The Economic Crisis

This week several Euro countries have been slashed to junk rating, and even Germany was not able to sell about a third of the bonds it offered -- no one was willing to buy them.  A diagnosis at Zero Hedge holds:
Since we have mentioned the “W” word [Weimar], we have an obligation to discuss what strategies best preserved the wealth of German investors during that dark period. (“Life was madness, nightmare, desperation, chaos,” writes Fergusson. We are not quite there yet – but we also note that sensible financial commentators have already begun to refer to Japan as our Weimar in waiting.)

Other, more valuable foreign currencies, for example. In 1923, that meant the US Dollar. This time round, since the Swiss National Bank has lost the plot, we would favour the Canadian and Singapore Dollars. Back then, the answer lay in gold, and we think it does this time, too, as the finest currency protection paper money can buy.

One can also consider gold and silver mining companies – John Hathaway of Tocqueville Asset Management has written very nicely about the “Golden Mulligan” being presented to investors who missed the gold bull on the way up.... 
Yale Economist Robert Shiller has suggested that one of the reasons for equity investors’ irrational exuberance in the 1990s (it was Shiller, and not Greenspan, who coined the phrase) was the fall of the Berlin Wall- which seemed to conclusively display the superiority of western free market capitalism over the discredited Soviet model. 
Now the superiority of the western model is so apparent that we have cash-strapped eurocrats looking to raise money from the Communist leaders of a country, most of whose citizens live in abject poverty. This writer is proud to call himself British; he would be disgusted to be regarded as European.
The two problems at the core of the collapse seem to me to be the idea of monetary manipulation as a way out of the crisis, and the idea of Keynesian stimulus as a way out of the crisis.  The two models are sometimes said to be in competition; in truth, they are mutually-reinforcing points of failure.

The problem is that both of these theories are wrong about the origins of wealth, and how wealth is produced.  Understanding that issue is the beginning of an understanding of how to build a stable system.

In spite of economics' reputation as 'the dismal science' (a nickname, as you recall, that came from Malthus' writings on population growth), it isn't actually a science but an art. In the arts, it is not uncommon to discover that a fashionable idea plays out badly in the end, and older forms are proven to be more valuable than we thought they were when we set them aside.

The problem with monetary theory is that it begins from an assumption that wealth increases as debt increases (because, according to the theory, 'every asset is someone else's liability' -- if I borrow money from you, my debt is a liability of mine and an asset of yours). The debt of the public sector is thus the wealth of the private sector (because we own the bonds). Thus, you can repair the economy by taking on more debt (which increases private wealth, allowing the private sector to stimulate itself by trading debts as if they were wealth).

Wealth doesn't come from debt, and in fact it doesn't come from money. Wealth comes from production -- a fact that Marx understood better than modern economists, with his labor theory of wealth. Marx's problem was that he tried to make labor account for all wealth, whereas in fact it accounts for only some increases in wealth. Marx was smart enough, though, to know that it wasn't money that creates wealth. 

If I have a factory or a farm that is producing wealth for me, I can take on a debt in order to expand my operations. According to monetary theory, wealth is created because I take on a debt to the bank, increasing the bank's wealth. In fact, wealth is being created whether I take on the debt or not -- it is the factory or the farm that is creating the wealth. All the debt does is allow me to expand the wealth-creating instrument faster than I could have done otherwise.

Now, if that is the case, the function of money is not to create wealth, but to serve as a store of value and an accounting mechanism for trade. Proper monetary policy would therefore be to sustain the stability of your store of value, so that trades and debts in that money are stable and reliable for those making such trades or taking on such debts. The political policies associated with such stability are counterindicated by all the best advice of modern economists, and therefore opposed to what the politicians would do if they could come to an agreement.

In America this is sometimes called the 'strong dollar' policy, but actually it's the pre-Federal Reserve policy.  The Federal Reserve was created to stabilize the dollar through monetary policy; instead the banks who lead it have used that as a pretense for profiteering manipulations that have cost the dollar 96% of its purchasing value since the creation of the Fed in 1913.  This is what we would expect to happen if we gave control of our wealth to professional gamblers, and indeed it is just what did happen.

The value of the dollar in terms of what it could purchase, before the Fed, actually was stable.  You can test this assumption with this calculator.  Put in an amount, say $100, with the starting year 1790 and the ending year 1890.  The value in terms of the consumer price index is almost the same.  Now go from 1790 to 1890.  Suddenly it takes over a thousand dollars to equal a hundred dollars in 1790 purchasing power.  

This is one of the three major problems with the global economy.  Once we have a stable currency, we can perhaps address the other two.  The first of these is the unsustainable nature of entitlements, both here and in Europe; and the second is that the modern technological economy has no place for many people who once could be gainfully employed.  (The link is to an optimistic counterargument; the facts regarding unemployment among the unskilled are surely known to all of you reading this page.)

The first two problems are given to conservative solutions; the last one really is not, and will require a new conceptual model from us.  The closest extant one is what the British used to call "outdoor relief," that is, government make-work that uses the unskilled even though it is uneconomic to do so.


