his conservative foil in the pre-second World War period understood the role of banks, debt and money in the economy. It’s been obliterated from the text books, but of course it hasn’t been obliterated from reality, which is why we had the financial crisis.

Chris Martenson: So let’s talk about one last piece of economic so-called reality; behavioral economics tells us that people are irrational, right? Predictably so. And we -- you and I we already know that because we interact with people and we’re humans and so we understand that. But classical economics still assumes people are rational. Again, this is a bad assumption, correct?

Steve Keen: I think we’re actually doing them a favor calling what they described as their behavior as rational because it’s not what they described as rational, because it is not rational at all. It’s prophetic. Their definition of rational is that someone has a model which can help them accurately predict the future. And if you walk into the street and say “I have someone that has a model that can predict the future”, how would you describe that person? And the person you said, “Oh you mean Nostradamus or Jesus or do you mean a prophet?” And they say “Oh no, I mean you. You’re a rational person, therefore you have a model that can help you predict the future accurately." They’d lock you up. Now that’s what they actually developed as the definition of rational. And the reason that happened, when you look in the development of history of economic over time is in some ways it was an inevitable necessity for them to reach this absurd position because they tried to argue that you could work out the economy without considering people’s expectations of the future. When you read Keynes, he  said he uses classical economic theory as one of those pretty polite techniques suitable for a well paneled ballroom in stable conditions, which tries to deal with the present by extracting from the fact that we know very little about the future. Which was an accurate characterization of the mainstream economics at the time Keynes wrote.

But what they’ve tried to do by supplanting Keynes is rather than saying we can ignore the future, the only way they can tame the impact of the uncertainty of the future on the decisions we make today is to presume we can accurately predict the future. So falling for this nonsense of rational expectations was a necessary consequence of trying to build an equilibrium model of the economy, and that’s where they’ve ended up. Interestingly enough there’s a paper by one of the leading apparatchiks in this whole area called Robert Barrow. Robert Barrow wrote a paper in 1984 I think called "The State of Rational Expectations in 1984." And he wrote in the paper that one of the cleverest things about the rational expectations revolution as they describe it -- this is a direct quote, “The appropriation of the word rational” by which case it meant that anybody who wanted to oppose them had to either support irrational behavior or talk about deviation from rationality which is a very difficult thing for economists to do. So he’s actually admitting they stole the word from the dictionary. That’s what appropriation means. So I’m appropriating it back and I now describe what they call as rational expectations as prophetic expectations. That’s what they use in their models to cancel out any uncertainty about the future, any capacity for state actions to affect the level of the economy and also any capacity for crisis to happen because if you could predict the future of course you’d never walk into a crisis, would you?

Chris Martenson: No, no. So if I add this all up, by failing fundamentally to account for the proper role of debt in the economy and demand and the way it pulls demand forward from the future into the present, appropriating the word "rational" and misusing it badly in models -- this whole idea that we have some form of equilibrium economics as if it were a closed form equation where if we just dialed everything right we could have this perfect steady state of full employment, full capacity, all that. Given all those things, if you put them in a spot that says you’ve got a bad model, Steve what’s the risk of having bad models at the heart of your monetary policies?

Steve Keen: Well certainly you’re going to run into a wall you don’t even see coming your way. This is of course what happened in the financial crisis. If you look at the conventional literature, they simply can’t explain where it came from apart from saying it was due to a big exogenous shock. Now I don’t know where you noticed it; I didn’t see any meteor landing next to my city. Did one hit yours? Exogenous shock means something from outside the planet pretty much, outside the economy. There's a paper by, what’s his name? Ireland, think of the country Ireland -- talking about the failure to suspect crisis during 2010, running during 2010 and he wrote saying that the failure to anticipate the crisis makes you think maybe we should revise our whole economic theory approach. He then said, "no, if you take a look at it we can find that the reason the crisis happened in 2007 is the economy was hit by exogenous shocks to technology and preferences," which are the two categories they talk about, technology and preferences for consumers, "of roughly the same scale and size as that in previous down turns. But they’ve then got bigger and lasted longer. And therefore we can explain the crisis because there were shocks to technology and preferences."

Well what were they, mate? Identify them please. What happened, did consumers suddenly start disliking Coca Cola? Was there a wave of people buying fresh water rather than Pepsi? What’s going on there that explains this huge movement? And of course they can’t do it so they bring everything down to exogenous shocks. And of course the real world would be an exogenous shock if you leave it out of your model. And fundamentally what they’ve done is, by leaving out the banking sector, any crises that emanate from the financial system will be a surprise to their models. Now they’re bringing in -- ever since the crisis hit, they decided they needed to included the financial system in their source of things that impede the market from reaching a perfect equilibrium. But as usual—and you’d know this well—they incorporated as they incorporate everything else, saying the financial sector is now a source of additional friction. Of course friction is something that slows you down.

If you believe the system is going to converge to an equilibrium, then the friction will mean you get to equilibrium more slowly. It doesn’t explain acceleration and why you suddenly fly off rapidly and have a crisis so they can explain why once a shock hits the financial sector means you take longer to get back to equilibrium. But it doesn’t explain the financial sector as a source of accelerance that caused the crisis in the first place.

Chris Martenson: It all sounds so self serving because you know one of the things that the central banks really want to do is to, at least from my perspective, is to enable sovereign entities to deficit spend and so they need a large and willing pool of people who are willing to absorb that debt. And if those don’t exist they will themselves become that willing pool. It feels to me like the whole thing is a bit self serving because --

Steve Keen: No it’s not; there I’m going to disagree with you. That is -- in fact the same economists who developed this fantasy, one thing they do want to do is they want to justify a role for the central bank in setting the reserve interest rate. So that’s a major part of their model, so they want to justify the status and importance of the central bank, as a setter of the price of money. That’s what they want to do. In terms of the volume of loans being generated by the government, they are actually in favor of 100% of those -- if the government runs a deficit, they’re in favor of that entirely being financed by selling bonds to the public. And they are -- they would prefer to see the government running a surplus, not having a deficit at all. So you’re seeing -- I can understand where you get that position from, but the fundamental nature of their thinking is that the economy is best that the government is a size zero. That’s the extreme neoclassical. Of course, people like Krugman don’t believe that and that’s something in his favor. But the extreme neoclassicals actually believe that you should get the government down to virtually not existing at all. They believe the private sector works perfectly well without any government intervention whatsoever. And when you look at the horror that’s being imposed on Europe right now, the fact that there is a fetish running government surplus over here is another product of the economic theory.

Chris Martenson: Well, so let me tell you where I get this view, and my view stems from this. You’ve shown before that it’s technically possible for a debt based money system to operate in a non exponential fashion, but all the real world data I have Steve, shows near perfect exponential behaviors, r-squareds of .99, right? This is both for debt and monetary aggregates individually.

Steve Keen: Yep.

Chris Martenson: So I see a big problem with having an exponential money system on a finite planet, that’s the core of my view. But mainstream economics I think—what I’m seeing from the central banks is I feel —this is my perception, they have got us on an exponential debt train and they need to continue that. And whether that continues in the public or the private sphere is a little bit irrelevant. I agree with you they would prefer it happen in the private sphere, but if it’s not happening there perfectly happy to continue that train in the public sphere if necessary, maybe under exigent circumstances. How do you respond?

Steve Keen: You’re wrong about their ideology and why they’re doing it. They don’t even know that that’s the case; they don’t think there is a particular trend and they’re preferred situation would be to drive public debt down relatively toward zero and they ignore private debt completely. So you’re gracing them with too much comprehension of the world in which they live. There’s a wonderful sci-fi book I read a short while ago called The Wyandotte Girl and it had a wonderful line in it where the protagonist was not at all a likable person who was described as suddenly realizing the world he understood was not actually the one in which he lived.

Chris Martenson: I regularly give people too much credit and so if I look at what -- I thought for sure somebody in the Federal Reserve would have been following the same data I was which was starting in 1970 in the United States total credit market debt has been compounding at nearly 8% per annum, 7.9%. And income, GDP, GNI, whatever we want to measure, has been roughly half that rate. So to me it looks like since 1970 there’s been a very concerted effort to have credit and credit markets expanding at roughly twice the rate of the underlying income growth. To me that’s just a math problem waiting to happen. Are you telling me that in the Federal Reserve there’s nobody who looks at that and says, “Sooner or later that just breaks”?

Steve Keen: Yep, nobody looks at it in the Federal Reserve.

Chris Martenson: Really? That’s disappointing.

Steve Keen: I deal with these people on a daily basis and to give you an idea of how primitive their thinking is there—this is not the Federal Reserve, this is the Australian central bank, the IBA—but I was once at a speech by one of the deputy governors there and he and I had a chat after the whole thing and I was talking about the problems of the debt to GDP ratio, the private debt to GDP ratio. He quite literally said to me, “I don’t know why you worry about that because you’re preparing a stock to a flow”. He thought I was making a stock flow error. Now a stock flow error, you being a properly trained scientist and engineer, you know that the stock flow comparison is adding a stock to a flow and thinking you've got a meaningful amount [Inaudible 00:23:49] looking at rate of change, makes the mistake between -- people often think interest can’t be paid and they're comparing—the loan doesn’t create the interest and they say "you should have given the interest for the loan as well as getting the loan." What they’re doing is they’re looking at dollars and dollars per unit of time and not realizing they can’t combine the two that way. But to make a comparison of stock to a flow, to get a ratio like you and I are working on in terms of debt to GDP ratio makes imminent sense because the ratio tells you how many years it will take to repay the debt you’re in. So that’s the level of stupidity. And it’s not that the guy is stupid at all; it’s that they simply have a mental framework that doesn’t allow them to consider that issue so they come up with nonsense reasons why not to think about it.

Chris Martenson: So let’s talk about this 200 trillion dollars of debt; I’m sure you saw that McKinsey study. The world is saddled with that monster amount. Can that ever be paid back?

Steve Keen: No.

Chris Martenson: Okay. What terms is it going to get dismantled then?

Steve Keen: Well we should be writing off large parts of it, and I would actually write it off by the capacity of the government to create debt-free money. That would be using what I call the modern debt jubilee. So it would be quite feasible to do that on a grand scale and change the effective basis of a large part of our money supply from credit based to fiat based. So it’s quite feasible to do it that way.

We won’t do it that way of course. What we’ll do is let people go bankrupt and hound people who can’t pay their debts, etc., and force them to pay debts which are unsustainable like is happening in Greece right now. And what that will mean is rather than people being able to spend money, they’ll be forever paying off their debt with whatever income stream they have, and by doing it will depress demand in the economy so that as well as paying down their debt they’ll also reduce the size of the GDP and the ratio imbalance remains much the same. Of course the situation I’ve described has been the situation in Japan for the last 25 years. So this sort of madness can go on for a quarter of century. The only salve to it, and the reason that Japan has gotten away with it so successfully so far—there's two salves. One is the government running a deficit and running up its own debt. The government is the only organization that has its own bank, effectively. So that’s the reason the government can get away with running their debt. Government debt in Japan has gone from, I think when the crisis began in 1990, 75% of GDP to 250%. That’s provided a stimulus the economy wouldn’t have had without that incredible increase in government debt.

