Thursday, June 28, 2012
Why Biology Can Not Be Mechanized...
Mr. Herbert Spencer wishes to explain evolution upon mechanical principles.
This is illogical, for four reasons. First, because the principle of evolution
requires no extraneous cause; since the tendency to growth can be supposed
itself to have grown from an infinitesimal germ accidentally started. Second,
because law ought more than anything else to be supposed a result of evolution.
Third, because exact law obviously never can produce heterogeneity out of
homogeneity; and arbitrary heterogeneity is the feature of the universe the most
manifest and characteristic. Fourth, because the law of the conservation of
energy is equivalent to the proposition that all operations governed by
mechanical laws are reversible; so that an immediate corollary from it is that growth is not explicable by those laws,
even if they be not violated in the process of growth. In short, Spencer is not
a philosophical evolutionist, but only a half-evolutionist,―or, if you will,
only a semi-Spencerian. Now philosophy requires thoroughgoing
evolutionism or none. C.S. Peirce
Sunday, June 24, 2012
Letters: How to Mend Trust in the U.S. Economy
Published: June 23, 2012 LINK
To the Editor:
To the Editor:
Re “Broken Trust Takes Time to Mend” (Economic View, June 17):
Tyler Cowen argues that the “slow cure” for our economic malaise is to allow asset prices, wealth, trust, etc. to slowly rise. He states that the textbook cure of significant “Keynesian” government stimulus spending will not quickly restore prosperity because fiscal stimulus does not “rebuild confidence.”
Unfortunately, Professor Cowen seems not to understand that if the government were to let contracts for, say, $1 trillion to private enterprise to rebuild our failing highways, bridges, and municipal water and sewage systems, and provide resources for our shrinking public and higher education systems, this would quickly restore companies’ confidence in the profit opportunities that are available if they hire workers and buy materials from other United States companies. When these newly hired workers go out and spend their wages, the confidence of United States retailers would immediately surge as these additional customers break down the doors to get at the merchandise on the shelves.
Nothing will build the confidence and trust of business and workers quicker than the continuous ringing of cash registers. Paul Davidson
Morton Grove, Ill., June 17
The writer is editor of the Journal of Post Keynesian Economics and author of “The Keynes Solution: The Path to Global Economic Prosperity” (Palgrave Macmillan, 2009).
Wednesday, May 30, 2012
The unseen but perhaps decisive grand alignment of the nations!
Original Link: http://fabiusmaximus.wordpress.com/2012/05/22/39076/
Summary: Yesterday’s post The end of the post-WWII world is not the end of the world discussed the large-scale processes at work now. Today we discuss the most astonishing — and seldom seen — aspect of these things.
The problems of the many individual nations in crisis have received ample attention from experts. The two global dimensions of the crisis have not. First, the global financial regime no longer works well (as seen, for example, in the faltering ability of the US to act as the reserve currency, the disinterest of other nations in replacing the US in that role, and the wild gyrations of currency values). Second, the large number of nations experiencing large-scale structural change. Here we look at the second — and least well seen — aspect.
Contents
What caused the disaster of the Titanic? There was no single cause, it resulted from a constellation of simultaneous events. Bad weather. Bad luck. Mistakes. Lost gear. Errors of judgement.
Similarly today we have the major nations of the world simultaneously at or near (1 or 2 years?) major inflection points: Eurozone, UK, Japan, USA, and China. In each case largely due to internal dynamics, as their current internal economic systems fail and require major reforms. It’s the geopolitical version of the planetary grand alignment (which allowed NASA to send the Voyager One and Two probes to tour the solar system).
.
This creates danger and opportunity for each nation (as in the legend of the meaning of “crisis” in Chinese), but also the possibility of global synergy in a bad way over the short-term. As shown in yesterday’s post, even successful transitions are painful. Most or all of the major nations in transition would depress the global economy and lead to geopolitical instability.
What about the long-term? It could be very good, if everybody works their way through to successful new regimes. Or very bad, if most major nations fail to do so.
(2) Causes
The odds of this synchrony are too great for this to result from coincidence. What systemic factor might account for it? These nations have different demographics, economic and political structures, social systems, and trade patterns.
My guess (emphasis on guess): the common elements are poorly managed debt and lax regulation of their financial industry — although in different ways. Debt excesses differ from nation to nation: internal or external loans, private or public sector debt, debt incurred for investment or consumption. It’s the debt supercycle (coined by Hamilton Bolton and Tony Boeckh of Bank Credit Analyst).