E Hines said...

Part I:

A small point: monetary theory suggests that debt creates money, not wealth.

That aside, the Fed's requirement, poorly executed by the later Boards, is to control price inflation, not wealth or interest rates--i.e., to sustain the store of value of money.

Inflation is nothing more than money supply increasing faster than the supply of goods that can be bought--relatively more money chasing relatively fewer goods.

One of the tools the Fed uses to manage price inflation is through interest rates--the cost of money--and one of the ways the Fed manages interest rates and the supply of money is by managing the fractional reserve of cold cash banks must maintain to backstop their lending. Larger reserves means less lending, interest rates go up, borrowing reduces and the money supply doesn't increase so much--ideally, falling back to the rate of increase in the supply of goods and services for sale. Increasing the fractional reserve required also directly reduces the amount of money available to chase those goods and service.

A crux of the matter, though, is the difficulty of pricing a heretofore non-existent good--a cancer cure from Babe Ruth's era, for instance. Even more difficult is pricing the underlying, and preceding, development required for that cure. This end of the inflation question, however that inflation is measured, is rarely explored.

Anecdotally, consider the increase in quality of life--technological and social--between the 1790-1890 and the 1890-1990 periods. The increase coincides with the increase in the money supply and its associated price inflation.

It takes money to develop new stuff. These things could have been developed--eventually--with a money supply that only kept pace with the goods and services supply, but that would have been a very slow development. Money supply increases, then after a lag, price inflation develops. It's in that lag that significant development and production can occur.

Further, today's supply of goods and services are enormously different from what was available 100 years ago, and that by itself alters the meaning of what is the value that money stores--this is implied by the differing inflation rates that result from the differing inflation measures (CPI vs GDP vs per capita GDP, etc). I can by a Kindle for $140 today. I have no hope of buying it with the $25(?) that money would have been worth in 1790. George Washington could not have done better than his wooden teeth, if he'd sold his entire distillery business.

How to speed development? One way is the way we've done it: throw money at the problem. This leads to price inflation, ultimately, but "ultimately" has a widely varying set of time lags. Additionally, one result of price inflation is that the money price of labor goes up, too. If the lags are managed, price inflation occurs, but that means wages stay more or less in line with the price of goods and services labor produces and the store of value that is money is more or less preserved.

Despite the apparent loss of value my current store has compared to that value 200 years ago, I wouldn't trade the quality of life I have today for that lost time for all the tea in China--or any other store of value. The trick is to keep the lags in line, and to keep the value of labor in line.

That last is what goes to the entitlement excesses we have today--and too much of Europe has today--and the unanswered question of who should pay for those entitlements.

Eric Hines

E Hines said...

Part II:

I did it--I exceeded the new comment facility's limit....

And it goes to the second question--what to do with those a technological society does not (I don't accept "cannot"--every society has some of these; I don't think the "excess" above this level is of necessity unemployable) employ. This is how to find a way to retrain these so as to make them employable, and how to alter our societal value of education per se so that more folks are "authorised" to go into a VoTech field. As Douglas(?) has pointed out in another thread, college isn't for everyone, and as a practical matter (if not a present social matter) it isn't needed by everyone.

Eric Hines

Grim said...

I'm not sure I agree with your essential concept, Mr. Hines, that development of new technologies depends on an unstable currency. There were substantial new technologies developed in America from 1790-1890, and major infrastructure improvements like the trans-continental railroad come from that era also.

The pace of technological development did increase in the 20th century, but that seems to be associated with the reverse-pyramid nature of science: a single advance in our understanding of light, say, allows two advances in optics and laser theory; which allow multiple advances in lens development, communications, mapping, etc. The reason the scale increased doesn't appear to me to be that we destabilized the currency, but that we had spent the previous century locking in the basic patents from which to build.

We're in a similar period now, I think: there are substantial increases in our basic understanding of biology going on, but cancer treatments have stalled.

Does that mean we won't see any new advances until we come up with a way of throwing more artifically-created money at it. I think not. What's going on now is that we're laying the first part of that reverse pyramid; when it's complete, we'll see biotechnology leap forward on a logarithmic scale.

Put another way, your suggestion seems to be that we could stimulate that conceptual development to come more quickly by playing with the stability of our currency. I can't imagine that's the case. What we are waiting on is the mindset of our researchers: giving them more money now would simply lead them to spin their wheels faster. It's when the breakthrough comes that more money might help.

Grim said...

As for retraining people, retrain them to do what? We need a certain number of plumbers, say; after that, adding new plumbers just drives down the wages of plumbers.

This is the conceptual leap I'm talking about. Conservatives often will not admit that it is even possible for technology to develop to the point that unskilled people might not be employable in any number. I think it's not only possible but nearly certain to occur. What then?

Since employing them will be uneconomic, if they are to be employed it will have to be by the government -- which can choose to do things in uneconomic ways. Another more liberal option is to simply give them money so they 'everyone can live a dignified lifestyle' (to ensure their 'social equality,' as Mickey Kaus seems to phrase it).

