When First Principles and Reality are in Conflict….
Any successful reform of macro economics must begin by abandoning most of the false first principles that distort its vision and blind its worldview. The money system must be recognized as the macroeconomic control system. Commercial bankers making or denying loans (and borrowers seeking to add to or repay their debts), not governments or central banks tinkering with interest rates and inflation targets, must be recognized as the effective governors of the macro economy. Bankers creating excessive credit money to fund mortgages that inflated the disastrous real estate bubble (and banker bonuses) must be recognized as the “cause” of America’s current financial straits. And exporter nations providing excessive vendor financing to importer nations, to enable importers to keep buying and consuming and thus keep the creditors’ export-led growth models working, must be recognized as the cause of Europe’s current woes. Trading Mercedes cars for Greek promises to pay for them proved not to be such a lucrative business model as it once seemed.
“Credits” are not “money“. Savings are money, money that somebody has already earned or received as “income“. Credits are debts owed by people who promise to pay money in the future. But if the debtors can’t get money, then the credits prove to be worthless.
The “credit” all ends up in the hands of producers/lenders, while the “debt” all ends up owed by the consumers/spenders. There can be no consumers without producers, and there can be no creditors without debtors. There can be no new income earned and saved without other people borrowing new credit-money from a bank and “spending” that money. Too much credit granted to consumers/spenders sets up a balance sheet recession, where earners have all the money and spenders have all the debts.
Macro Economics IS Money Economics
The “market solution” to reconcile a balance sheet recession requires that the parties to the unbalanced transactions must switch roles. The producers/savers must become consumers/spenders, and the consumers/spenders must become producers/savers. This allows the spenders to produce and sell economic value and thus “earn” their money back and repay their debts to the creditors. But if the savers won’t agree to become spenders, then the borrowers have nobody to sell their economic outputs to and thus no way to earn their money back, and they CANNOT repay their debts.
It’s a simple monetary arithmetic equation that no amount of econometric obfuscation can alter. To resolve the credit-debt imbalances the spendthrifts must become productive savers and the savers must become spendthrifts. But saver and spendthrift are character types, printed in the DNA, and these people cannot become each other. So as Michael Hudson succinctly puts it, “Debts that can’t be paid, won’t be.” The credits prove to be worthless promises that cannot be kept. The savers have all the money, and the debtors cannot get it back.
The mistake was made by “assuming” borrowers would eventually become savers and repay their debts, even though the creditors/savers had no intention of becoming spenders and borrowers, which makes it arithmetically impossible for the imbalances to EVER be resolved within our monetary systems where all of the new money is issued as loans of credit by banks. To get more “money” into our current system, somebody has to take on more “debt” from the credit issuing banking system to spend into the economy. Only money received as “income”, not more money that is borrowed as “debt”, can allow debtors to repay their debts. And if spenders can’t borrow and spend more money, and if savers save and won’t spend, who will spend the money that will become incomes to the debtors who are supposed to suddenly transform into productive titans of thrift?
So if savers and spenders are not about to switch roles, then only the creation and distribution into their economies of new money by central banks or governments, which becomes income money in the hands of its earners or recipients, offers an arithmetically realistic solution to the current saver-debtor and creditor-debtor standoff. The new money could be issued by outright monetization of government bonds by their central banks, in which case interest paid and earned on the bonds is simply remitted to the government who owns the central bank. Or government who have not given up their sovereign authority to issue their own currencies can simply issue themselves money directly. Reality might impose consequences that are politically difficult to accept, such as monetary inflation that dilutes the purchasing value of credits and savings.
But unpleasant consequences do not refute the truths of arithmetic. We are already in the environment of unpleasant consequences of our past behaviors, too much lending and too much borrowing that created an impossible imbalance between creditors and debtors. The alternative to the creation and distribution of new government money is debt deflation, banking system insolvency and collapse, Depression, and social unrest and/or war (all of which the Ludwig von Mises Austrian school of economics believes is inevitable in any event, as the inescapable consequence of a credit-fueled economic boom).
Any macro model or theory that cannot capture this simple arithmetic of money as a fundamental principle is false. The truth is politically hard to accept, but money is comprised of positive and negative numbers (credits and debts), and reality is inflexible about the numerical truths and consequences of arithmetic. Macro economics is money economics, and arithmetic is its modus operandi and its binding constraint.
The Total is More than the Sum of the Parts
In a money economy, macro cannot be understood as an expanded version of micro economics, which deals with supply and demand of labor and real resources in the real economy, the exchange of relative value for relative value. A true macro must recognize that macro involves a separate system, the money system. Supply and demand of “credit” is the operative force. Money prices in the real economy, imbalances of incomes and spending and credits and debts, are consequences of lending and borrowing and credit-spending decisions. These monetary decisions are only tangentially related to the supply and demand curves in the real micro economy. The causation operates downward from money to the real economy, from the macro control system to the micro producing and consuming system.