At the same time, Japan runs a huge trade surplus that also lets it get away with it for a large length of time. Globally of course there’s no such thing as a global trade surplus; so that particular avenue goes. The only solution to the level of private debt we’re in and the drag that’s putting on the global economy is to have a huge amount of government spending. But of course with governments running their own deficits as well, we get caught in a stalemate. And so the likely outcome of all this is stagnation with levels of debt that remain constant while GDP falls.

Chris Martenson: And that sounds like a recipe for having an ever increasing proportional flow of what real income and productivity is occurring from the general populous to the holders of that debt?

Steve Keen: Yeah, yep.

Chris Martenson: And so in the context of this wealth gap that we’ve got right now, which by the way I think is a bit false because it’s obviously been pumped up to some extent by the QE and other printing efforts of the central banks. But eventually just mathematically it sounds like if you play this debt game long enough and you don’t have some sort of rebalancing or if you’re over expressing debt relative to income sooner or later even if you have -- unless interest rates go to pure zero, if there’s any nominal rate of interest at all what you’re going to find eventually is that 100% of your income ends up being consumed by debt payment somewhere. Not now, but at some point, is that right?

Steve Keen: That’s the eventual truth. You don’t get to 100% by any means, you get to the stage where you can’t stay alive and pay your debt at the same time. If you don’t make your debt payments, let’s say you’re talking people in a mortgage of course, then the house gets repossessed. Now that means that the pressure is on you unless you can walk away as Americans did, given the legal system there with you know, jingle mail. It gives you an inability to consume other things and so it’s just a gap -- it’s the gap between what you’re getting as an income and what is the absolute necessary level of spending to maintain your minimum lifestyle. And if that gap falls to zero then you know the whole thing collapses because people go bankrupt and it just cascades through all their other spending and they go from being in a desirable level of disposable income to being wiped out. And that’s -- that -- we’re so close to that level at all times now because so little deleveraging occur during the crisis itself. So little deleveraging is possible.

Chris Martenson: Right, right. Let me back it our really wide for one second then I’m going to close in on Greece. I’m looking at things like the social security and entitlement shortfalls in the United States, and of course this is a net present value calculation; all future flows and outflows -- inflows and outflows are balanced and then you get a number, right? And so when I go over to the Congressional budget office and I look at their projections for inflows, I see that they just smoothly give about a 3.3% rate of GDP growth for the United States for the next 100 years, right? So of course this is exponential growth, you model it out, you discover that by the year 2076 the United States alone in current dollar terms has a GDP as large as the entire world today. So given where we are with respect to oil, other resources, water, soil, things like that, I find it hard to intuitively -- in fact I will reject this intuitively—that the idea that the United States will alone have an economy consuming as much as the 100% of the world today by 2076. It feels to me like there’s something in there that just doesn’t work in this story.

Steve Keen: More than something. The whole awareness of the extent to which an economy is based upon the exploitation of free energy and the necessity that that generates -- generating entropic waste, both in terms of heat but also when you’re processing minerals actual physical waste. And then the impact that has upon a biosphere of a limited scale. All that thinking has been completely excluded from economics because they’ve never ever developed a system of thinking, they think in equilibrium terms. So that project forward 3% of growth per annum indefinitely without thinking, well, what is systemic impact upon that, given the scale of the planet we’re on, given the amount of capacity of the biosphere to absorb that waste heat, etc. You’ve probably seen it Chris, there's a wonderful article called "Exponential Economist Meets Finite Physicist." Have you ever seen that?

Chris Martenson: Oh yeah by Tim -- Mr. Brown.

Steve Keen: Right. What that argues of course is that even if you leave out global warming—I don’t think you would have any global warming deniers on your reading list but even if you did, even ignoring the complete existence of global warming, if we carried it forward the current rate of per-capita growth in global GDP and emphasize per capita to get away from population growth as well. So even stabilized population that had the same per capita rate of growth we’re talking about now. I think in something like about 250 years time, through that entropic waste, entropy being generated by the production process—

Chris Martenson: Just waste heat.

Steve Keen: Simple waste heat. The temperature level of the planet would be hot enough to make water evaporate; so we join Mars at that stage. If you get the thing going for 450 years, with the lovely effect of the exponential function, by that stage the surface temperature of the earth would be equivalent to the surface temperature of the sun.

Chris Martenson: So you think we might stop somewhere before then?

Steve Keen: We might stop somewhere before that. This inability to bring this into economic thinking is one of the many, many flaws so I’m actually working with Bob Errs (ph) and a few other people who are energy aware physicists working in economics trying to bring energy into the production equations that economists use because they completely leave them out. They have equations that presume you can produce output using capital and labor where energy is not included as a factor.

Chris Martenson: I’m so glad to hear that that’s happening because it’s by far the largest gaping hole in all of this for me. And by the way, I get all the time people send me emails like when Ray Kerswell says, “Oh the world is going to be 100% on solar in 16 years” because he’s just sort of taken some simple doublings and penciled them out. And you know I was just in Mexico City and the place is just one giant traffic jam and it’s not unique. I was in Lima a while before that, same thing. It doesn’t matter which city I go to I see humans burning oil at just this phenomenal pace and there’s no way we’re going to replace any of that traffic with solar powered cars at any point soon, not on a percentage basis. And yet you know the world -- the United States is going to peak in shale oil output in the year 2020 at the latest, I think it will be sooner given the hiccups they’ve had there with the pricing. And that’s to me like right around the corner, and yet you have people buying Spanish 50 year bonds at whatever that went off at, 3% or something. Tell me in the world of finance who is buying a 50 year bond and can they not connect dot A to dot B in this story?

Steve Keen: Again it’s that inability to think in the long term. This is one of the great weaknesses of conventional economic thinking again because people think in equilibrium terms, static equilibrium. They call it dynamic [Inaudible 00:34:33] equilibrium models but they’re not dynamic in any genuine sense of the word. They don’t extrapolate, they don’t look at the long distance extrapolation and say "well this obviously can’t be maintained forever so we have to have a feedback that reduces that rate of growth or causes something else to change." They don’t have that so the complete lack of system thinking is then captured by the -- when they’re going to get a job in the finance sector, they work on a three month quarterly basis and the basic answer on that question -- I don’t know if I can use French on your program, "I couldn’t give a shit about what’s going to happen in 50 years time. I’m looking for my bonus in three months. And the fact that Spanish bonds is rising and I can make a plan, I’ll buy them."

Chris Martenson: Well certainly seems as short sighted as I thought it might be. So let’s turn to Greece for a second. You’re friends with Yanis Varoufakis, Greece’s new Finance Minister, is that correct?

Steve Keen: Yep, mm-hmm.

Chris Martenson: How long have you known him?

Steve Keen: I met Yanis in 1989; so quite some time ago.

Chris Martenson: What’s he like?

Steve Keen: He’s a great bloke. The funny thing about Yanis is if you -- you don’t need to ask me, you can watch TV. In other words what I’m saying is the personality you see on TV is precisely what he’s like in private. He is a wonderful orator, he’s very magnanimous, he has a beautiful voice and fills the room with his voice. He’s every bit as big as he looks in terms of physical physique. He works out more than I do and certainly more than most economists do. Very warm, plenty of bonhomie and highly critical of mainstream economics and well trained in mathematics; so that’s what made us good friends when we first met. Because most critics of mainstream economics criticize mathematics and the mistaken belief that it’s mathematics that led economics astray. I describe what economists call mathematics as "mythematics." And Yanis is one with me on that front. He regards their math as delusional and he actually did a masters in mathematical statistics before he ended up doing his PhD in economics. And so he is highly enough trained in mathematics to know what economists do is trite, or garbage or wrong. And he’s been pushing that line for many, many years in economics in the way he teaches and the work he did in game theory and so on.

The general thing is he’s a very, very warm and large personality guy. To give you an idea, the last thing that happened, give an element of that too, my university in Sydney shut my department down, University of Western Sydney. I got an invite out of the blue to Western Sydney function, gave me a surprise. I opened it up and saw why: Yanis Varoufakis was talking at a conference and he insisted he was not going to give the talk unless I was in the audience. So I got invited. Now that’s both balls and respect for a friend and integrity. So I -- I really feel for him in this position because when he got offered the position of Finance Minister and when Tsipras won the election he said, “Thank you I’m delighted to receive this poison challis”.

Chris Martenson: He knew what he was getting into, didn’t he?

Steve Keen: He knew what he was getting into but I think it’s even worse than he thought because, for example, I made a couple of suggestions about macroeconomic arguments that he can make with the other finance ministers and he said, “If only they were interested in macro economics”. He said he can’t even get them to discuss macro economics and yet they’re making decisions about the macro economic fate of Europe in general, not just Greece.

Chris Martenson: Well you described somebody who is genuine, authentic and full of integrity. I notice that the bureaucrats in EU have not taken to him all that well perhaps because of the same descriptors we just used.

Steve Keen: Partially that. I think it’s also a question of intellectual orientation. Most of the finance ministers lawyers, [Inaudible 00:38:31] in particular has a PhD in law and this is one thing that goes wrong with the political process, not that I’m in favor of winning economist jobs in economics obviously because they’re totally delusional most of them. Yanis of course I completely support getting an economics position. But if you’re not even trained in the area where your portfolio responsibilities lie, then you’re likely to interpret that portfolio using your own intellectual background. And the intellectual background of those people is law, law involves signing contracts and from their point of view Greece is trying to weasel out of a contract.

Chris Martenson: Right.

Steve Keen: That’s entirely the wrong way to think about what’s going on there. My suggestion, one of my columns was that maybe the way Yanis should argue is to take a lawyers point of view and saying, “Part of your contract with us was that if we followed austerity, unemployment would peak at 16%. By now it would be 12, it’s currently 25, you have broken the contract and we want to break out of it” that way but he just simply can’t even get to first base and discussing the economic impact of the policies on Greece.

Chris Martenson: That certainly seems like a tough place and I totally understand this whole thing about law, lawyers and how they think. I’m trained in -- I got trained in pathology so everything is risk and probability for me. But lawyers are trained to think in a certain way and our own FOMC is stacked to the gills with people with JD degrees when it’s supposed to be people who represent a cross section of industry and regions and thinking, but it's pretty well stocked with lawyers and academics.

About Greece then, so Yanis comes in with Tsipras and they’ve got some campaign promises, they come out of the gate and I was among many who had high hopes that Greece’s new government would inject at least some reality into these debt negotiations. It was Yanis who came out and said “I’m the Finance Minister of a bankrupt country”, right? That was just brilliantly honest, something I think we need desperately in today’s day. The troika negotiations, saw very little coming out in new terms for Greece It looks like they’re not just on the eleventh hour; they’re on the eleventh hour 59th minute of this whole thing. They’re getting short on cash, what’s going on there right now?