The latter idea is the easiest one, and therefore it will be the default for Congress if we don't come up with something better.

Grim said...

It would be OK to do that planning on a contingency basis, though: you could say, "I believe the market will find solutions for these problems; further, it is an axiom of my philosophy that market solutions should always be preferred. However, if the contingency should occur that..." and then plan from there.

If I'm wrong, then, you'll end up where you want to be. If I'm right, though, you won't end up conceding to the easy option because there's no obvious alternative.

E Hines said...

...essential concept, Mr. Hines, that development of new technologies depends on an unstable currency.

I wasn't clear; that's not my essential concept. What I said was that throw[ing] money at the problem was one way. Further, this is not touting instability. Price inflation, for instance, isn't of necessity, unstable. We've been living in a regime of price inflation for several hundred years, some inflation periods being greater than others. What's unstable is when the rate of price increase gets out of hand, or when the rates--the inflation--becomes unpredictable. And what I was pointing prior was an association between price inflation and quality of life improvement rate. No causal relationship was implied. There may be one, or it may run in the other direction, or as happen so often, the may be a third factor driving each of these.

But throwing money and other resources at the problem can, indeed, stimulate conceptual development--and practical development, as the Manhattan Project did. And getting built and into action the latest CERN particle accelerator.

We may be in a period of technological base-building, again; this is another path to development.

Conservatives often will not admit that it is even possible for technology to develop to the point that unskilled people might not be employable in any number.

Certainly conservatives are highly skeptical of the thought. Technology is the end of the world as we know it and will render all of us utterly dependent on robots and leave us nothing to do but contemplate our navels has been the plaint against technological advances for a long time. I just think there'll always be a need for plumbers, and in employable-useful numbers. They just won't necessarily be doing plumbing.

Conceptually, I agree with you on contingent planning. But can we actually trust the government not to cry that the contingency is needed? There was, briefly, an agreement in the present government to tie spending to tax revenues except in case of emergency. Then the next several spending bills to be proposed were claimed to be needed because this was emergency spending. Nor is this excuse-making limited to the Obama administration. I don't have a good solution to this one.

Eric Hines

Dad29 said... long as there are elections, there will be an integrity problem with elected officials.

Wealth creation includes three categories: manufacture stuff, mine stuff, or grow stuff. We could add distribution and merchandising, except that those are, at the core, derivatives--that is, "cost of doing business" for one of the first three categories.

The value of labor, thus, depends on the number of people who can participate in any of the above (productively.) All others: lawyers, accountants, etc., are subtracting from wealth.

Finally, it seems to me that 'technology happens,' rather than "is bought" with dollars.

Invention--the lightbulb, radio, and many chemo or biological products were a result of curiosity and/or conviction, many of them un-funded until AFTER the proof-of-concept existed.

Granted, after that p-o-c, money talked and chaff walked. But the money came from stored capital which was originally that of farmers, manufacturers, or miners (or from derivatives of same, e.g., surplus of banks, lawyers, distributors, merchants (etc.)

So. Does the Fed really 'create' money? Not any more. Now it's fiat, not even backed by gold or other actual wealth-stores.

IOW, it's really confidence, not money; and the USGummint has managed to preserve confidence, for the time being.

rcl said...

The concept that we'll run out of jobs for the average worker can't be proved by any example on the ground I'm aware of. It only exists as a theoretical construct most probably based on "sustainable" growth. The future of developed countries is more jeopardized by their suicidal birth rates than by technology. If you aren't growing you're dying.

Our country has absorbed 20 to 30 million aliens to do jobs Americans won't do. The reason Europe is overcrowded with Muslims is because they were short of workers. Unemployment levels now are due to the economic structure not too much technology.

Housing is the foundation for the consumer economy and prosperity. Europe's demographics doom it to collapse. Even with America's 2.3 kids per family we will not sustain the growth curve necessary to maintain the standard of living we achieved in our lifetime. It has nothing to do with technology. If anything tech may come up with something that might help out.

There's an elitist arrogance in this argument as well. Once I took off my tool bags I've been the lead tech guy in the companies I've worked for. IMHO the best CNC operators, machine programmers and plant managers are the grunts right off the floor. No college degree teaches what they know building the product. I can teach a cabinetmaker to use CAD/CAM software easier than I can teach a degreed CAD/CAM draftsman to draw something that actually works and can be built.


rcl said...

Ignore "Ignor"! I was going to prattle on but thought better of it.

I wish we still had the delete option.

douglas said...

"As for retraining people, retrain them to do what? We need a certain number of plumbers, say; after that, adding new plumbers just drives down the wages of plumbers. "

We may need more plumbers, but a few years ago there was no such person as a home theater installer, or electronics stores that employed sales staff, warehouse people, cashiers, marketers, etc. New technologies create new needs and/or wants where we can use our new found wealth. The problem isn't that we don't have jobs for the low skill worker by design, it's that we're not hiring because the economy stinks, and our dear leader keeps making it worse, so business waits for an improvement instead of expanding.

rcl said...

