The Difference Between Validity and Truth
While mathematics and formal logic can identify valid and invalid forms of reasoning, the truth or falsehood of a statement is determined by the correspondence (or lack thereof) of the contents of the statement to events and causal mechanisms in the real world. Falsehoods validly stated are assumed by economists to be “true”, when in fact they are merely “valid”. Economics has become a “formal” discipline, whereas physics and other sciences are “empirical” disciplines. Empiricism begins with observations about reality, then builds theory that is logically consistent with the actual workings of reality. Theory is constantly tested against reality to insure the content of statements is “true”. Empiricism practices “inductive” reasoning, working upward from the particular (real world observation) to general statements about how the world works. If theory fails to predict observed realities, or if theory is contradicted by observations from reality, then the theory is recognized as deficient or discarded as false.
The First Principles Trap
Economics has become a “deductive” discipline, working downward from first principles, which are assumed to be “true” and are rarely tested against actual reality, then deducing how the world “should” work based on the logical implications of the first principles. Induction attracts philosophical realists who are interested in discovering truth. Deduction attracts mathematical theorists who are interested in abstract speculations and modeling forms. Realistic empirical disciplines are never so confident in the truth of their first principles that they claim their models are comprehensive descriptions of reality. Physics is intensely aware that they have yet to find the grand unified theory of everything, and the history of physics is the history of revolutionary revision of first principles in the face of contradictory empirical evidence and more comprehensive theory.
Economics has been going in the opposite direction, assuming (whether implicitly or explicitly) that its models are “true” replications of the real world. But as Wendy Carlin recognizes, mainstream macroeconomics has completely ignored the effects of money and banking in its modeling. Economics, in its centuries long error of conflating “value” with “money” such that producing economic value somehow automatically produces “money” to enable purchase of that value, has utterly blinded itself to the empirical fact that a nation’s monetary and financial system IS that nation’s “macro” economic control system.
Can We Finally Wean Off Barter Logic?
The “real” economy can be quite accurately “modeled” as a barter system where subjective value is exchanged for subjective value and transactions are facilitated via the use of money. But “the real world” does not exchange value for value in a barter economy. We “buy and sell stuff” (including labor, goods and services, resources, land, financial investments, etc.) for money. Money is an “objective” numbers system that obeys the laws of arithmetic, whereas “value” is a subjective psychological phenomenon that exists in the minds of people who need and want stuff. Economic activity adds “value” to resources, makes stuff “worth” more to people who want stuff. Economic activity is a positive sum, value-adding enterprise.
But economic activity adds precisely zero “money” into the economy. And unlike economic activity that adds “value” by applying human effort to resources, money does not add to itself. Money, as it is currently issued in the form of bank loans, is a zero sum numbers system where all positive number “credits” are offset by equal negative number “debts“. “Bankers” add money into the economy, by making loans and by buying government securities, and borrowers “spend” that money into the economy where it becomes the the recipients’ income and the economy’s money supply. But the money supply is all owed as debt repayments by the bank borrowers.
This is a problem. One person can only have “savings” of money if some other person or government has borrowed and spent that money into the economy and has not yet earned or taxed his spent money back out of the economy to repay his debt. When the debt is repaid, both the credit (the positive number of “money”) and the debt (the equal negative number of monetary “liability”) are extinguished on the bank balance sheet, leaving no money and no debt. Money is a zero sum financial accounting system, interposed over a positive sum value-adding economic system, in which everybody wants savings but nobody wants debt. Which is an impossible contradiction of basic arithmetic, under current operation of our money systems.
Economic Value
This money creation and allocation process has no logically or mechanically necessary connection with the production of economic value. The real economy and the money system are two separate systems. One produces value. The other creates and allocates money and debt. Indeed, an entire large scale “financial economy” has developed where financial assets are bought and sold and monetary wealth is transferred from losers to winners, arguably without producing any “economic” value at all.
Money is gained and lost in a “derivative” process that has become wholly abstracted from the real value-adding economy. Winners can use their earnings to buy anything that is for sale in the real economy, but can it be truly claimed that these money earners added proportionate (or any) “economic value” into the system that they then “exchanged” for the fruits of other people’s efforts? Quid pro quo, something for something, value for value, is the moral underpinning of a market economy. Homo Justicus is real people. We may not be economically rational actors all the time, but we certainly know injustice when we see it.