Steve Keen: Well in terms of Greece itself, panicked attempts to get money out of the country by people that have got deposits there. That’s been stalled because of the belief for a while the crisis will be resolved and they'll stay in the Euro. But basically massive uncertainty amongst people; great support for SYRIZA but people worrying that they’re going to get steamrolled by the Troika. Which they’re no longer allowed to call "the Troika," I find that quite hilarious. They call it "the institutions" instead. [Inaudible 00:41:23] unemployment  suddenly falls from 25% to 3, thanks very much.

So very I think trepidatious in Greece itself. A lot of frustration because the Greeks actually don’t want to leave the Euro. They know that their economy is very weak. They want to be involved with Europe in general; they don’t want to face East, in other words, where basically they're aligning themselves with Russia or getting caught up with Turkey and so on. So they’ve got strong political reasons to want to stay in the Euro. And they’re trying to find a way to go from what they’re calling a bad Euro to a good Euro. But the approach of the EU is so strong in maintaining the current terms of the condition that that’s imposing just the bad Euro and in some -- to me I don’t think the European Union appreciates how close there is to a breaking point because they don’t actually provide -- the brinkmanship scares me because if they time it wrong, if they actually get to the point where Greece says, "we can't pay its debts," that triggers all sorts of obligations throughout the leveraged world we live in right now, rewriting of debt and so on; it’s scary. The European Union is playing it right to the brink.

Chris Martenson: It seems to me the chance for this to break is higher than ever. I feel the same brinksmanship going on with respect to the way the West and Russia are treating each other at this point in time. You know what, when I add all of this up, all of these pressures and tensions, it feels a lot to me like a world that’s just ready for another financial accident of some kind. It’s got that sense of we’ve got these sclerotic institutions and ways of thinking and don’t know what to do besides what we’ve just done. It isn’t working so we do more of it and we’ll just keep doing that until it breaks. That’s my sense. In your mind, where do we go over the next five years in this story?

Steve Keen: Well England and America are on an upper trajectory in private borrowing again; America more so than England and that’s what’s giving you apparent prosperity over there. So that growth trend could continue for some time. I give it about five years as a maximum though because America is growing from a level of private debt of about 140 plus 5% of GDP I think as the Federal Reserve currently records it. The last big boom—I date the boom from 1992 forward to 2007 because you only had a little blip during the .com bust and the subprime bubble took over where the .com bubble gave up and you had this overlapping period of prosperity going on for 15 years. That simply can’t continue this time because that began from about a 90% private debt to GDP ratio; you’re now at 145% and you reached a peak of 165%. So you've got head room of something like, at best, another 20% of GDP before another private sector catastrophe comes along, people stop borrowing or there are people who can’t manage to roll over their debts and they collapse and cause a financial tidal wave or banks that end up having hot potatoes in their books that they can’t get rid of at the right time and bang another crisis. So that’s the endogenous, if you like, time that I would give it.

The other one, which is where the Federal Reserve comes in, is that because the Federal Reserve doesn’t comprehend the importance of private debt and because they’re seeing growth going on and they’re not quite certain where it’s coming from but they’re applauding that it’s happening. They may get into an interest rate rising cycle and not understand the consequences of raising those rates because again from their point of view increasing interest rates simply redistributes income from borrower to lender. The borrower suddenly gets a more expensive rate which means they can spend less but the lender gets the larger amount of cash and they can spend more, and one cancels the other out, minor macro economic impact. What they would do is slow down the rate of growth of the economy by controlling people’s desires to invest, that’s how they perceive the whole thing. They wouldn’t realize that by putting those rates up they may stop people from borrowing from banks, meaning the money creation process suddenly comes to an end and then we go down again. So the Federal Reserve can end up pricking this bubble this time around without knowing the bubble is there.

Chris Martenson: It wouldn’t be the first time.

Steve Keen: No.

Chris Martenson: So that’s a reasonably safe bet if they’re going to create an accident, maybe that would happen the same way as it happened last time. Well Steve thank you so much for your time and we’re out of time here today. I know that you do keep a blog over at Forbes where people could follow you a bit.

Steve Keen: That’s right, yep.

Chris Martenson: I see that at Forbes.com/sites/stevekeen. Beyond that, best of luck with working with the people who are trying to bring maybe some view of what we’ll call the real world—energy and resources, the environment, all of those other outside things—into the world of economics. It’s really honestly I think one of the biggest things we have to do.

Steve Keen: Thank you Chris, glad to talk to you again. I'd like to catch up again when I’m back in America one day.

Chris Martenson: Absolutely, thank you Steve.

Steve Keen: Bye bye.

About the guest

Steve Keen

Steve Keen is Professor of Economics & Finance at the University of Western Sydney, and author of the popular book Debunking Economics, a second edition of which has just been published (Zed Books UK, 2011; www.debunkingeconomics.com).

Steve predicted the financial crisis as long ago as December 2005, and warned that back in 1995 that a period of apparent stability could merely be “the calm before the storm”. His leading role as one of the tiny minority of economists to both foresee the crisis and warn of it was recognized by his peers when he received the Revere Award from the Real World Economics Review for being the economist who most cogently warned of the crisis, and whose work is most likely to prevent future crises.

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72 Comments

seangrif's picture
seangrif
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Down with brinkmanship, up with reconciliation..great podcast!

This pod cast should be compulsory listening in every parliamentary chamber across the planet. 

Arthur Robey's picture
Arthur Robey
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Empirasism Rulz

(At least in this model that we call Reality)

It sounds as though Prof. Keen is a scholar of Meadows. Let us be generous and assume that the ivory tower is gifted enough to understand the real world implications of the Limits to Growth and are just not going to go there.

Feralhen asked me about the moment of Price Discovery.  My best answer is that every lever will be pulled to delay that moment for as long a possible. Over here in Australia we are controlling demand by controlling the immigration rate. Of cause externalities are ignored. 

Man is not a rational animal, man is a rationalizing animal. 

davefairtex's picture
davefairtex
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Steve Keen is The Man

I hated economics when I was in college - but that's only because I didn't have this guy as my professor.  His version of economics makes sense.  All the bits hang together.

I like his modern debt jubilee, how banks generate money - and he's plugged into resource limits on a finite planet too.  How much better can you get?  The man is solidly grounded in reality.  The Varoufakis bit was icing on the cake.

I think I'll go listen to the podcast again.  I think its awesome we had him on.

BTW, Keen has a very clear explanation of why debt grows at an exponential rate over time - it has to do with the fact that the central banks never allow the debt from the most recent Ponzi cycle time to deflate - they feel the need to start a new credit cycle to deal with the previous Ponzi.  What results if you zoom out far enough?  Exponential growth in debt.  Not because of a structural problem in our monetary system about paying interest, it is because of human nature's endless desire to avoid economic pain - rinse, repeat.

We saw this very thing in the housing bubble: it was started in order to deal with the dotcom crash.  Now they're trying again ... creating a bond bubble to deal with the deflated housing bubble.  Repeated bubbles + no time to deflate = exponential growth in debt over the long term.  And the bankers (who aren't part of the standard economic model) have no interest in "tapping the glass and disturbing the fish" - they want debt maximized, because that's how they make the most money.  Maximize debt, and you maximize banker income, and (as a side effect) its control of government policy.

At the core, we have a bunch of lawyers running the Fed, advised by a staff of economists who don't have money and banking as part of the important bits defining how the world economy works, egged on by bankers who have been defined out of the model so they can't possibly be at fault when things go sideways.

I'd say that the banking establishment finds this status quo all very useful.

"Its all about aggregate demand."  (Ignore the bankers, they don't matter)

And a Jubilee?  Can't free people from their (debt) slavery.  Not allowed.

Arthur Robey's picture
Arthur Robey
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One B. Bernanke Blogs.

Over on zerohedege we have the Oracle himself. I invite you to count the number of times the word "equilibrium" is mentioned.  

Its a competition.  A bit like guessing how many jellybeans are in the jar.

http://www.zerohedge.com/news/2015-03-30/ben-bernanke-pens-first-blog-po...

gillbilly's picture
gillbilly
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Excellent!!!

Great podcast! General Equilibrium Theory has always been based on flawed, if not plain wrong, assumptions of marginal utility. Thank goodness there are economists working on alternate theories that move away from this gawd awful foundation of rational consumerism. I remember having this conversation awhile ago on this site and it was pointed out that the GE Theory merely replaced Value Theory. (based on labor, as well as including historical value) Something to consider.

I like how Keen wasn't afraid to call Chris's view of the FED "wrong." I'll bet Chris got a kick out of this since he was basically being accused of giving the FED too much credit. smiley

I also believe the idea of anti-fragility is built into the status quo of Equilibrium thinking, as Keen professes. Contrary to what those at the FED probably think, short-term targets are the only goals realistically considered, i.e., short-term binding contracts (leveraging) have become the deciding factor of keeping that equilibrium in place. Can you imagine the unraveling of those contracts if there were a massive jubilee? (even though there are some currently that create their own jubilee by walking away)

Regardless of the advantages to banks for maximizing debt, I think it is also somewhat human nature for many people to want the status quo, as Khanemann says in this video, some like the room temperature set at a constant 70 degrees, and if you don't have FU money to ride out the storms, 70 degrees feels pretty good:

cmartenson's picture
cmartenson
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It's worse than that!
gillbilly wrote:

Great podcast! General Equilibrium Theory has always been based on flawed, if not plain wrong, assumptions of marginal utility. Thank goodness there are economists working on alternate theories that move away from this gawd awful foundation of rational consumerism. I remember having this conversation awhile ago on this site and it was pointed out that the GE Theory merely replaced Value Theory. (based on labor, as well as including historical value) Something to consider.

As Steve explained, it's even worse than that...the standard economic models have the assumption of not just a perfectly rational set of actors, but every one of them endowed with perfect clairvoyance...able to integrate all current knowledge into a framework that allows them to make perfect decisions.

This was needed because otherwise the models just didn't behave properly.

Which is why you have jokes like this one;  three economists are locked in a basement and are beginning to get hungry, but they are not worried.  Why Not?  Because soon enough one of them will just assume sandwiches to have always existed in the basement.

The real mystery is that despite the massive failings of standard economics over the past decades at explaining or predicting anything at all useful, their every word is still fawned over by the world...

jgritter's picture
jgritter
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Disturbing

Well, that was unsettling.  I share Chris's slack jawed incredulity.  For some time I have been frustrated with how little credit Chris gave the FED.  I almost gave this podcast a pass thinking it was just going to be another central bank beat down. Surly, I though, intelligent people must know what's going on, they must have a plan.  I was fully prepared to accept that the plan might be to jettison most of the human race, not personal, just business.  To find that TPTB may not, no shit, honest injun, have any f***ing idea that their models and projections are insane is disturbing, to say the least.