The brainiacs manipulating our economy, even the "conservative" experts, don't grasp how much government tinkering stifles the ability of citizens to create growth and prosperity. We need our own Milton Friedman to stand up for liberty and opportunity.

North of The Medicine Line our neighbor has decided they're going to be a petroleum Super Power. I guarantee the market in Saskatchewan and Alberta for plumbers is strong and getting stronger. If the bureaucrats and politicians would slack the reins and let this horse run there would be more pipe laid in the next twenty years than Grim could ever imagine. Those plumbers the experts say we won't need could get back to pushing a six figure income again.

jms said...

I'm so glad to hear someone revisit the basic principle that wealth is not money ... wealth is the goods and services that we produce. Money is just the stuff we use to exchange those goods and services. If you want to have a wealthy society, you have to produce goods and services.

I suggest that there is a possible rare point of common agreement between liberals and conservatives on this point: Wealth cannot be accumulated, distributed or redistributed unless it is first created. We need to create more wealth of one form or another. For a long time, America produced a lot of wealth in the form of manufactured goods. Free trade undercut our ability to do that, but we were able to transition to providing a lot of wealth in the form of services, notably financial services. Now that the integrity of the American financial services industry is damaged and undercut, we need to find a new way to produce wealth.

The most obvious answer is staring us right in the face. We are experiencing a fossil fuel boom in the form of natural gas extraction. Natural gas can be converted into liquid fuel. Fuel is a legitimate form of physical wealth. It's a good that people need and can use to produce other kinds of wealth. At this stage in our nation's history, stifling the energy production industry is incredibly counterproductive. The world needs more energy than ever. We can produce and export it, and in the process both create jobs and provide the raw materials for the production of more of the goods and services that are the essence of wealth.

But we're stuck with bad politics -- the politics of greed and envy.

The good politics is the politics of aspiration. "My neighbor has a nice car. I am going to work longer or smarter so that I am more productive and make more money so I can have a nicer car too." That's good. That's a virtue. It results in the production of more wealth, and when enough people do that, the result is a wealthier, more successful society.

But the Obama presidency has been characterized by the politics of greed. Greed is the pursuit of unearned wealth. Greed drains an economy because it directs peoples ambitions away from a positive sum game (wealth creation), to a zero-sum game. "My neighbor has a nice car. The government needs to tax him more and give me a subsidy so I can have a nicer car." That's the basic principle of redistribution as applied to the general public. Other examples of the politics of greed are subsidies, bailouts and stimulus. People who would ordinarily be productive and aspirational become greedy when government waves free money around. In one sense the OWS people are right when they say that Wall Street has become greedy. That's the natural result when you wave around free money, and Obama has shoveled more free money -- bailouts, loan guarantees, smbsidies, tax rebates, etc, then at any other sector.

But the most corrosive politics of all is the politics of envy. Envy is the desire to sooth your lack of wealth by destroying other people's wealth. In the context of the Obama administration, the politics of envy consists of policies intended to confiscate and destroy other people's wealth, not because doing so makes poor people better off, or balances the budget, which it doesn't. They say that it is unfair for some people to have more wealth than others, and it is the purpose of government to mow down rich people's wealth.

Of course, destroying wealth is a negative-sum game. The more Obama's supporters fight for their principles, the poorer and poorer the country becomes.

The real problem with America is that we have adopted the politics of greed (wealth redistribution), and envy (wealth destruction) instead of the politics of wealth creation. I wish I had some answers as to how to get that message across because I think that it's the underlying root of the endless depression the country, and world is sinking into.

Joseph W. said...

There is a great deal wrong with this post.

Firstly, "monetary manipulation as a way out of the crisis" - is, in fact, the original "Keynesian stimulus." They are the same. A major point of Keynes' General Theory was that, in times of low employment, inflation is the best way to get it back on track. (The idea's wrong, but it's central.)

That said, no, there is no monetary theory out there (Keynesian, Monetarist, Neoclassical, Austrian, or what have you) that teaches that "wealth increases as debt increases" so that "you can repair the economy by taking on more debt." And there certainly isn't one that teaches that "wealth comes from money." This "monetary theory" of which you speak is a travesty, a nontheory. The economists of the last 250 years have not been waiting for you to shoot down these ideas. (Classical economists, in fact, wrote of the need to pierce "the monetary veil" - precisely to avoid any such fallacy. The profession has not regressed so far as you seem to think.)

Even to a Keynesian - crudely speaking - unemployment is caused by insufficient aggregate demand; and inflation or deficit spending is used to create demand, not wealth; but the demand is supposed to stimulate production. To an Austrian, unemployment is caused by misallocation of resources - malinvestment, often caused by governmental policy - so
a bad monetary policy can cause resources to be misallocated, and a good one can cease to do that kind of harm, but it's not the same as saying the monetary policy, by itself, is wealth or is creating wealth. Again, no one says that. There is no school of economics, anywhere, that teaches that money itself is wealth or the source of wealth. Money is a medium of exchange, and signals where efforts need to be directed.