Ditto for the banks. Some got into trouble speculating. Some the old fashioned way, by excessive and imprudent mortgage and business loans. Some were ordered or pressured by governments to make bad loans (often to the government).
But no matter what the path, the result was debt that could not be paid back and wrecked banks. There may be no other path to the future other than mass defaults and rebuilding many of the world’s banks (at somebody’s expense). The new world will probably build a fundamentally different global financial system than ours, learning from our generation-long experiment with debt. It’s a useful tool but, like many powerful tools (opiates, nuclear power, nailguns) becomes a fearsome thing when misused.
(3) A tour of the nations
(a) The Eurozone
The Eurozone is furthest along of the major nations in the cycle of crisis and resolution, and exhibits many of the traits only dimly visible elsewhere. It might also be the template that other nations follow to disaster: incorrect diagnosis of their problem, dogmatic adherence to unworkable solutions, reluctance to confront their core structural problems, and a refusal to learn from either economic theory or history.
Worse, Europe’s leaders appear unwilling to address their core problem. Perhaps because Europe’s people are not yet willing to do so. As we see in the Greek polls: 80% want to stay, 80% don’t want to pay the price of staying. Polls in Germany show a similar contradiction.
Francisco Blanch (Global Investment Strategist, Bank of America Merrill Lynch) explains the first three problems:
Japan’s increasingly elderly majority have locked the nation into box of dyfunctional guaranteed to fail policies. Some experts believe their leaders have in effect given up on finding a solution, and just wait for the eventual singularity — wrecking the existing order and making possible a new Japan. The process probably will be painful. Here are two obituary notices:
The UK now confronts decades of errors: over-reliance on North Sea oil (rapidly depleting), a poorly managed and over-size financial sector, and large public debt and liabilities. Worse, their leaders and people appear clueless about their problems and possible solutions. For details about this bleak situation see “Thinking the unthinkable – might there be no way out for Britain?“, Dr Tim Morgan (Global Head of Research), Tullett Prebon (UK brokerage firm), July 2011 (large pdf) — An excerpt looks at their future:
All these are in earlier stages of the crisis cycle which will test their people and leaders. Some will be in effect voted out of the major league nations; others will become regional hegemons or even perhaps superpowers in the next world order. For more about China and India see the FM Reference Page listing all posts by nation.
(4) For more information
See these FM Reference Pages for other posts about these topics:
Summary: Yesterday’s post The end of the post-WWII world is not the end of the world discussed the large-scale processes at work now. Today we discuss the most astonishing — and seldom seen — aspect of these things.
The problems of the many individual nations in crisis have received ample attention from experts. The two global dimensions of the crisis have not. First, the global financial regime no longer works well (as seen, for example, in the faltering ability of the US to act as the reserve currency, the disinterest of other nations in replacing the US in that role, and the wild gyrations of currency values). Second, the large number of nations experiencing large-scale structural change. Here we look at the second — and least well seen — aspect.
Contents
- The grand alignment of the nations
- Cause of the grand alignment
- A tour of the nations
- For more information
What caused the disaster of the Titanic? There was no single cause, it resulted from a constellation of simultaneous events. Bad weather. Bad luck. Mistakes. Lost gear. Errors of judgement.
Similarly today we have the major nations of the world simultaneously at or near (1 or 2 years?) major inflection points: Eurozone, UK, Japan, USA, and China. In each case largely due to internal dynamics, as their current internal economic systems fail and require major reforms. It’s the geopolitical version of the planetary grand alignment (which allowed NASA to send the Voyager One and Two probes to tour the solar system).
.
This creates danger and opportunity for each nation (as in the legend of the meaning of “crisis” in Chinese), but also the possibility of global synergy in a bad way over the short-term. As shown in yesterday’s post, even successful transitions are painful. Most or all of the major nations in transition would depress the global economy and lead to geopolitical instability.
What about the long-term? It could be very good, if everybody works their way through to successful new regimes. Or very bad, if most major nations fail to do so.
(2) Causes
The odds of this synchrony are too great for this to result from coincidence. What systemic factor might account for it? These nations have different demographics, economic and political structures, social systems, and trade patterns.
My guess (emphasis on guess): the common elements are poorly managed debt and lax regulation of their financial industry — although in different ways. Debt excesses differ from nation to nation: internal or external loans, private or public sector debt, debt incurred for investment or consumption. It’s the debt supercycle (coined by Hamilton Bolton and Tony Boeckh of Bank Credit Analyst).