I feel like a passenger on an airplane.  As a reasonably educated person I can look at a map, look at my watch, calculate the amount of time the airplane can continue to fly and realize that we're not going to make it to the destination we all bought tickets for.  Ok, the flight crew will find an alternate airport, travel plans will be disrupted, inconvenient and disappointing, but nobody is going to die.  Not going to retire to a warm sunny place and spend my golden years in leisure, but perhaps food, shelter and medical care. Plane keeps flying.  Hmmm, not good.  Flight crew must be looking for a place to crash land.  So, no retirement, work until you can't, die in poverty.  Not pretty, but there you go.  Plane keeps flying. It becomes apparent that the plane is on autopilot, the flight crew is oblivious, the cockpit door is locked and that we are going to fly straight into the side of a mountain.  

Cognitive dissonance.  Trying to wrap my head around the idea that we seem to be headed for the collapse of the industrial civilization bubble without any meaningful attempt at mitigation at all, bummer.

John G

Jim H's picture
Jim H
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Left unanswered is Chris' question

Why does this system (of debt-based money) keep compounding on itself in exponential fashion?  Steve Keen completely ducked this one... he just said that the FED economists, and others of the same Keynesian ilk, would rather not see government deficit spending/gov't growth, along with some comment (I forget) regarding his model that shows debts could be covered without exponential growth.   

My head is going to explode.  Maybe it's like 9/11... nobody could have seen it (the exponential debt-berg) coming.. just a failure of imagination.  Riiiiiiiigggghhht.  

 

 

Jbarney's picture
Jbarney
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Great and Alarming Description
jgritter wrote:

I feel like a passenger on an airplane.  As a reasonably educated person I can look at a map, look at my watch, calculate the amount of time the airplane can continue to fly and realize that we're not going to make it to the destination we all bought tickets for.  Ok, the flight crew will find an alternate airport, travel plans will be disrupted, inconvenient and disappointing, but nobody is going to die.  Not going to retire to a warm sunny place and spend my golden years in leisure, but perhaps food, shelter and medical care. Plane keeps flying.  Hmmm, not good.  Flight crew must be looking for a place to crash land.  So, no retirement, work until you can't, die in poverty.  Not pretty, but there you go.  Plane keeps flying. It becomes apparent that the plane is on autopilot, the flight crew is oblivious, the cockpit door is locked and that we are going to fly straight into the side of a mountain.  

Cognitive dissonance.  Trying to wrap my head around the idea that we seem to be headed for the collapse of the industrial civilization bubble without any meaningful attempt at mitigation at all, bummer.

John G

This is one of the best descriptions I have read in a while, and it is scary to think how close to the mark these words come for me.  Whether it be discussions about over population, debt problems, sustainability issues, people having their perceived future retirement taken from them...all of these things are building.  If you take the plane analogy....it is amazing how many people are calmly sitting in their seats, just looking out the window...waiting for the plane to land.

With this description we can just hope that the plane analogy isn't right at all, that we are closer to the ground, riding smoothly along in a vehicle.  2008 was a pot hole.  Perhaps that next one will be a pretty nasty frosty heave.  Perhaps, just maybe, the future can be navigated. 

 

 

Time2help's picture
Time2help
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Tables Upright, Please
Jbarney wrote:

With this description we can just hope that the plane analogy isn't right at all, that we are closer to the ground, riding smoothly along in a vehicle.  2008 was a pot hole.  Perhaps that next one will be a pretty nasty frosty heave.  Perhaps, just maybe, the future can be navigated. 

That might depend on your definition of "isn't".  I don't think The Thing is going to let us off the hook that easy. From a Control Theory standpoint, things tend to break suddenly and permanently when you get to where we are.

Perhaps your local mileage may vary (?)

climber99's picture
climber99
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Posts: 188
Initial thoughts

1. An economist who understands money creation/destruction.  cheeky

2. Does he really appreciate the role of energy in our economy or does he share Zerohedge's  ignorance of peak oil and peak net energy ?  blush

3. Thinks the Ponzi scheme could carry on for another 5 years in US and UK if we can continue our private debt expansion. smiley Let the party continue.

4. Thinks that there should be a debt jubilee.  Savers will not be happy frown Zerohedge will be livid.

5. He didn't predict much on Greece indecision No solutions apart from a debt jubilee, Europe would fall apart as the rest of southern Europe demand the same. Germany would go insane. Not good for peacefrown

 

Thanks Chris. Loved it. I'll go and hear the podcast again now.

climber99's picture
climber99
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pole-zero diagram?

Is that a pole-zero diagram, Time2help ?  Not seen one of those for 30 years.  We don't design systems like that any more.  We just built them and see what happens; yep that works, lets roll it out; shit that didn't, just blown my face off. 

Atreat's picture
Atreat
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Great, Great podcast

Thanks!

AKGrannyWGrit's picture
AKGrannyWGrit
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Posts: 474
Well I didn't study economics

Well I didn't study economics in collage so I had to listen to the podcast several times to make sure I understood the light bulb moments that kept going off.

It seems to me that we, Mr. And Mrs. Middle America, the ones who work hard, pay taxes, fight in the wars and are decent people, are the backbone of this country.  So it is shocking to learn that those with the purse strings don't think in the long term.  They are apparently indifferent or clueless to the plight of us "Middle Class".  As I have said before we are being quietly exsanguinated (QE).  Gee the economy doesn't look good let's stick a straw in the goose that lays the golden eggs (we Middle class) and see if there is any blood left. (QE - 4 on the agenda?)

Living in the land of plenty is seductive. Private planes, private drivers, expense accounts, eating at restaurants, having someone clean your house and getting your clothes dry cleaned distances people from the main stream economy.  Heck I go to COSTCO, Wal Mart, SAM's Club or a mega grocery store and the abundance of products gives the appearance that availability and good times will last forever. Lack and want are not part of the American way of life, or so it appears. Those who steer our country are out of touch, short-sighted and indifferent.

That sound I have been hearing these last few years wasn't planes flying overhead it's the sucking sound of the straw that's removing the last amount of life-blood from us middle class.  And I thought I needed a hearing aid.

Cranky Granny

davefairtex's picture
davefairtex
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flows make payments

JimH-

Why does this system (of debt-based money) keep compounding on itself in exponential fashion?  Steve Keen completely ducked this one...

Jim, I answered it.  My source: Steve Keen's other lectures.  He explains it in detail there.  However you have to have an open mind to truly understand it.  If you already have the "must create enough money to cover interest payments" belief system locked in place, your mind will reject the evidence - just like the neoclassical folks have rejected everything Steve Keen has to say.  They aren't stupid, but their entire life education precludes them from even considering his concepts.

The good news is, once you get it, you will wonder how you missed it in the first place.

The fact that I am involved in finance for a small business may have helped, actually.  Watching the P&L statements come by every month, and then watching the balance sheets, you start to understand instinctively how the flows (P&L) and the stocks (balance sheet) cannot really be mixed.  They do affect one another, but a stock is a stock (it just sits there, unchanging), and a flow is a flow (it varies every month).  And you need to manage both.

In this case, you use your flow (P&L) to slowly pay off the principal & interest on your stock (balance sheet loan liability).  Flow through the P&L is the key to making your interest payments.

You can have a $200k loan liability, $50k in the bank in assets, and making your payments are no problem as long as your cash flow is enough to make the $5k monthly payments.  There is no need to have "$200k + interest" sitting around on the balance sheet to service your debt.

Same thing if you borrow money for a house.  You don't need to have $300k + $30k in interest in the bank to be able to repay your $300k loan.  You just need an extra $3k/month in salary flow and you're good.

Example: to enable $1M in annual flows, our company needs only $50k in working capital.   (Ok, we need more, but it is possible to operate on that little).  We aren't going bankrupt.  We are profitable.  From a "system" point of view, our capital needs ($50k) are completely dwarfed by our flow through our P&L of $1M.  In a real sense, $50k of "fiat money created cash" enables $1M of annual flow.  If we had to borrow that $50k to enable our $1M of flow, do you think we could make the payments?  It would be easy.  Trivial.  Our $1M flow vastly exceeds our required $50k money stock - its a 20:1 ratio.

That's business.  Most businesses have a much larger cash flow over a much smaller working capital base.  Capital base was borrowed into existence, but the interest payments for that borrowed capital base are easily repaid from the rapid flows (10:1, 20:1) across the P&L statements of those companies.

Same is true for households.  Paycheck-to-paycheck America may have $5k in the bank, but they make $50k per year (i.e. $4100/month).  $5k in created-bank-credit "enables" maintaining the household on that income of $50k per year.  Another 10:1 ratio.  With such ratios, its quite possible to make interest payments on $5k.

Writ large, "the system" doesn't require that much in working capital to run.  Demand deposits (checking accounts) are 1.19 trillion, while total bank credit (total bank loans outstanding) is 11 trillion.  And this 1.19 trillion in borrowed working capital enables (provides liquidity for) a GDP of 17 trillion.

Flows make payments.  Not stocks.  If Keen were here, that's what he'd tell you.

 

Time2help's picture
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Re: Pole-Zero Diagram?

I offer solidarity.

davefairtex's picture
davefairtex
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keen's debt jubilee

For those that don't know, Steve Keen's "modern debt jubilee" is this:

A one-time payment, from - the Fed, lets say - to every adult citizen in the United States of $50,000, of freshly printed bank credit.

There is a catch.  If you are in debt of any kind, you must use the money to pay down (or pay off) your debt.

Cost: perhaps $14 trillion.

No creditors take losses.  Every creditor is made whole.  No defaults occur.

And those who are debt-free, get to keep (or spend) that $50k.  No moral hazard.

It would be inflationary, but not as inflationary as you might think.  As we know, when debt is repaid, money is destroyed.  What debts would be destroyed?

Credit cards & auto loans ($1.2 trillion) and a large chunk of mortgage debt ($9.3 trillion) would more or less vanish.  US government-originated student debt ($842 billion) wiped out.  America's citizens would be (largely) private debt-free.

Banking would suffer tremendous losses - not as balance sheet losses, but future income losses.  All that future interest income from all those debt slaves: wiped out in an instant.  No more 29% credit card debt.  It would all be repaid.  Bank credit lent at interest would largely be wiped off the map, replaced by fiat money created by Steve Keen running the Fed.

Corporate bond debt would remain in place, so would the sovereign debt.

Like FDR's one-shot gold devaluation, it would immediately reflate the economy and remove the personal debt burden at the same time.  Prices would probably jump higher.  How much?  I have no idea.  Likely, economic activity would explode.  Not hyperinflationarily, but with $50k in fresh money in hand, a whole bunch of low-debt poor people would likely go on a shopping spree..."I want a brand new car."

Not saying that particular aspect is a good thing, mind you.  But the debt paydown - that's the part I like.

Anyhow, that's his concept.