Marx's "labor theory of value" - and it was a theory of value, not of wealth! - is not closer to the truth than any modern school; it was a dead-end extension of classical economics (in fact, the original verbiage is from Adam Smith; but Smith understood it better than Marx). (Technically, in Marx's work, it was a definition rather than a theory, but it was a singularly useless one, and has nothing to teach us today.)

Economics, you say, "isn't a science but an art." Also not true. In art, there are nine and sixty ways of constructing tribal lays and every single one of them in right. In economics, there are right and wrong answers, and there is weak and strong reasoning (though finding out which is which is difficult, and the study is inexact).

Finally, your notion that unemployment "isn't given to a conservative solution" - is also not correct. Your solution is the Luddite solution - deliberately keeping or creating inefficiency to keep more hands at work, or else those newfangled power looms will throw thousands of weavers out of work. It was wrong in the Luddites' day and it's wrong now.

What puts hands to work is not new demand, but sufficient capital investment (training workers to become more skilled is, of course, a type of capital investment). And a conservative solution to getting more of that - is to undo various government policies that choke it off. Find out which regulations most discourage manufacturing in this country, and abolish them. (Better still, leave the regulation of air quality, workplace safety, and the like at the state level.) Abolish price controls, especially the minimum wage. Phase out the welfare state and cut back taxes accordingly.

Joseph W. said...

...and, as a commenter in the article you link to suggests...get government out of the education business completely (or else scale their role back massively). Now there's an enormous capital investment, of which the state makes a typical pig's breakfast, and misallocates resources enormously. (Everyone forced to spend twelve years inside, whether or not he's academically inclined; and at the end of it our problem's finding work for unskilled workers?)

Whether these solutions are the best ones or not, they are certainly conservative.

douglas said...

This article I just saw today illustrates perfectly why the problem is that they (the elite, government, whoever) are telling everyone that they need to go to college, so everyone with a reasonable brain goes, academically inclined or not (as opposed to intelligent, which may or may not be academically inclined). So, we have no one filling the jobs apparently quite available for plumbers, machinists, welders and electricians.

As for production, must it be said that production means physical production? My father always explained money to me as labor banks, and it could be white collar or blue collar labor that filled those dollar-banks, so that the labor could be exchanged, so that seems to imply that labor can be white collar service or non physical production labor.

Joseph W. said...

Conservatives often will not admit that it is even possible for technology to develop to the point that unskilled people might not be employable in any number. I think it's not only possible but nearly certain to occur...

I would love to live in a world of such fantastic wealth! But you continue:

Since employing them will be uneconomic, if they are to be employed at all it will have to be the government...

You are treating unskilled workers as a class in the strictest medieval're born unskilled, you die unskilled, and so the state simply must step in to employ you unskilled. In reality, training you to some useful skill is a type of investment better made privately than by the state. Which leads to your next question (which you state before):

As for retraining people, retrain them to do what? We need a certain number of plumbers, say; after that, adding new plumbers just drives down the wages of plumbers...

If you try to do this, or any other kind of capital investment, by means of central planning - that's the problem you run into. That is why the shops of communist Europe shifted constantly between gluts and shortages. On rumors of a shortage, the goods would disappear from the price-controlled shops. The state would try to reallocate production; but without a properly functioning price system, they had no way to calculate.

In a country with a functioning market, increased demand drives prices up, so that you get high prices instead of shortages; and if they persist, you get increased production to drive the prices back down. This is the very problem that the market solves best - when it is allowed to function.

To put it the classical way, "High prices are the cure for high prices. Low prices are the cure for low prices." High wages in plumbing attract more people into that business; which tends to bring wages down; until the marginal plumber is better off training for another industry. If too many people have gone into it, driving wages down, the incentive is for the marginal plumber to get out of that business, so the prices eventually rise. That's what prices do. In a functioning market, that's what they're for.

There's a link under my Favorites bar to the full text of Henry Hazlitt's Economics in One Lesson - your understanding of will improve immensely if you give this work your time. (And it'll be an easier read for you than Avicenna for me.)

Joseph W. said...

Douglas, you're quite right. Properly understood, "production" means value production, not physical production. The same rules apply whether or not physical goods are being generated.

Joseph W. said...

P.S. - And I thoroughly agree that having the government not only push for, but pay for, "maximizing warm bodies in college" is a simply dreadful way to allocate resources. It is based on some false ideas about human nature, and a cripplingly weak understanding of economics.

Grim said...


I always appreciate your comments, which tend to be the kind of aggressive responses that make me revisit my assumptions about an issue. That's always valuable.

Now, when you say that the great economists are not waiting for me to rebut these arguments, they may not be; but I wasn't talking about the great economists. I was talking about these guys. The idea "One's financial asset is another's financial liability," combined with "inside versus outside wealth," gives us the proposition that all wealth sums to zero; but there can be more or less of it bouncing around, as long as the sum is zero. Thus wealth increases as debt increases: the difference between a society with millionaires and a society without them is that the richer society has more people owed a million dollars.