Ditto for the banks. Some got into trouble speculating. Some the old fashioned way, by excessive and imprudent mortgage and business loans. Some were ordered or pressured by governments to make bad loans (often to the government).
But no matter what the path, the result was debt that could not be paid back and wrecked banks. There may be no other path to the future other than mass defaults and rebuilding many of the world’s banks (at somebody’s expense). The new world will probably build a fundamentally different global financial system than ours, learning from our generation-long experiment with debt. It’s a useful tool but, like many powerful tools (opiates, nuclear power, nailguns) becomes a fearsome thing when misused.
(3) A tour of the nations
(a) The Eurozone
The Eurozone is furthest along of the major nations in the cycle of crisis and resolution, and exhibits many of the traits only dimly visible elsewhere. It might also be the template that other nations follow to disaster: incorrect diagnosis of their problem, dogmatic adherence to unworkable solutions, reluctance to confront their core structural problems, and a refusal to learn from either economic theory or history.
Worse, Europe’s leaders appear unwilling to address their core problem. Perhaps because Europe’s people are not yet willing to do so. As we see in the Greek polls: 80% want to stay, 80% don’t want to pay the price of staying. Polls in Germany show a similar contradiction.
Francisco Blanch (Global Investment Strategist, Bank of America Merrill Lynch) explains the first three problems:
To begin with, it should be apparent by now that forcing consumers, corporates and governments to delever all at the same time is a painful policy. With consumers, corporates and governments in Peripheral Europe all rushing to sell assets, GDP has nose-dived in Spain, Italy, Greece or Portugal, to name a few. With GDP contracting at a faster rate than overall indebtedness in Peripheral Europe, debt to GDP ratios are not showing much improvement and borrowing costs are soaring, pushing some economies into a debt deflation spiral.In the New York Times of 20 May 2012 Paul Krugman explains the last of these problem, showing how today’s situation in the Eurozone is similar to that of the US-European situation at the end of WWI.
… As European deficit countries face a similar current account problem to that of the US but lack a flexible currency, continued debt rollovers are only perpetuating the problem. Meanwhile, Germany has instead shown a similar position to China several years ago (Chart 15). Quite strikingly, Germany’s foreign position has barely budged, making it nearly impossible for Peripheral countries to regain competitiveness. Put differently, the core is fast absorbing capital and labor, and exporting misery to the periphery. Germany is having its cake and eating it too, for now.
… Unfortunately, this situation is unlikely to persist. World history is littered with ruinous experiments linked to a lack of exchange rate and monetary policy flexibility (Chart 16). The gold standard in the Great Depression, the lost decade in Latin America, and the Asian Financial Crisis are good examples of how exchange rate distortions led to economic ruin. … But in the absence of currency, monetary and energy flexibility, the European sovereign debt crisis is far from over and about to start its most dangerous phase.
Read Keynes from Essays in Persuasion:The situation will eventually sort out. Despite the hysterical forecasts of doom, Europe will not sink forever like Atlantis. The process might be quick (these things tend to accelerate fast), but probably with much turmoil and pain. Here are some incisive recent articles about the Euro-crisis:
“Ultimately, and probably soon, there must be a readjustment of the balance of exports and imports. America must buy more and sell less. This is the only alternative to her making to Europe an annual present. Either American prices must rise faster than European (which will be the case if the Federal Reserve Board allows the gold influx to produce its natural consequences), or, failing this, the same result must be brought about by a further depreciation of the European exchanges, until Europe, by inability to buy, has reduced her purchases to articles of necessity.”He {Keynes} then goes on to discuss the folly of American policy, which simultaneously demanded that the Europeans pay in full while denying them the ability to export enough to make those payments. So here too we are repeating ancient mistakes. But why does nobody learn?