Arthur Robey's picture
Arthur Robey
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Flows pay the interest.

St.Steve has a post on Forbes about the stocks and flows.

http://www.forbes.com/sites/stevekeen/2015/03/30/the-principal-and-inter...

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I disagree with Keen vigorously on this one

I get the argument hat Steve Keen makes in his "debt money isn't by design exponential" but it's flat out wrong from a real world perspective.

First, we have the empirical evidence which shows a 0.99 R^2 for an exponential curve fit a credit growth in the US over the past 60 years.  If one want's to argue that such a system is *not* inherently exponential by design, then one has a rather steep hill to climb.

Second, the way in which Steve chooses to model the system works out as not being exponential by design because he has perfect stocks and flows modeled in.  Every stock is offset by perfect flows all matched by the perfect spending of interest income within the exact same groups that first borrowed the money from the banks.

However, once you have imperfect stocks and flows then things rapidly go out of balance and towards exponential behavior.

Consider a simple system where just one wealthy industrialist accumulates all the flows for one year, lends them all out again as debt, and then cannot even begin to spend all of his interest 'earnings' each year.  Now the interest earnings are not cycling around and as this industrialist lends out even the excess interest earnings they are compounding the problem.

With any sort of accumulation and stagnation in the system it tends towards exponential increase and this is what we both actually and expect to see in the real world.  

As bad as assuming perfectly rational actors is the assumption of perfect stocks and flows.  Might as well call them immaculate stocks and flows because they'd be a miracle....

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Compounding the problem.

Thanks for pre-digesting his argument. I could not grasp the nub of the issue.

This is as far a I have got: If an entity accumulates more money than it can spend, then it has to lend out the surplus at interest,  and next year they own even more wealth than they can spend.

A compounding problem that I do not seem to have.

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Dave

I am fully aware of Keen's thesis on how debt money does not need to grow exponentially in order to keep debt serviced.  The point of my post was not to induce you into a lecture, it was simply to point out that Keen does not address the fact that debt-money has in fact been growing exponentially.  So, this ends up an academic argument.  It's a model he is referencing.  I am asking about the real world.  

Why then does debt run away from money in most systems?  Keen, in the Forbes article linked above, simply says, again kind of ducking the question, but indeed recognizing the tendency;  "..the causes for this phenomenon are far more complicated than a simple mathematical certainty because banks lend money, but not money plus interest."  

And yet, we know that debt runs away from money.. I have often times linked this chart put together by a guy who was trying to figure out how money works;

    DebtMoneySupplyRatio.png

http://simonthorpesideas.blogspot.com/2013/04/total-global-debt-and-mone...

There it is.. over and over.. debt running away from money.

So here's my take;  We have a money system where observation and data suggest that it tends to grow exponentially, in a world where resources are becoming ever more limited.

Saying that the money system does not in fact have to grow helps us how?  I still believe the model to be flawed.  Your explanation Dave is simplistic - of course is only takes a relatively small amount of salary flow to pay off a large mortgage debt... but, the fact remains that the money I am using.. the money I get from my employer, was first borrowed into existence somewhere else.  As I pay off the debt (principle), that money is destroyed.

Most debt is back loaded regarding the ratio of principle-to-interest.. as we all know.. the principle level of that mortgage will stay stubbornly high for a long time if you don't make, "extra" payments against the principle.  But during the end of the term.. you are paying more principle than interest finally.. meaning that money is being destroyed at a faster rate.  My observation would therefore be that, during the waning phase of a big debt boom.. like a housing boom, debt (money) principle is being destroyed at a quicker rate vs. the early stages... how about this dynamic?  Is this in the model?  Does it matter?  Again, exponential growth is what we see.  It appears to be a feature of the system even if Keen wants to argue that it does not have to be.  

late edit:  Just saw Chris' post after I posted mine.  What he said  : )

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my two 'bits' from a simple mind on the money business

Looking at the big picture time wise, that is going back to the pre industrial revolution era of only 'renewable' energy sources, the money systems were almost all commodity based. They did not have our modern belief meme that a bigger future tomorrow is guaranteed.  Once that belief is challenged successfully by some historical data showing shrinking energy/resource supplies, the fiat money cookie will crumble quite quickly.  Since it is a debt based system based on more and bigger energy tomorrow,  it must fail in a shrinking energy world. 

Economist's theories of the economy, to this simple mind, remind me of blind men examining the elephant and coming up with varying descriptions.  If the elephant starves to death  and becomes so weak it dies. then every one of those theories are non sequitur.  A few economists might even be crushed when the beast falls over.  It appears to those of us with vision who step back a little for a wider view that the elephant is currently not as healthy as a few years ago; maybe even stumbling when it walks. Apparently the econophant is very dependent on the environment it calls home.

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perfect stocks & flows

Chris-

You don't need perfect flows when the vast majority of participants have a 10:1 ratio between the flow across an income statement and the money stock required to enable that flow.  Payments are made easily.  Almost all businesses look like this.  Almost all people look like this.  They require very little in the way of money stock/bank credit to enable a much more massive flow.  That's how interest payments are made.  Flow.  Plenty of individual cases of "stagnation" can happen without any problem.  That 10:1 (or 20:1) ratio allows for an incredible amount of slop in the system.

I could write code to model this out no problem.  I can see in my mind how it works.  It all hangs together.

The economy isn't just one wealthy industrialist.  Its millions of people and businesses who need very small amounts of bank credit stock to enable vastly larger flows through their accounts.    For every wealthy industrialist whose stock of bank credit outnumbers his flow, there are 50,000 people for whom exactly the opposite situation holds true.  The one enables the other.

Secondly, just because money grows exponentially (and it clearly does - and Steve Keen has always agreed with you on this score), that does not prove that your structural flaw thesis is the correct explanation as to why this occurs.  The two statements are logically unconnected.  Consider the following:

  1. Money grows exponentially
  2. My theory says it grows exponentially because the sky is blue.
  3. Therefore, money grows exponentially because the sky is blue.

Steve Keen's thesis for why money grows exponentially?  Its an unintended consequence of a politically-minded Fed trying to "fix the business cycle."

The Fed itself causes the exponential growth by short-circuiting the natural tendency in the economy to deflate after every ponzi debt bubble, because they want to serve their political masters, who intensely dislike economic "busts."

Instead of allowing a natural period of deflation after a ponzi pops, the Fed rapidly drops interest rates in order to restart the borrowing cycle.  There is no time for actual deflation and a reset back to the proper natural level of debt, and this constant series of boom-then-short-circuited-bust events results in a growth in credit over time.  You can see the effects of the short-circuit in the chart below: every time the business cycle peaks, loan growth drops (resulting in a recession and economic pain - which results in political pain), and so to "fix" this, the Fed rapidly lowers rates to restart the lending cycle.  Since that average LOANINV percent change over time consistently remains above the 0% line - that's exponential growth by definition.   A new boom is created immediately to "fix" the previous bust.  Housing boom "fixes" dotcom bust, bond bubble "fixes" housing bust, etc.

We all know this.  But the "why" of it - we only need to know that the politically-minded Fed dares not allow economic pain to last long enough to clear out the ponzi credit growth from the previous cycle, so LOANINV growth very rarely drops below 0.  Exponential growth is an unintended consequence of focusing entirely on "fixing the current bust", getting the current politician re-elected, without considering the long term effects.

The "political Fed" explanation is quite sufficient to explain exponential money growth.  In my opinion.  There is no requirement to add in a monetary-structural issue.  Occam's Razor and all that.

 

 

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So, let's take stock....

Although a model shows that, under certain circumstances, a debt based money system could be stable without exponential growth, what we actually have is this;  a system prone to business (debt bubble) cycles, whose monetary policy is run by folks who don't like (the downside) of business cycles, especially since they (those who set monetary policy) are bankers, and the downside of a business cycle is deflationary, and deflation hurts banks.

Dave pulled up a chart that I have shown in the past as well... except mine (from Douglas Short) goes back farther to show that, prior to the 1950's, and prior to the final stage of central bank mission creep that has fully engulfed us today, deflation was in fact allowed to happen - this version tells a much more dramatic story I think;

So, I am still confused as to why I should be dissuaded from telling people who want to learn about the money system, and the dynamics thereof, the following;

1)  Money is created as debt.

2)  When money is created as debt, only the principle is created... the interest must come from the existing stock of debt money. (This is absolutely true as stated.. I have simply not tied it to exponential growth as direct cause vs. effect).

3)  The amount of debt in the system can, and often will (see chart I posted earlier in this string) start to run away from the amount of money in the system - this has various names;  the upside of the business cycle being one of them... debt bubble cycle being another.  

4)  The downside of this cycle, were it allowed to happen, would be deflationary (not enough money in the system to service the debt) and data shows (chart above) that deflation is anathema to those who set monetary policy.  Therefore the system ends up in a state of nearly perfect (mathematically speaking) exponential growth.  

Cutting out the middle parts 2), and 3), we can shorten the above to;

1)  Money is created as debt.

2)  Therefore the system ends up in a state of exponential growth.  

   

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Then let's have a test...

I wonder if anyone can ever show an interest or debt-based money system, ever, in all of history that did not turn out to be exponential?

The very concept of a jubilee was predicated on seven periods of seven (49 years) which was judged to be the maximum amount of time an interest and debt based money system could operate before needing a reset.  That's a pretty old concept.

I cannot come up with any examples...

But let's take the stocks and flows in a simple example and prove that this cannot work out.

Person A borrows $1,000 at 10% annual interest from Bank A.

That's it.  That's the whole system.

Fortunately the bank requires $100 per year of 'work' from Person A, so immediately after person A pays the bank $100 in interest out of their stock of borrowed money the bank pays it right back to Person A.

Look, no exponential increase in anything, right?  There's always a stock of $1,000 of money in the system and the flows make it all work out.  This can go on indefinitely for as many years as we like.  

The only problem comes in right at the end when the loan has to be paid which requires both the $1,000 and $100.  Then the system is short $100.  That is a a simple stock issue.  There's no way I can see for the flows to magically create an additional $100.  

It's not how the system works.

So, the question is, in this simple two-party system, where does the $100 come from?  The only possible solution is to have Person A perform additional work right before the loan is due, be credited (not paid) the right amount to have the $1,000 in his possession cover both the remaining balance and the interest on that balance.

As I said, immaculate stocks and flows are what's required.  They never happen.

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Correction

 

Steve Keen: ...Chris, there's a wonderful article called "Exponential Economist Meets Finite Physicist." Have you ever seen that?

Chris Martenson: Oh yeah by Tim -- Mr. Brown.

Steve Keen: Right.

 

"Exponential Economist Meets Finite Physicist" (see http://physics.ucsd.edu/do-the-math/2012/04/economist-meets-physicist/  ) was written my Dr. Tom Murphy, previous podcast guest:

http://www.peakprosperity.com/blog/tom-murphy-time-honest-ourselves-energy-risks/75359

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Adiós, limits to growth. Hola, economic orthodoxies.