(There are several rather obvious fallacies in this approach; I can loan you a lot of money to buy beer, but that doesn't mean that your debt really represents an asset that can be relied upon to sum to zero. It's as likely that you'll drink the beer, thereby forgetting to make any money, so that I'll have to try to get my money out of you in some other fashion).

By the way, the labor theory of value is actually John Locke's; Smith got it from him. I read Marx's version of it as a theory of wealth, however, because he isn't interested in how goods are priced: he's interested in how some people get rich (his answer being, of course, that they do it by improperly leeching away the wealth created by laborers).

Grim said...

Second, you say, "In art, there are nine and sixty ways of constructing tribal lays and every single one of them in right. In economics, there are right and wrong answers, and there is weak and strong reasoning (though finding out which is which is difficult, and the study is inexact)."

That's true, but by that standard philosophy is a science. And indeed, it is the root of all the sciences!

Yet it is not a science but an art (as is history, properly understood). The question that matters isn't whether there are right or wrong answers, or good or bad ways of approaching a problem. The question that matters is whether the good way is the scientific method. In economics, it isn't and can't be: there are nothing like laboratory conditions, and nothing is ever replicable. (There's also no null hypothesis, properly speaking, although as you know some don't insist on that criterion in determining what is a science).

Grim said...

Third (and last, for now), your long response is a classic example of what I mean when I say that conservatives refuse to consider the problem. You're giving me von Mises, essentially:

"In the capitalist society there is a place and bread for all. Its ability to expand provides sustenance for every worker. Permanent unemployment is not a feature of free capitalism."

I'm aware that this is the theory.

Now, I'm not proposing the Luddite answer to the problem -- if you'll notice, what I'm saying is that we need a better answer than that one (which is also FDR's CCC type answer). I don't have a better answer, but I think we'll need one.

Why? The problem with your theory is that it assumes that people are more flexible than they really are. The pace of technology means that not only low-skill jobs but even currently high-skill jobs are being automated (just as secretaries have largely been replaced by word processors and blackberries).

There are a few jobs that are in no danger of being replaced by technology, now or in the future: novelist, say. Almost anything that can be substituted with capital will be (especially and first in Japan, where labor is at an increasing premium due to the collapse of birth rates; but once the Japanese have made the investment of developing the technology, even nations with excess labor can deploy that technology far more cheaply than they could have developed it).

Thus we have a problem: every job that is easily to define as a series of steps can in principle be automated, and is likely to be so.

So we retrain people as the technology changes. Well, you can retrain most people to be a plumber, but there will be a point at which plumbers are no longer needed in the area. So they can move, or retrain again. Now, moving around means leaving family (including elderly parents who may need you); so there is less flexibility than assumed by the model.

Also, you can't retrain everyone to be a mathematician. There is less flexibility here, too, because many jobs are simply beyond the capacity of many millions of people. No amount of retraining will make them able to do these jobs, which happen also to be the jobs least likely to be replaced.

People also aren't infinitely flexible in terms of the number of times they can retrain. Even those people who are mentally flexible enough to retrain over and over, as technology changes, will need to be sustained and supported while they retrain -- which they can't be expected to be able to do out of pocket, since these people being driven out of work by the technology curve are going to be the ones with the least ability to store up wealth.

Now, you may be right that the society's wealth will be increasing all along -- and it may even be wonderful to live in such a society, if we can figure out a way to address these problems. Current economic theory doesn't seem to have an answer for it, though; it just denies the problem exists, or it points to government intervention as the problem. Yet the problems I have cited above assume the market is working perfectly, without baleful influence from government.

Joseph W. said...

I wasn't just referring to "the great economists," but all the major schools of economic thought. Visit a site like, and you'll get a taste for how modern, non-Keynesian economists are writing. (And you'll see that the baby-level pre-economic mistakes of which you're accusing the profession...are really quite absent.)

You've given me a link to an article on accounting (albeit on an economics weblog). Now, in accounting assets and liabilities are measured in terms of money. There is nothing on that page that begins to amount to the idea that "money is wealth" (in the economic sense of the term) or "money creates all wealth" (again, in the economic sense of the term), or the other fallacious thinking that you imagine underlies "monetary policy." It's simply a basic description of "assets and liabilities" (not "wealth and poverty") in the macroeconomy. There is nothing in there that says "more debt equals more net wealth" - in fact, that is the opposite of what the authors are saying; their point is that, however much debt there may be, if you add each sector's balances and subtract each sector's liability, the result is zero!

That article doesn't, by itself, address the issues with which you're concerned. (It appears to be part of a series which might be getting there.) It certainly doesn't commit the egregious, pre-economic fallacies you're (wrongly) accusing modern economists of making.

Grim said...

Before you were on me about value versus wealth, but I think I got that one right; now you're making a distinction between economics and accounting, which strikes me as somewhat artificial. Accounting as a practice is how you get the numbers to which you would apply your economic theory; but if you have a theory of accounting, then you're already at the theoretical level. In any case (as you note) this is a part of a series on a theory of macroeconomics which revolves around fiat money.