- “Tempting Rationale for Leaving the Euro“, New York Times, 15 May 2012
- “Greece’s predicament: Lessons from Argentina“, Peter Kretzmer and Mickey Levy, VOX, 16 May 2012
- “Greece Must Exit“, Nouriel Roubini, Roubini Global Economics, 18 May 2012
- “Europe’s Depressing Prospects: Two Reasons Why Spain Will Leave the Euro“, Michael Pettis, Roubini Global Economics, 18 May 2012
- “Today Germany Is the Big Loser, Not Greece“, Marshall Auerback, Naked Capitalism, 21 May 2012
Japan’s increasingly elderly majority have locked the nation into box of dyfunctional guaranteed to fail policies. Some experts believe their leaders have in effect given up on finding a solution, and just wait for the eventual singularity — wrecking the existing order and making possible a new Japan. The process probably will be painful. Here are two obituary notices:
- A bearish perspective on Japan by Hayman Capital Management, a Harvard Business School Case Study, 12 April 2012
- As Japan sails into the shadows, let’s wish them well and wave good-by, 14 July 2009
The UK now confronts decades of errors: over-reliance on North Sea oil (rapidly depleting), a poorly managed and over-size financial sector, and large public debt and liabilities. Worse, their leaders and people appear clueless about their problems and possible solutions. For details about this bleak situation see “Thinking the unthinkable – might there be no way out for Britain?“, Dr Tim Morgan (Global Head of Research), Tullett Prebon (UK brokerage firm), July 2011 (large pdf) — An excerpt looks at their future:
Our analysis indicates that the British economy, as currently aligned, is incapable of delivering growth at anywhere near the levels required by the deficit reduction agenda. In the decade prior to the financial crisis, the UK economy became hugely dependent upon debt. Taking public and private components together, debts have increased at an annual average rate of 11.2% of GDP since 2003. The two big drivers of the economy have been private (mortgage and credit) borrowing, and huge (and debt-dependent) increases in public spending.(d) China, India, and the US
Together, the severity of Britain’s indebtedness and the challenging outlook for the economy mean that the UK is now mired in a high-debt, low growth trap.
- Three of the UK’s 8 largest industries (real estate, financial services and construction), which account for 39% of the economy, are incapable of growth now that net private borrowing has evaporated.
- Another 3 of the top 8 sectors (health, education, and public administration and defence) account for a further 19%, and cannot expand now that growth in public spending is a thing of the past.
- This means that 58% of the economy is ex-growth, a figure that could rise to 70% if, as seems probable, growth in retailing is precluded by falling real consumer incomes. a very British mess
All these are in earlier stages of the crisis cycle which will test their people and leaders. Some will be in effect voted out of the major league nations; others will become regional hegemons or even perhaps superpowers in the next world order. For more about China and India see the FM Reference Page listing all posts by nation.
(4) For more information
See these FM Reference Pages for other posts about these topics:
Tuesday, May 08, 2012
Investing in a G-Zero World...
The planet is ripe with investment opportunity, according to most of the speakers at an ETF conference I attended yesterday in Boston. From emerging markets to sector rotation to alternative betas, optimism abounds, attendees were told.
As usual at these type of events, focusing on what could go wrong was minimized, although in fairness I did moderate a session on risk management. In any case, it was hard to miss the penchant for seeing the investment outlook as flush with possibility. That’s a worthwhile perspective, up to a point, although as I listened to the speakers I kept thinking about Every Nation for Itself: Winners and Losers in a G-Zero World
, Ian Bremmer’s new book that I read (most of it) on the train ride to Beantown.
Bremmer is the president of the Eurasia Group and a keen geopolitical analyst. In his latest book, he argues that the world is headed for a period for a “tumultuous transition” that’s bereft of the leadership that used to prevail when the U.S.-centric club of nations—the so-called G7, which evolved into the G20—kept the international system humming and put out the fires, or at least kept them from burning free. But those days are gone and “we have entered a period of transition from the world we know toward one we can’t yet map.” He writes that
Bremmer’s argument is laid out in breezy fashion, covering the waterfront of macroeconomics, politics and international relations. It reads like an extended op-ed than with footnotes. But his view is certainly persuasive, in part because he provides numerous examples of how the geopolitical world order is evolving and what it means for the future.
For instance, the prediction by some that the rise of emerging markets will fill the vacuum left by a debt-laden U.S.-Europe-Japan power system may be expecting too much. As Bremmer explains, “the BRICS [Brazil, Russia, India, China, South Africa] countries now hold summits and talk publicly of shared interests, but there is much less to their partnership than meets the eye.”
To the extent that geopolitics influences markets (and it does), investing isn’t going to get any easier in the years ahead. Geopolitical risk is almost certainly on the rise, and for lots of different reasons. True, it’s a different type of risk compared with the Cold War, but it’s a risk nonetheless. More importantly, it’s much more of a multi-faceted risk, which means that there are probably a lot more unknown unknowns out there.