Thanks to Chris and Steve for this outstanding conversation!  I have only listened to it once, and need to listen a few more times, as it's quite rich.

I have been asked to teach mostly economics next year at the high school where I work.  Professionally, this is likely to be very good for me, as the economics courses are part of a specific program of study that is internationally recognized and which will make it easier for me to get jobs at other international schools. 

However, it means it also means that a more general social studies course that some colleagues and I designed and tailored specifically for our student body is being canceled, not because it is unpopular (it's popular) but because it isn't part of this branded program of study.  In that course, I have been able to dedicate about 2 months to exploring with the students limits to growth and major destabilizing shifts in our civilization, which is another way of saying that we have been able to study the three E's.  

So, my school and I are being rewarded, at least in the short run, for turning towards hyper-specialization and away from a broad general look at our civilization. The problem is that we need more generalists who look at the whole forest and fewer specialists who fixate on individual trees, yet even as we careen between the rock wall and the precipice, it seems that most of the passengers in our civilizational bus are busy peeling gum off the seats or tuning the radio.

I'm currently at a very old UK university at a training course for my new program.  Mervyn King is going to give a lecture here in May titled A Disequilibrium in the World Economy.  I wonder how radical his speech will be.

Here is one of the orthodoxies I found on a test and grading key that we looked at today.

Question:  When calculating inflation for the purpose of policy-making, economists might calculate a core/underlying rate of inflation. Explain why they do this. 

Answer (from grading key):  [Full credit will be given] for explaining that large and sudden changes in the price of one or two products (or product groups) may distort the measured rate of inflation.  In order to focus on the general price trend, the government may calculate a core/underlying rate of inflation, which excludes products or product groups with highly volatile prices, such as energy and food, on which to base economic policy. Reference to specific products/product groups such as food and energy is not required. 

Source: IB Economics HL Paper 3 May 2013

My alternative answer:  Calculating core inflation as opposed to simply using the basic techniques that were  used to measure inflation since WWII and before only became popular in the 1980's, and was part of a wave of changes to the measurement of inflation that - apparently - were designed to understate inflation. According to John Williams, if inflation were measured as it was before 1980, our current rate of inflation would be around 3.5%.  

It is no accident creating a measure of inflation without food and energy happened soon after the inflationary oil shocks of the late 70's and early 80's. Contrary to its purported dual mandate of price stability and moderation of long term interest rates, there is another school of thought that claims that the Federal Reserve was designed mainly to provide a backstop for the America's largest banks.  Since these banks abhor deflation and prefer some amount of inflation, the measurement of inflation has been changed to make it seem less apparent, to make it easier for the Fed to subtly inject inflation into the monetary system.  In other words, we juked the numbers and lowered the bar, mostly for the benefit of the big banks and the political class.  After all, what household can go without food and energy? These categories clearly belong in any meaningful measure of inflation.

Probably, this alternative answer would get few or no points in the current grading scheme.

I don't think any of the teachers in this training course had heard of Steve Keen, but now they have.  The thing is, even those teachers interested in exploring heterodox approaches to economics will often have to choose between preparing their students for the test and showing their students that the emperor is not wearing any clothes.  

Specialization and hierarchy still hold the day, while the perspicacious are mostly ignored, or waived away with pretentious yet fatuous dismissals such as, "well, debt-to-GDP ratios don't matter because you can't compare a stock to a flow." So classic...

Next year, I will try to prepare my students for the test which means teaching them to know when to say, "the emperor is wearing a lovely purple robe today..." but I will also invite them to notice the real state of his attire.  

Keen's Debunking Economics is already on my classroom bookshelf.  Hopefully, somebody besides me will pick it up.

 

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You go, Hugh K!

Pat-on-the-back for bringing real knowledge into a high school classroom! :)  I bet it was fun to watch your students digest information that actually got them thinking about "how things work", and that helped them make more sense of their world.  Much more interesting than rote learning/memorization!

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Iceland To Take Back The Power To Create Money (maybe)

http://www.theautomaticearth.com/2015/03/iceland-to-take-back-the-power-to-create-money/

Who knew that the revolution would start with those radical Icelanders? It does, though. One Frosti Sigurjonsson, a lawmaker from the ruling Progress Party, issued a report today that suggests taking the power to create money away from commercial banks, and hand it to the central bank and, ultimately, Parliament.

Can’t see commercial banks in the western world be too happy with this. They must be contemplating wiping the island nation off the map. If accepted in the Iceland parliament , the plan would change the game in a very radical way. It would be successful too, because there is no bigger scourge on our economies than commercial banks creating money and then securitizing and selling off the loans they just created the money (credit) with.

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simple systems - flow is critical

So let's use the example of your simple system, modified in two important ways to conform with reality.

Guy borrows $1000 from bank.  He has $100/year in interest payments to make, and so let's call it $20/month.  For him to qualify for this loan, he must have payment coverage of say 25%.  He needs a salary - from somewhere - of $80/month.  Otherwise - he can't get the loan, right?  That's reality, at least in the good old days, and this is our first change to conform with reality.  Initial condition: you need enough salary to cover the P&I payments with a decent amount left over.  Otherwise, no loan.

So, how does our borrower make his payments?  Cash flow from his salary.  That was in the initial conditions.  It takes him 10 years to pay it all off.  And he does, assuming he can keep his job that provides him his flow.  (Bear with me, I'll explain how).

Now then, when the loan gets fully paid back, the bank has no more assets or income.  Probably, it closes.  [We ignore for the moment what happens to the interest payments - which are likely recycled back into the economy, as salaries, dividends to shareholders, etc].  But now I hear you cry, "but wait!  All the money is gone from the system!  And then some!"

No.  Turns out, we have one more modification to make to adapt the simple system to conform with reality.

There is this thing called base money.  Before the system starts, the Fed provides an additional chunk of base operating currency for the economy that provides a level of underlying liquidity so that money can still flow even when every single loan in the system is paid off.  And remember, flow is critical to making those payments.

So in a sense, it is base money that enables continuous flow - regardless of what happens to individual banks and individual borrowers.  Even if all banks close, there remains enough money to enable enough flow through the system so that the economy can still function even with zero bank credit outstanding.

So once you add in base money, everything works fine.  The simple system - turns out, its too simple.  It is missing some absolutely critical bits.  Add in flow and base money, and everything works.

Are these things fake or artificial?  No.  They both exist.  To get a loan, you must show you have the flow to cover payments.  And base money also exists.  It has, since 1914.

What can we conclude from all this?  Flow is critical to the model working, and its also critical for the real economy.  Without flow, people cannot make payments.  When the flow slows in the economy, that is when people start having real trouble. 

Just in talking this through, I am realizing that deflation effects are as much about slower flow as it is about reduced quantity of money.  Some people (Martin Armstrong) suggest that flow is actually much more important than money quantity.  And indeed, in our hyperinflation podcast, we saw that once people started money flowing much faster, that led directly to price increases.

Without modeling flow - by trying to model a system just using "quantity of money" - you are missing a critical piece in understanding how things really work.  In fact, without flow, nothing works.  Consider: what happens when you attempt to model human physiology by looking only at the quantity of blood.  Does that work?  Of course not.  Without blood flow - when the heart stops - the body dies.  Same idea.  So modeling a bank/debt/money system without including modifications that take into account flow just won't work.  It can't.  Flow is the magic that enables everything to happen, in the body, and in the monetary system too.

If you hand someone 10 trillion dollars and they keep it in the cellar, its not inflationary.  No flow = no inflation.  If you hand that same person 1 million dollars, and it gets passed from person to person such that everyone in the economy holds it for 60 seconds, that's hyperinflation, because math says it will change hands 525,000 times in one year - resulting in "GDP" (activity) of 525 trillion over that year.  From only a million bucks!

I really love these discussions.  I learn some new nuance every time we talk about them.  Apologies if others find this sort of thing tedious and repetitive.  One of my "things" is that I want to really understand how stuff works.

Just as a matter of interest, ABMSL (Seasonally Adjusted base money) is one of the oldest timeseries that FRED has.  First entry was in May, 1914, at 3.93 billion dollars.  And change.

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stagnation issues

In thinking about this more, stagnation really is a problem.  When a depression happens, everyone hangs on tightly to their money, flow drastically slows down, and - the problem is not just a decrease in the quantity due to defaults -  it is that the flow of money has virtually stopped.

And we now know that flow is absolutely required to make payments on debt.

One way to kick-start flow is for someone to spend money.  Taking out a loan is helpful - not so much because the quantity of money increases (there is already lots of money out there - hiding under the mattresses), but because that newly borrowed money then flows into the economy and is spent, at least once.

Same thing for government spending.   Government snatches money from citizens via taxes, and then spends it right back into the economy.  That has an inflationary effects based mostly on flows.  Certainly with deficits, the quantity of money has also expanded (if you consider T-bills to be money - Armstrong argues that they act as money, even if they aren't actually bank credit) but the more important immediate effect is on flow.  Especially during times of high stagnation, like a depression.

Faster flow = higher (CPI) inflation.  Slower flow = lower (CPI) inflation.  Slower flow = a lot more loan defaults.

Quantity of money (at some level) doesn't matter, as long as confidence remains intact - and flow is probably a great measure of confidence.  Too slow = low confidence = defaults & CPI deflation.  Too fast = also low confidence = inflation/hyperinflation.

Attempts to predict gold price based on overall size of M2 are doomed to failure.  I know - I've tried.  However attempts to predict price based on flow (the change in loan outstanding) tend to be more successful.  My guess is, changes in loans (and government spending) reflect alterations in flow, while absolute size just reveals the amount of total stagnation: the sum total of all the wealthy industrialist cash piles.

And that is why I care about all this.  If I can figure out how things actually work, I can perhaps develop a model that can predict where things will end up.  That's why these details matter to me.  My ego here doesn't matter.  Coming to the correct answer - that's all I care about.

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Jim's proof by induction

JimH-

First of all, I like your chart - except that my chart is of changes in loans outstanding, and DShort's chart is the CPI.  They are most definitely NOT the same thing.  I hope you can understand why.  Mine talks about actual money growth (the subject under discussion) and DShort's chart talks about prices - which is not the subject under discussion.  If I could find a chart on loans dating back that far, I would simply love it.  I have been unable to get data on bank credit past 1947 - which is that LOANINV chart I put up.

Anyhow, from the get-go, your chart: "objection, irrelevant."  Nice chart, but not on point.

Now then.

1) Money is created as debt.

Yes.  Except for base money, which is not created as debt, and is not destroyed.  And currency too: not created as debt, and not destroyed.

2) Interest must be paid from the stock of debt money.

No.  Interest is paid from the flow of debt and base money through the economy.  Clearly some stock of money must exist (and base money + currency guarantees that it always will), but the flow is the critical bit, just like the flow of blood is critical to keeping a human alive.