Now, I still may be mistaken in my reading of what various people are saying; but as I remember the book you suggested earlier, which I believe I have read, it asserts that there are essentially two mistakes to economics: that of looking at the effects of something only on the short term, and that of looking only at the effects on one class versus all classes.

My understanding is that there is a more fundamental mistake in economic theory -- although I have read only so much of it past Schumpeter -- which is that their theory of human nature tends to be flawed.

But those links, although to financial newspapers, are by a journalist and a philosopher; you seem to wish to defend the honor of currently-writing economists. The main contemporary thinker that comes to my mind in this area is Nassim Nicholas Taleb, although he himself considers himself an epistemologist (that is, a philosopher). So perhaps you have recommendations for me beyond the blog?

Joseph W. said...

To go to your example...if you lend me money, you've got an asset in terms of my promise to repay; and I've got a liability in the same amount. If I tipple it away and seem unlikely to replay, your asset has just gone down in value - and you might need to adjust the books accordingly. (That may well be an issue they get to later in the series, because that is exactly what has been happening with government debt in the U.S. and Europe.) In the extreme cases, if you enforce the debt and recover your assets, or if I end up bankrupt, the government steps in and reduces your asset and my liability to zero; but that doesn't change anything those authors are writing about. And it doesn't have anything to do with the fallacy you accuse them of making.

Now when you are talking about the difficulties of "how many people will switch into plumbing," you are indeed getting into von Mises' territory. What you are dealing with is "the problem of economic calculation" -- that is to say, the overall question of how capital investments and production must be allocated. Everything from "How many plumbers, and where?" to "How much energy, and where?" The whole point of his treatise Socialism - it was quite a while ago, but I read it - is that the market can and does solve this problem in a way that central planning can't. (Mr. Hazlitt turned the arguments in this treatise into an extremely readable novel, Time Will Run Back - not so popular these days but an old favorite of mine.)

Joseph W. said...

(crossed comments there due to long phone call...will step back & read)

Joseph W. said...

If you mean that economists simplify problems in order to understand them, that is of course true. The first article you link to, on behavioral economics - an area I haven't studied, though I've read about it a little - this article fits my understanding of it. Behavioral economics may well end up modifying and improving our understanding of the way a market economy works; but what it does not do is plunge us back into the pre-economic fallacies you accuse economists of making, of imagining that "money is wealth" or "more debt means more wealth." Classical economists didn't hold to any such doctrines and neither do behaviorists, nor any other economists.

In fact, reading that article through, you can see the bigger issue is one the administration wasn't addressing in using the behaviorists' work. The policy in question was about how to get people to spend more to increase aggregate demand (i.e., Keynesian policy to attack a recession). The behaviorists' work was being used, not to deal with the quesiton of whether "increasing spending" or "increasing aggregate demand" is the right idea in the first place - only with how to get people to do that spending.

The second article you link to does not give an accurate picture of what classical economists say -

Classical economists, perhaps uniquely among members of the human race, would assume you made your decision fully aware of the implications of your actions, that you weighed up those implications and came to the conclusion that, all things considered, the cheese and bacon burger is the better choice.

Complete rubbish - the author doesn't know what he's talking about. Classical economists recognize that, if you bought it, you wanted it; and if you paid more for it, than you would've for the alternative, either you valued it more, or at least the transactions costs were high enough that you took what was available. They never said anything about how calculated it was "better for you" in terms of health (or whatever). (Leftists who want to ignore basic economics are fond of arguments like this - to caricature and discredit, and so throw aside, economics instead of studying it.)

Joseph W. said...

As I remember the book you suggested earlier, which I believe I have read, it asserts that there are essentially two mistakes to economics: that of looking at the effects of something only on the short term, and that of looking only at the effects on one class versus all classes.

Those are certainly the two major mistakes in common economic thinking, which he deals with at length. In fact, his inspiration was Frederic Bastiat's What Is Seen and What Is Not Seen, which deals exclusively with those problems. But in addition to attacking these fallacies, he also gives a well-written positive account of how prices operate to allocate resources, how higher taxes discourage investment and production, and how inflation distorts the signals sent by a freely-functioning price system.

If you think, for example, that a free market in labor can't possibly solve the problem of how many people need to get out of carpentry and go into plumbing, then that book would repay a re-read for sure. (It's from the 1940's - the author was a journalist covering Wall Street before and after the '29 crash - but I was still being taught the fallacies he attacks in public school in the '80's...there's a lot to be said for the classics.)

Joseph W. said...

Now, then, I certainly do draw a distinction between "assets" in accounting - which the first article you linked to was about - and "wealth" in the broad economic sense, as the thing we want to maximize to have a prosperous country. Creating fiat money will create the former, as a matter of course, without per se increasing the latter at all. (What's actually happened is that wealth has been redistributed; whichever bank gets the new funds now has a larger claim on the wealth that is out there.) Every economist understands that; as do you and I.

A Keynesian might favor doing this anyway as a way to stimulate economic activity, to cause some wealth to be generated that otherwise wouldn't be. But even the worst of them wouldn't imagine that the money itself was the wealth, or that the creation of the money, all by itself, was the creation of wealth.