The fact we live in a multi-polar world is no surprise at this late date. But as Bremmer’s book reminds, the multi-polarity may be even more nuanced and byzantine than we thought just a few years ago.
It’s easy to see a G-Zero world as favorable for investment opportunities, but it’s also a world filled with new and uncertain risks. That’s good news for talented managers who have the brains and the resources to navigate the shifting landscape. Well-run global macro strategies, for instance, may be well-positioned to exploit the world ahead. But history suggests that most investors (and institutions) will still have a tough time beating a benchmark of all the major asset classes. That’s been true for the past decade, as my recent review of the Global Market Index vs. multi-asset class mutual funds shows. Bremmer’s books implies that we should expect more of the same. In fact, if his worldview is correct, and I think it’s largely on the money, then the competitive profile of broad-minded asset allocation with simple rebalancing rules is going to remain a tough act to beat. Perhaps that’s the only constant you can count on when it comes to investment strategy.
This post originally appeared at The Capital Spectator
As usual at these type of events, focusing on what could go wrong was minimized, although in fairness I did moderate a session on risk management. In any case, it was hard to miss the penchant for seeing the investment outlook as flush with possibility. That’s a worthwhile perspective, up to a point, although as I listened to the speakers I kept thinking about Every Nation for Itself: Winners and Losers in a G-Zero World
, Ian Bremmer’s new book that I read (most of it) on the train ride to Beantown.Bremmer is the president of the Eurasia Group and a keen geopolitical analyst. In his latest book, he argues that the world is headed for a period for a “tumultuous transition” that’s bereft of the leadership that used to prevail when the U.S.-centric club of nations—the so-called G7, which evolved into the G20—kept the international system humming and put out the fires, or at least kept them from burning free. But those days are gone and “we have entered a period of transition from the world we know toward one we can’t yet map.” He writes that
This is not a story of the decline of the West or the rise of the rest. In years to come, none of these players will have the power to bring about needed change. The G20 doesn’t work, the G7 is history, the G3 is a pipe dream, and the G2 will have to wait.
Welcome to the G-ZeroWhat’s the G-Zero? “A world order in which no single country or durable alliance of countries can meet the global leadership.”
Bremmer’s argument is laid out in breezy fashion, covering the waterfront of macroeconomics, politics and international relations. It reads like an extended op-ed than with footnotes. But his view is certainly persuasive, in part because he provides numerous examples of how the geopolitical world order is evolving and what it means for the future.
For instance, the prediction by some that the rise of emerging markets will fill the vacuum left by a debt-laden U.S.-Europe-Japan power system may be expecting too much. As Bremmer explains, “the BRICS [Brazil, Russia, India, China, South Africa] countries now hold summits and talk publicly of shared interests, but there is much less to their partnership than meets the eye.”
These countries don’t have much in common beyond a shared desire to increase their international influence and to limit the ability of established powers to impose their will on everyone else. China and India are among the largest energy importers. Brazil and Russia are among the world’s most important energy exporters, giving them a very different view of policies and events that push crude oil prices higher. China and Russia are authoritarian countries that face internal ethic and religious challenges to their territorial integrity, while India and Brazil are genuine multiparty democracies with governments that must weigh the need for sometimes painful reforms against frequent fluctuations in public opinion. China and India are rivals for influence in South Asia. China and Russia compete for influence in Central Asia—and in Russia’s Far East. Brazil is the only BRICS country that lives in a relatively stable region. China, India, and Brazil each have far more trade with Europe and the United States than with Russia. South Africa, admitted to the group in December 2010, has virtually nothing important in common with any of them.Do you see the obvious implications that flow from that multi-dimensional matrix of incentives, conflicts and challenges? Neither do I, and I suspect that it’s going to be hard for most folks to figure out what’s relevant, what’s not, and how to tell the difference. In fact, real-time events only strengthen Bremmer’s argument. For example, the latest political upset in the “revolt against austerity, cuts” in Europe is yet another sign that the rise of G-Zero world has momentum. Indeed, the triumph of Francois Hollande in the French presidential election threatens to complicate the tension between Paris and Berlin as the Continent struggles to solve its ongoing euro crisis and balance Germany’s preference for austerity with France’s new-found preference for fiscal stimulus. A similar conflict looks set to roll on for policymakers in the U.S., where divided already government reigns supreme and the possibility (likelihood?) of an extended run awaits after the November elections.