Financial Value
If a large class of participants is getting a whole lot of something for nothing merely by manipulating the ownership of financial assets, manipulating the creation and distribution of money numbers, then the market economy is failing in its morally necessary role as an equitable “distributor” of the system’s real economic work and real economic value. When some participants are systematically able to “take” more than they “produce“, then distributions within that system are being determined by power, not by “market forces“, according to theories of how markets are supposed to work.
Forces vs. Power
In our world of Big it really is market power, not competitive market forces, that determines economic distributions. To maintain moral legitimacy, the issue of distributions must be addressed “politically“, something John Stuart Mill was advocating in his 1848, Principles of Political Economy. But so far the beneficiaries of market power have managed to convince the masses that we still live in a competitive free market system where it is possible for some individuals to “earn” a billion dollars of personal wealth.
To put this claim in perspective, that is the equivalent of one man unaided by anyone else producing 5000 houses priced at $200,000 each. He would have to produce 100 houses per year, every year for 50 years, a complete $200,000 house every three and one half days for 50 years straight, to “earn” a billion dollars by his personal economic efforts. And this is assuming he already owned all the land and materials and tools to build the houses and the $billion is his “profit” and personal income, and he never spent a dime of it on anything. This kind of personal wealth could never be possible in a competitive free market system. Reality-defying personal wealth cannot be justified as “earnings”. So the evidence suggests that market power, not market competition, makes such extreme wealth possible. Which means appeals to the moral justification of “market distributions” are false.
Magical Money
The barter models that inhabit mainstream macro utterly fail to see where all of the money “comes from” in the first place (it comes from banks, creating credit money and issuing money in the form of loans of bank deposits). Which is why Richard Koo’s, The Holy Grail of Macroeconomics, which explains the macro economy in terms of credit and debt creation and stocks and flows and imbalances, is the closest thing economics has to its “grand unified theory of macroeconomics“. Steve Keen is also developing a new macro from this money-conscious perspective, and “heterodox” economists like Keen’s fellow Australian Bill Mitchell, and Michael Hudson and others from UMKC, have understood the role of money for many years already. Even the IMF, represented by “research” authors Kumhoff and Benes, is acknowledging the need for monetary reform. As did Irving Fisher and CH Douglas during our last monetary system collapse in the 1930s.
The Isolation of Monetary Realism
These monetary realists are systematically sidelined from mainstream economics as a looney fringe, which effectively ostracizes them from the public debate. Hyman Minsky, whose analysis of the monetary causes of the business cycle and dire predictions of the collapse of Ponzi finance are almost universally reviled among bankers, was another clear and true voice crying from the macroeconomic wilderness.
Math is a wonderful language to calculate probabilities of real world outcomes, if and only if the principles that are captured in the formal equations are true to reality. When the principles are deficient or outright false, mathematical econometrics merely offers the illusion of precision. Its predictions are as often as not precisely the opposite of what happens in the real world. It doesn’t “work“.
The Empirical is Reality
“Real” sciences like physics and civil engineering would be ashamed to call themselves “sciences” if their confident predictions were as often disproved by reality as are the predictions of econometricians who have trapped themselves in the misconception that their defective models are “true“. Their perception of the world must be blinkered and distorted so that the world that they permit themselves to ‘see‘ conforms to the world as it exists in their theory, rather than adapting theory to a clear view of reality as occurs in truly empirical disciplines. When their econometrically precise bridges and buildings collapse in fatal ruin, when they unwittingly construct financial time bombs that they believe to be “stabilizers“, deluded economists do not question the truth of their theories but rather blame “the world” for failing to perform as their models say it should.
They are prisoners within what William James called “conceptual realism“, where they take their concepts to be “real“, and they judge the world true or false as it conforms to or contradicts their concepts. In fact it is reality that is real and it is our concepts to which judgments of truth and falsehood apply. “Perceptual realists” recognize reality as the judge, and adapt their concepts to match observable reality.