Grim said...


I waited a bit to give you time to read those through.

Yes, I agree that the framing of that paragraph is tendentious. Although not quite so much so as you may have read it to be: when he says "the better choice," he doesn't make any claim about why you might have decided it was better. It could have been for any number of reasons, including the ones you give.

The assumption, though, is that you're making something like an informed decision. What you may be doing instead is reacting to pre-rational, subconscious decisions being made by a part of the brain that values fat for reasons that were quite right in prehistoric Africa, but less useful today. Yet the judgment is made, as he notes, just that way by a lot of people.

So there is a serious question, in spite of his inartful phrasing.

"... it doesn't have anything to do with the fallacy you accuse them of making."

What of this?

This is sometimes called “inside wealth” because it is “inside” the private sector. In order for the private sector to accumulate net financial wealth, it must be in the form of “outside wealth”, that is, financial claims on another sector. Given our basic division between the public sector and the private sector, the outside financial wealth takes the form of government IOUs. The private sector holds government currency (including coins and paper currency) as well as the full range of government bonds (short term bills, longer maturity bonds) as net financial assets, a portion of its positive net wealth.

This clearly prescribes increased government debt as the (only available) mechanism for increasing the net wealth of the private sector. That doesn't make any sense, however, if the increased wealth (in the form of future bond payments, an asset against which I can borrow) is wasted; that will destroy the wealth of the private sector by extracting it.

This may be a semantic issue (although given your work in mathematics, I know that semantics are quite important to you). I'm not sure we are using the word "wealth" in the same way (and it may be that I am using it differently than the authors intend, for that matter). I regard wealth as actual prosperity, as for example in the ability of a man to eat a steak when he wants it, whether he buys it or cuts it off one of his own steers. Such wealth can obviously decrease or not in a net fashion.

This theory regards wealth as something that must net to zero, so that if my wealth increases someone else's must decrease. That strikes me as plain nonsense; but perhaps they simply intend the word to mean something other than I understand by it.

Dad29 said...

(Better still, leave the regulation of air quality, workplace safety, and the like at the state level.)

Well and good in cases where there are not several States involved in one case (e.g., water quality in the Great Lakes.)

I certainly favor States over the Fed, but some things cannot be jig-sawed.

Grim said...

A reasonable point, D29. There can also be international issues that can only be resolved by treaty, which also indicates Federal involvement. A good example is the Chattahoochee river that runs from the mountains where I grew up through Atlanta and to the Gulf of Mexico. It waters areas of Georgia, Alabama and Florida, and has major water issues because of Atlanta's thirst (and reservoir, Lake Sidney Lanier, named after the highly honorable poet). There is also, I am given to understand, a treaty with Mexico pertaining to some sort of fishing industry: a certain amount of freshwater has to flow in order to maintain some species that interests Mexico. So the Army Corps of Engineers is involved to maintain the lake; and the State Department to see that the treaty is honored.

Joseph W. said...

Dad29 - Agree with that; it gets you into real "interstate commerce" anyway. I think you see my larger point - which is that reduced federal regulation is an example of a conservative policy, which can be used to encourage more capital investment, and thereby to put more unskilled workers to work (possibly by training them into skilled or semiskilled workers).

And that is the largest point that I want to make here - that it's a dreadful idea to take the population of unskilled workers (or farmers, or weavers) as fixed, so that any development that reduces the demand for them must necessarily throw the rest out of work. That was the central fallacy of the Luddites. (Which they solved by smashing machinery that might reduce the demand for a given type of worker.) Says this, we've gone from 70-80% employed in agriculture (in 1870) to 2-3% in 2010; yet we do not suffer 67-78% unemployment.

This is because people, even large populations, really can change or gain trades; the key to it is capital investment; and if that's controlled by a private market, it can be (and is) handled very efficiently. Which is why this country is as rich as it is, and would be richer yet with more conservative policies, and we don't need government make-work schemes to fill the gap.

On the accounting article - yes, it is very much a semantic issue, and they are not using "wealth" the way we normally use the word in political discourse (as the thing we want to see maximized). I didn't spend a lot of time at that weblog but I believe the article is part of a long series on monetary policy - so it makes sense for it to use accounting definitions and concepts. That doesn't mean the authors have got this kind of wealth confused with the "Wealth of Nations."

"My work in mathematics" - you flatter. I was a math minor and a decidedly unsuccessful physical chemist (M.S., no doctorate, no publications) and have read a little here and there on my own because I like to. Don't take me that seriously, not compared with the real mathematicians.

's about bedtime. btw, my university-town library does have both Avicenna's Metaphysics and a book placing them in context. And both have been checked out. Later!

Grim said...

Checked out by you, I presume? Or do you mean to suggest that there's someone else reading Avicenna's metaphysics in your town? That's got to be statistically unlikely!

Joseph W. said...

I mean, alas, by somebody else - they weren't on the shelves. (There were some books in Middle Eastern script there - I couldn't tell you if Arabic or Persian - but no matter because I can't read them.)