To the extent that geopolitics influences markets (and it does), investing isn’t going to get any easier in the years ahead. Geopolitical risk is almost certainly on the rise, and for lots of different reasons. True, it’s a different type of risk compared with the Cold War, but it’s a risk nonetheless. More importantly, it’s much more of a multi-faceted risk, which means that there are probably a lot more unknown unknowns out there.
The fact we live in a multi-polar world is no surprise at this late date. But as Bremmer’s book reminds, the multi-polarity may be even more nuanced and byzantine than we thought just a few years ago.
It’s easy to see a G-Zero world as favorable for investment opportunities, but it’s also a world filled with new and uncertain risks. That’s good news for talented managers who have the brains and the resources to navigate the shifting landscape. Well-run global macro strategies, for instance, may be well-positioned to exploit the world ahead. But history suggests that most investors (and institutions) will still have a tough time beating a benchmark of all the major asset classes. That’s been true for the past decade, as my recent review of the Global Market Index vs. multi-asset class mutual funds shows. Bremmer’s books implies that we should expect more of the same. In fact, if his worldview is correct, and I think it’s largely on the money, then the competitive profile of broad-minded asset allocation with simple rebalancing rules is going to remain a tough act to beat. Perhaps that’s the only constant you can count on when it comes to investment strategy.
This post originally appeared at The Capital Spectator
Friday, May 04, 2012
Spain Is The New Greece...
Author: Marshall Auerback
Nearly one Spaniard in four is unemployed, according to data released on Friday, as the country’s economic and financial predicament prompted a government minister to talk of a “crisis of enormous proportions”.The data from the National Statistics Institute showed 367,000 people lost their jobs in the first three months of the year. At this pace, Spanish job losses are equivalent to 1 million per month in the United States. That means more than 5.6m Spaniards or 24.4 per cent of the workforce are unemployed, close to a record high set in 1994.
Spain has become the new Greece. Actually, in many respects Spain is now worse than Greece. The Spanish unemployment rate is already so high and unlike Athens, Madrid has made no headway in reducing its public debt levels (whereas the Greeks are close to running a primary fiscal surplus at which point they could leave and turn the problem back on to Brussels). Moreover, Spain has a huge private debt burden that is twice that of Greece.
Although I have warned on these pages before that Spain’s austerity program was leading the country to disaster, my reaction to this economic catastrophe has been one of amazement. Just take a look at this employment data
Spain First Quarter Unemployment: Summary (Table)
2012-04-27 07:00:00.13 GMT
Yet, until now Rajoy Administration has been saying that the marginal decline in GDP estimated by the Bank of Spain for the first quarter was exaggerating economic weakness. Now we have the spectacle of the Spanish government suggesting that the Bank of Spain estimate of a .4% decline in Q1 Spanish GDP is too pessimistic. But in light of these numbers, what kind of GDP decline should one realistically expect when employment falls two percent non annualized in a quarter? At least a four percent annualized decline. more likely much higher. Yet who is talking discussing that as a real possibility in Brussels? Nobody. Everybody remains asleep at the wheel.
For years, the Spanish GDP figures have been hard to square with the underlying collapse in industrial production and rise in unemployment, both of which were more realistically reflecting the scale of the country’s collapse into depression.
When I said a few months ago that the Spanish government was lying about their numbers, I was attacked by a few Spanish readers of this blog, who claimed I was a nefarious hedge fund manager, likely loaded up to the gills with CDSs on Spanish debt who was trying to foment panic. For the record, I have never bought a credit default swap in my life. If anything, I was trying to foment panic because I was horrified by the new ultra austerity stance adopted by the recently elected Rajoy Administration.
Now consider the reality: the economy is crashing, hence the unemployment rate rise. Yet German Chancellor Angela Merkel and the ECB President, Mario Draghi, continue to insist that one can have both fiscal restriction and a lower domestic price level despite the fact that Spain has a non financial private debt to GDP ratio of 230%.
Interestingly enough, Dutch levels of private debt to GDP are even higher, at 249%, the highest in Europe. By contrast, the Italians still have net household savings. So who are the real “profligates” in Europe?.
Those who embrace these ruinous austerity policies will soon be seeing the experiencing much the same kinds of conditions as the Spanish (albeit from less depressed levels) including the moralistic Dutch, whose finance minister has been a crusader in favour of even harsher fiscal rules than those embodied in the Stability and Growth Pact.We have also recently witnessed a big surprise decline in the German consumer confidence index last week as well as a collapse in an Italian retailing sentiment index. The austerity disease is intensifying the crisis, even in the core.