3) Money creation gets out of control because of bankers.

Yes.  100% agree.  Banks are motivated to create debt money, because they benefit from it.  The more they create, the better they do.  That's why things get out of control.  By design, they are motivated to do so.

4) Politics ends up short-cutting the deflation cycle.  At least these days.

Yes.

Here's the essence of my issue:

If we focus on "the interest not being created", we are focused on the wrong thing.  First of all, its not correct: flow is the prime issue, not stock, regarding ability to make interest payments.  Slow flow = cannot pay.  Fast flow = payment is easy.  Total money supply can remain unchanged and either situation can develop.

Secondly, and more importantly, I believe we should focus on the motivation of bankers and their ability to create money (and the system's current unwillingness to let it unwind) - that's where the problem lies.

Unless we identify the actual root cause of our problem, any solution we propose based on a false premise will lead to a solution that simply won't work.  Or if it does work, it will be strictly by accident.

 

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Sorry to disagree with you Jim

Sorry to disagree with you Jim.  Money is also created when banks pay bonuses, wages, dividends, make asset purchases etc.  The money thus created, circulates and comes back as "interest" money.

 In effect:  interest money pays the  bonuses, wages, dividends, asset purchases and other costs that the banks incur.  If you disagree with me, Jim, please explain where the money to pay bonuses, wages, dividends and asset purchases comes from if not from interest.   

I was waiting for this myth to reappear so I could dispel it, yet again. 

You will need to look elsewhere to explain our "growth imperative"

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A point of clarification...
davefairtex wrote:

1) Money is created as debt.

Yes.  Except for base money, which is not created as debt, and is not destroyed.  And currency too: not created as debt, and not destroyed.

In fact, base money is created as debt.  

The mechanism involves the Fed taking something onto its balance sheet (and issuing credit, and more rarely currency) and that "something" is always a form of debt.

In the past that 'something' was Treasury paper.

And the Fed collects the interest on that paper.  Whether the interest goes towards paying the expenses of the Fed and the 6% dividend of its stock holders, or it gets remitted back to the US Treasury, the base money is still generating interest payments.   

Base money comes from POMO activities.  It can be both created and destroyed by the same process.

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Don't be sorry...

To disagree with me Climber.  I am very crusty with Dave because we have long running divisions over the issue of Gold market manipulation and we just always seem to butt heads - that does not mean I am always crusty   : )

You said,

  Money is also created when banks pay bonuses, wages, dividends

I would agree with you that these things are paid out of retained interest.. and also from fee-based income that the bank earns.  I question though why you call this money creation?  The interest money was pre-existing in the system... consisting of pre-existing money that is "flowing" in the system.  

I continue to believe that the growth imperative comes from the very nature of debt-based money.  I would state this simply:  When old loans are being paid off faster than new loans (money) are being created, then we have deflation through debt destruction.  Central banks hate deflation and fight it with monetary policy such that we are usually (see the chart from Dave) in a mode of money (load) growth.  This is the root of the growth imperative.       

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base money - clarification accepted

Chris-

I accept your point of clarification.  Was that the only issue you found with my post, then?  :-)

So assuming that was your only issue, I will agree that base money does have debt associated with it, but it is not bank credit per se, since it was not borrowed into existence.  There is nobody who is going to "repay the base money" and thereby destroy it - unless the Fed decides to do that on its own.  Furthermore, I contend that the Fed can always find something to buy in order to issue base money.  They've shown themselves to be pretty adept at doing so.

So in our simple model, and indeed in the real world, we should stipulate that base money and currency will continue to exist even after every bit of "standard bank credit" is repaid.  Therefore, income and flow can continue to exist without standard bank credit, and therefore interest payments can continue to be paid via that flow.  Most importantly, no new money needs to be issued to "make the interest payments" - as long as the flow is fast enough to do so.

So, our simple model should include:

a) the ability of the borrower to repay the loan via sufficient cash flow prior to being able to borrow the money.

b) base money and currency already extant in the system, that is not normal bank credit, and will exist after all bank credit is repaid.

c) the loan that is made, and then repaid by the monthly income flow across the borrowers account over time.  The money used to repay the debt could be bank credit, cash, or base money.

I will freely concede that if complete stagnation occurs, and one entity or group acquires essentially all bank credit, all cash, and all base money, and refuses to spend any of that money for any purpose, then no flow will occur and all loans will not be able to be repaid.

Perhaps that really does happen too.  Maybe that's why the Fed encourages borrowing, and government spending - to "fix" stagnation issues during depressions.

But again, we are identifying the actual problem here.  It isn't about "not having enough money to pay the interest" - it is not a lack of money quantity, but rather, it is instead about problems with money flow.

That's my contention, anyway.

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davefairtex
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agree Jim

JimH-

I continue to believe that the growth imperative comes from the very nature of debt-based money.  I would state this simply:  When old loans are being paid off faster than new loans (money) are being created, then we have deflation through debt destruction.  Central banks hate deflation and fight it with monetary policy such that we are usually (see the chart from Dave) in a mode of money (load) growth.  This is the root of the growth imperative.

I agree with everything you say here.

To my mind, "the nature of debt-based money" critically involves its method of creation, and that is where the trouble lies.  The creators themselves are incentivized to create as much of it as possible.  And the creature "guarding the hen-house" is Fed the Fox, under the influence-if-not-control of the banking system it allegedy regulates.  It is this that lies behind the ever-growing debt load.  Complete self-interest, the only motivation required.

The more they lend, the more they make, and the larger their control over society.

By focusing on "creating the interest" issue, we distract ourselves from the real culprit: Its just the bankers.  That's it.  That's the root cause of the problem.

I don't have a simple fix - but I certainly know where the problem is coming from.  Glass Stegall, eliminating banks that hold more than 5% of US deposits  - that's a good start.

And Iceland's solution might be a good idea too.

Lastly, a state bank that provides basic banking services and no "gotcha" fees, I'd toss that into the mix too.  I'm sick to death of $60 billion a year charged to the poorest Americans for overdrafts, etc.

There.  Problem solved.  Mostly anyway.

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climber99
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Just had a moment of

Just had a moment of clarity.  Steve Keen said that the US and UK could have up to 5 years of private debt  fueled GDP growth before it starts to collapse under its own weight. Right? He said that and I agree with him that this a high probability event.  Therefore what will the government's response be to keep the show on the road? This is what I was asking myself before my rare moment of clarity. Are you ready for this?

We need another layer of debt accumulation to form the base of the pyramid to support all the previous debt above it.  This debt will come from an expansion of the population.  As the periphery countries struggle, the US and UK will attract/accept more and more net immigration and encourage larger families   It may be possible for this new influx to take on sufficient debt to keep the Ponzi scheme going. 

I present my evidence.  The UK's population is growing by 400,000 per year (not all from net immigration but also a higher fertility rate) and is the highest rate in the EU.  I understand the US population is also expanding at a high rate due to the same reasons.

What do people think?

ps By the way, don't attack me. I believe in introducing measures to decrease population not increase it.  I've just started reading Catton's seminal book Overshoot.  We're on the road over the cliff.  

 

 

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aggrivated
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so, I will ask the dumb questions

For there to be a growth in the economy, the growth in population will require more goods and services which is a growth in resource use.  Does this not mean, since both the UK and USA have pretty high resource utilization rates at the present, that the additional resources will be pulled from other countries?  Is that why we have to extract these resources by force?  At what point will the rest of the world say--'Enough!'  ?

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if not borrowed, where does base money come from?

Great discussion thread.

Dave, you said:

davefairtex wrote:

I will agree that base money does have debt associated with it, but it is not bank credit per se, since it was not borrowed into existence.  There is nobody who is going to "repay the base money" and thereby destroy it - unless the Fed decides to do that on its own.  Furthermore, I contend that the Fed can always find something to buy in order to issue base money.  

So, if base money is not borrowed into existence, what do we call it when the Fed prints currency and lists it as a liability on their balance sheet to offset the assets they have? Is it just a 1:1 transformation? 

I wonder what assets were on the Fed balance sheet on Day One (before the POMO started)? Shareholder's capital? And I guess Paid-in Capital is not redeemable, so it's not really a debt..

(I edited my post after a bit more study)

Cheers!

 

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davefairtex
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base money

dlumb77-

When the Fed buys something, it is from someone who has an account at the Fed.

To buy something, they simply make a (digital) deposit into the member's account, and then they take delivery of whatever it is they bought.  (Nice work, if you can get it)

So on the balance sheet (seen here: http://www.federalreserve.gov/releases/h41/Current/h41.pdf) assets increase (by the value of the thing they bought), and so do liabilities - the reserve account of the seller.

Currency is bought by member banks, from the Fed.  The member's account is debited, and the Fed ships a pallet of cash to the member bank.  http://www.newyorkfed.org/aboutthefed/fedpoint/fed01.html

"Base Money" consists of all the member bank balances, plus all the cash in circulation.  Note that all balances in excess of that member's reserve requirements are able to be spent by member banks on anything they want.  Two timeseries apply: RESBALNS, RESBALREQ.

Note also, that if all the bank credit in the system were to vanish, the member (reserve) balances at the Fed would still exist, and could still be used to buy anything - such as FRNs, for instance.

While the vast majority of currency and base money is currently "backed by" debt (i.e. to balance out the liabilities of the base money deposits, the Fed owns assets consisting of bonds of various kinds in equal amount), the Fed also owns gold certificates - on the balance sheet at $42/oz.  Valued at around $11 billion, they are worth at today's prices maybe $300 billion.  So that is $300 billion in gold vs maybe $4 trillion in debt.  Currency is about $1.2 trillion, reserve balances $2.5 trillion, on a total balance sheet of $4.48 trillion.

So - long winded answer to your question:

So, if base money is not borrowed into existence, what do we call it when the Fed prints currency and lists it as a liability on their balance sheet to offset the assets they have? Is it just a 1:1 transformation?

Yes its 1:1.  They are increasing a member's reserve balance (i.e. their Fed bank account) in exchange for a debt asset.  And it doesn't just have to be a debt asset.  It could theoretically be gold too.  Maybe even a bunch of long COMEX gold contracts!  :-)

I wonder what assets were on the Fed balance sheet on Day One (before the POMO started)? Shareholder's capital? And I guess Paid-in Capital is not redeemable, so it's not really a debt..

The Fed does have paid in capital, about $28 billion.  It also has those gold certificates, allegedly worth $11 billion (on the balance sheet) but actually worth north of $300 billion.  It also has buildings too - about $2 billion.

But - before?  How long before?  Here's a fun document: https://fraser.stlouisfed.org/docs/releases/h41/h41_19160101.pdf

This is the H41 (Fed balance sheet) dating back to 1916.  This was clearly typed out - on a typewriter - with corrections written in by hand.  Some places you can even see white-out.