Money, Value and Price
Value does not create money, but money creates “price“. Money price is not simply an abstract numerical expression of “value“, as misguided macro has so long believed. Excessive mortgage lending creates $600k bungalows mortgaged by $50k incomes. There is no relation here between “price” and “value“. Price can readily be explained in a macroeconomics that recognizes it is dealing with the money system, not the real micro economy. Prices in the micro system must be recognized as consequences of lending, borrowing, and credit-spending decisions made in the macro money system. Credit money is created and spent BEFORE the money is earned by the spender. The seller, the recipient of the spending, earns money after he sells some good or service that he has already produced.
But the money that becomes his sales revenue and income must be created and borrowed and spent before he can earn it. Savings only becomes bank deposits AFTER a bank has extended credit and the borrower has spent that new bank deposit into the economy, where the spending recipient deposits it in his bank as his savings. Barter-model mainstream macro insists that savings “creates” bank deposits, and that banks can’t lend until after a depositor has saved. But this view is simply ignorant of how our money systems actually work.
The “payable” price of those $600k bungalows might top out at around $200 – $300k. But excessive credit expansion inflates the ‘price‘ of those houses by 2 to 3 times. The borrowers WILL default, and all the money everybody thought they were making will evaporate when the insolvent banking system that loaned all the money is bailed out by governments who can ONLY get the “money” back from whoever now has it. Who has the money? Capitalists and producers and savers have all the money. Who has no money? Debtors. Who is the money owed to? The banking systems that created it as credits. Where can debt-ceilinged governments get money to bail out their banking systems to prevent their economies from collapsing? By taxing the money from the people who now have the money.
Present Era Solutions
You can’t get money from an unemployed bankrupt stone. And you can’t employ him and increase his income so he can pay his debts by imposing monetary “austerity” on the economy in which he lives. If you’re not going to try to get the money by taxing it from the people who now have it, or by convincing capitalists and producers and savers to spend their savings on consumption (with depressed consumption there is no incentive to invest), then there are ONLY 2 numerically cognizant policy options available to address the current imbalances between debtors whose earnings have collapsed, and creditors whose assets have become worth less in a depressed market where nobody can buy those assets for the price that is still owed against them:
- The Austrian solution: let the defaults roll, let CPI and asset prices plummet to “sound footings”, let the banking systems and buyers who inflated those prices collapse and the economies fail, let businesses fail en masse and Depression and revolution and war run its course, wiping out all the “malinvestment” that we call “civilization” and starting over with a few monied plutocrats ruling a much depopulated world of desperate serfs
- The Keynesian solution: let governments continue to borrow unlimited trillions from their banking systems or from the people who now have the money, at interest (bank loan interest is money that was never created and doesn’t exist except as a debt), and spend (or give) that money into the economy where earners/recipients can use it to pay their cost of living and also pay their debts to the banks, which keeps an economy working, and which indirectly bails out the banks by bailing out the banks’ debtors. An alternative to unlimited government debt at interest is for governments to monetize their new debt through their central banks or simply issue themselves the new money. Monetary inflation acts as a tax on the purchasing power of the money now in the hands of the winners of the failed Ponzi economy, while new money distribution restores the masses’ income-driven ability to pay their debts and participate in the economy.
- The neoclassical/neoliberal non-solution: advocate domestic austerity and unlimited economic expansion to grow and export our way out of our arithmetic problems (export to whom? we might ask). But applying the new macro understanding of the empirical evidence we see that “economic” growth is only possible as a consequence of “money” growth, which in our current system is “credit-debt” growth. This ‘solution’ advocates that the private sector resume its upward trajectory of borrowing and total debt, rather than the Keynesian way of government debt growth. The Ponzi arithmetic of money keeps working as long as evermore new money is created and spent into the system to keep up the incomes of the spenders whose “monetary” demand drives the rest of the economy. Without money in the hands of spenders, there is no point in producing things for “sale”. But private sector debtors have reached their personal debt ceilings, and many have lost their appetite for personal Ponzi finance of unaffordable lifestyles, and bankers are no longer financing Ponzi consumer spending, so option #3 is actually a “non-solution”, even if the world can discover enough resources to support unlimited growth of production and consumption.
I am aware that all real world economies are “political” economies, and that powerful interests are able to suspend or banish realistic facts of monetary arithmetic from their nation’s public debates. Insofar as economists want to get jobs working for these interests, they cannot admit realities that don’t serve the interests of their paymasters. This political phenomenon discredits the discipline of economics in its pretense to be a “science“. But it does not excuse macro economists from their scientific sin of blinding themselves to the monetary workings of the real world.
Wendy Carlin reports that a new generation of economics students is more interested in true understanding of the macro economy than in lucrative employment in London’s City or on Wall St. If this is true, then it is one of the conditions that are needed for a conceptual paradigm shift in macro economics. Strauss & Howe’s “generational cycles” model supports this kind of macro shift in priorities. In, The Structure of Scientific Revolutions, Thomas Kuhn quotes from Max Planck’s, Scientific Autobiography,
“a new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it.”
There is always political opposition to change, from the status quo powers that be. There are careers and reputations at stake, incomes and wealth and privileges. In the psychologies of power, ego and self-interest trumps scientific truth. Will truth ultimately prevail in the new macro economics? If Kuhn and Planck are correct, then rogue economists are going to have to step up their teaching of truth in violation of the deeply imbedded but false macro orthodoxies. And we will have to wait and see what the next generation is able to do with their new knowledge.