You can see what the Fed had on its balance sheet back then: it was mostly, gold.  My guess: member banks deposited their gold with the Fed, and got a deposit credited to their account at the Fed - base money - which they could use as reserves for loans they would later make, and/or to buy FRNs from the Fed.

Looks like Fed was a central clearinghouse and depository for member bank gold.  Way back when.

Assets:

  • $344 million in gold
  • $56 million in short term paper
  • $27 million in bonds & warrants

Liabilities:

  • $54 million in paid-in capital
  • $400 million in deposits from member banks
  • $13 million in FRNs.

That was certainly another era.

climber99's picture
climber99
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Good question

It's a great question, aggrived. Where will the energy and resources to expand population and GDP growth in the US and UK come from? 

Here's an interesting thought experiment: If Russia decided to keep their energy and resources for themselves and their future generations. What would the US response be ?  Bear in mind a $610 billion   military yearly budget (2013 figure) for the US alone. 

Now look at the turmoil in the Middle East and Ukraine and ask what Nation is driving all those conflicts forward and why.  Also ask why US won't  allow Iran to have nuclear weapons but other countries like Pakistan with few energy resources can.

Obviously there are formidable difficulties/risks like China and nuclear weapons to contend with. 

ps Next on my reading list is  "the race for what's left" by Michael Klare

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Arthur Robey
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Multi-dimensional money.

In this discussion the Multi-dimensional aspects of the economy are discussed. Reducing the entire economy to one dimension, money, leads to a gross over simplification. 

http://fromalpha2omega.podomatic.com/entry/2015-03-25T06_53_16-07_00

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Stocks and Flows. The "ah-ha" moment

Dave, 

Your last comments put the ribbon on the package for me. That H41 (Feb Balance Sheet) statement from 1916 shows where it all started: The banks deposited lots of gold at the Fed, the Fed credited the bank's accounts and printed currency. The currency went off into circulation. In more recent times, the Fed prints currency (or credits bank's accounts) in exchange for things like T-Bills, MBS (or anything at all). It's just a 1 for 1 exchange house.

So, now all the other pieces make sense: Money moves around the economy as a reflection of economic activity. Velocity is the amount of movement as a ratio to the Money stock. GDP is the nominal sum total (in dollars) of that movement. Money that is saved (hoarded) does not circulate to lubricate economic activity. (This is the stagnation you refer to). When a loan is created, the newly loaned money mixes with Base money and "looks" the same in the system.

To the topic of interest payable on loans, this is simply siphoned from existing money flows. Interest paid on loans may either recycle into the economy (as Bank's operating expenses: staff, etc) or be hoarded by banks. Paying back the principle of a loan extinguishes the debt, but Base money still exists even without debt outstanding.

So, if the only condition required to create a new loan is to prove that the loan can be serviced ("I have a job and can pay interest"), then the maximum size of debt that can be created could be calculated by knowing 2 things: The percentage of flow that can be appropriated for debt service ("How much interest can I afford each month") and the interest rate. As interest rates drop, more debt can be serviced and therefore the maximum possible amount of debt can increase. Also, as more and/or bigger flows occur (More economic activity - GDP increases), there is more flow that can be appropriated for debt service.

Good. So now we've worked out the difference between stocks and flows. So, why do debt-based money systems always go exponential, as Chris describes:

cmartenson wrote:

I wonder if anyone can ever show an interest or debt-based money system, ever, in all of history that did not turn out to be exponential?

Is it because in every society some people start to save (hoard) and this reduces the money supply (M0)? Then, government is forced to produce more Base Money to keep the economy lubricated. Then more of this gets hoarded. And so on. We go into an escalating spiral as those who have and can attract money ("the wealthy") increasingly hoard the new Base Money that is produced?

Yeah, I can see how that's going to result in severe social/economic stratification and the destruction of value of the currency if ever the hoarding reverses.

So the exponential problem is not because the money is interest-based! It happens because the money can be infinitely created (by fiat) as a reaction to hoarding. 

BTW, something different would happen in a non-fiat system (like gold): the money would get hoarded and there would be no money available for everyone else.

Wow!

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davefairtex
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exponential systems

dlumb77-

Yes.  You have it now.  You see the same thing I do.  I too really enjoyed seeing that Fed statement from 1916.  That's why this place is great.  People ask questions, and I think, "hmm, how DID it all start?", and we get to see some really old piece of history - an original source document, no less - and things all start to make sense.  Reading the Fed balance sheet from 1916 was pretty easy - especially compared to the mess we have today.

So to your question - why do these systems go exponential?  Here is my theory - actually, its Steve Keen's theory:

The more loans there are outstanding, the more money the bankers make.   Bank upper management have stock and/or options, and are rewarded on quarterly performance.  All the incentives are in place to maximize current performance - which means, the folks given the magic power to create money are directly incentivized to maximize the amount of money created.  Foxes, hen-houses, etc.

Each boom, bankers are straining at the leash to loan as much money as possible.  Each bust, the Fed is begged to drop rates to bring the boom back.  As a result, the bust doesn't last long enough for bad credit to be written off and/or defaulted upon in any real size.  CHS calls this "the ratchet effect" - each new boom begins from an overall higher level of indebtedness.  This process ends up being effectively exponential over a multi-decade timeframe.

As I think about it, it is likely that the Bretton Woods/gold standard was a limiting factor on the Fed's ability/willingness to drop rates and open the money-creation floodgates.  If they were too easy and too much money was created, then gold left the country.  Once that limiting factor was gone, the slope in the money growth rate went substantially higher.

And about saving/hoarding/stagnation:

I think the saving/hoarding/stagnation issues occur during times of trouble - not so much during times of plenty.  Once a bust happens, money velocity plummets, since people start saving, repaying debts, cutting spending, and they also stop borrowing.  As a result of the velocity drop, debts become a whole lot harder to service.  On top of that, you start having money destruction, since debts are paid down, and people start defaulting.  That's a double-whammy - less quantity, and less velocity.

If you add government austerity as the cherry on top, why you reduce velocity even further.  Governments act as a velocity increaser - they snatch taxes from people's savings, and then spend that money directly into the economy.  Less government spending (at a time when velocity is low) just exacerbates the problem.  Greece is our poster child for this effect.

So, reduced government spending, increased hoarding by people and companies, reduced quantity via defaults and loan pay-downs, and you have a situation that spirals down into a very unhappy place.  Low velocity + lower quantity = a really bad environment to pay down debt.

The whole paradox of thrift never really made any sense to me, but now I get it.  If increased thrift happens during a time of high unemployment, reduced government spending, widespread defaults, and loan paydowns, money velocity will slow to a crawl.  Only very well qualified borrowers will survive such a period.

If you add to that bank failures and depositor losses, then money flees from deposits into currency which goes right under the mattress.  Velocity just stops.

And when velocity stops, all debts become unserviceable, regardless of how much money quantity there is in the system.  Unless you happen to have enough money under the mattress to cover your payments.

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Arthur Robey
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As one Hoarder to Another.

I would not mind the .gov spending the money wisely,  but that is not in their interests.  They spend it on balloons, tinsel, lies and war in order to get re-elected. Bring back real democracy where the councils are selected by random ballot.

Just like jury duty. There should be a law that says that it is your duty to lead if your number comes up. This would lead to a fair cross-section of the demographic. 

All laws would be passed in a referendum. (Think internet)

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Farmer Brown
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Warts and all

Hi Chris,

I have been following Steve Keen and of course your work for quite some time and am delighted you chose to have him on the program.

Based on Davefairtex's and your discussion, are you saying that Steve Keen is right about his argument that debt based money does not require exponential growth, so long as the dubious (in your estimation) assumption that stocks and flows are perfect is in place?

If so could you clarify the following:

First, let's just assume that stocks and flows are not perfect, like in the real world. In such cases, the lender gets wiped out for the amount of their asset (loan). Is the need to replace this money in the system where your argument for the need for a replacement mechanism (to infinity or currency collapse) comes from? Are you saying that if this portion of Keen's argument were neutralized for you, that you would then accept that debt based money does not require exponential growth?

That's where my question ends. The following are just observations:

Even if you were right that this money "had" to be replaced (which I do not believe is correct), replacing it would just bring us back to the level we were at before the loan was defaulted upon, so what you are really arguing, I have to assume, is that flows must not only be perfect, they must continually increase. If so, this  does not really square with your being OK with Keen's argument in all respects except for the immaculate flow question.

In any case, I don't even agree that Steve Keen's model requires stocks and flows to be perfect, or "immaculate" as you prefer to put it. When loans are defaulted upon, the asset (loan) gets destroyed, yes? This was bank-credit, not Fed-level money, as Davefairtex defined above. If so, then nothing really happened. Money got destroyed, but the loans that the money was servicing also got destroyed, so the net of it is that the system lost a burden that was not sustainable given the existing money flows, and both the burden and the money servicing it got zilched. From that point of view, it is incredibly healthy to destroy loans. It's kind of like clearing cholesterol from an otherwise healthy circulatory system.

Sure, banks may go bust, as many did in 2008, but the money supply is not required to keep growing. Yes, politically the Fed, Treasury and politicians chose to bail out some banks and injected a ton of liquidity into the system, but all of that was a political choice, not a system requirement, in my estimation.

Had they not done all this, more banks would have undoubtedly gone under, probably a lot of people would have been hurt, but the system would live on. Only loans that were provided for a sound underlying reason that had an underlying repayment mechanism possibility (i.e., sound loans) would be paid back - everything else would go bust. 

 

Keen's model seems to work to me - immaculate flows are not necessary - they can be full of warts.

 

edited to correct hopefully all typos

 

 

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PdeB
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Great discussion

Both in the podcast and in the comments. These sorts of rich conversations are why I'm here. Thanks to Chris, Dave, Dlumb77, Jim, and everyone else on this thread.

davefairtex's picture
davefairtex
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Posts: 5465
stagnation with "commodity money"

dlumb77-

I've been thinking more about your observation that commodity money might well have a harder time getting out of a condition of stagnation.  What happens if all the gold/gold-money ends up in one wealthy industrialist's hands?  Arguably, the problem is worse than with a fiat currency.  Government can always print a fiat currency to kick-start things, but with commodity money, you're just stuck.

In other words, I agree with you.  Its something to think about.  Perhaps something like that happened during that long depression in late 19th century.  "You shall not crucify mankind on a cross of gold."  Yellow brick road and all that.  I should study more about that period so I can speak from a place of knowledge, however.

Not saying one is intrinsically better than another - just, its important to understand the boundary conditions/upsides & downsides of each type of money.

An interesting discussion, thanks.  :-)

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thc0655
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Parallel money systems

What about parallell money systems: fiat dollars circulating along with gold/silver money. Gold and silver provide the foundation/anchor, and the fiat currency can be fiddled with when necessary.  This seems to be exactly what Hugo Salinas Price was saying.  It seems you end up with the best of both worlds and a helpful synergy between the two (or more) systems.  Let the people decide: all kinds of money/currency are allowed and would have to compete in the market place.

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