It is inconceivable to me that Super Mario Draghi won’t be changing his tune soon, in spite of what he and the Merkel government are now saying for public consumption. To continue with this present course will not only precipitate a collapse of the euro, but a political collapse across Europe.
There is no question that larger deficits are needed to support aggregate demand at desired levels. However, as all of us who have contributed to this blog have long noted, the problem is the national governments are currently like US states and as such are revenue constrained because they are USERS, rather than ISSUERS of the currency (as opposed to, say, Canada or the US, both of which are sovereign issuers of their own currency).
So relaxing the deficit limits without some kind of ECB funding guarantees can cause markets to abstain from funding the national governments, which creates a solvency crisis of the kind we are experiencing today. Said another way, without the ECB the euro members are currently deep into ‘Ponzi’, as my friend, Warren Mosler has described it. In reality, they have all been in ‘Ponzi” since day one. But it took a crisis of the magnitude of 2008 to make this manifest for the markets.
At some level, the ECB understands that, as it always”writes the cheque” when a systemic crisis pushes the system to the brink. It can be no other way, as it is the sole issuer of the euro. But for the most part, Europe’s policy making elites remain in denial, as they continue to turn away from the one entity that could address the insolvency issue.
And let’s be clear once and for all. The US government does not face the same kind of crisis as the Spanish, the Greeks, the Dutch or even the Germans. The US government has expanded its public debt ratio considerably in recent years but yields remain low and when the ratings agencies downgraded their assessment of the US sovereign debt the demand for it rose. Whither the so-called “bond market vigilantes”?
The Euro governments are in a different camp altogether. All those who actually understand that the member governments are using a foreign currency and thus are not at all like Japan, the US or the UK governments, appreciate that there is default risk attached to the paper issued from the EMU governments.
They also appreciate that with the non-elected eurocrats of Brussels insisting on a decade or more of austerity and implementing fiscal rules that these would ensure a crisis every time there has been a serious downturn in aggregate demand. And with that, the risk of default with government debt has risen. That is what we are seeing today across the euro zone. And in Spain it is writ large.
The mainstream austerity line is trapping Spain (as well, as Greece, Portugal, Italy, Ireland and soon the core of the euro zone) in a dangerous downward spiral of lost income and increased unemployment. I still think Francois Hollande’s likely election could well change the political dynamics in the euro zone, even though he generally buys into the mainstream neo-liberal euro line. Hollande is an “austerity lite” character, as opposed to being a genuine reflationist. But even he cannot be oblivious to the looming political and social dangers which await France, if he continues to pursue the policies embraced by the current President, Nicolas Sarkozy.
So far, Brussels has not let facts get in the way of a good neo-liberal theory, but it’s getting increasingly hard to ignore this emerging horror show.
This post originally appeared at New Economic Perspectives
Nearly one Spaniard in four is unemployed, according to data released on Friday, as the country’s economic and financial predicament prompted a government minister to talk of a “crisis of enormous proportions”.The data from the National Statistics Institute showed 367,000 people lost their jobs in the first three months of the year. At this pace, Spanish job losses are equivalent to 1 million per month in the United States. That means more than 5.6m Spaniards or 24.4 per cent of the workforce are unemployed, close to a record high set in 1994.
Spain has become the new Greece. Actually, in many respects Spain is now worse than Greece. The Spanish unemployment rate is already so high and unlike Athens, Madrid has made no headway in reducing its public debt levels (whereas the Greeks are close to running a primary fiscal surplus at which point they could leave and turn the problem back on to Brussels). Moreover, Spain has a huge private debt burden that is twice that of Greece.
Although I have warned on these pages before that Spain’s austerity program was leading the country to disaster, my reaction to this economic catastrophe has been one of amazement. Just take a look at this employment data
Spain First Quarter Unemployment: Summary (Table)
2012-04-27 07:00:00.13 GMT
| 1Q Quarterly Yearly | |||||
| 2012 | Net Change | QoQ % | Net | Change YoY% | |
| Both Sexes | |||||
| Over 16s | 38,493.70 | -14.5 | -0.04% | -18.4 | -0.05% |
| Active Workforce | 23,072.80 | -8.4 | -0.04% | 10.9 | 0.05% |
| Employed | 17,433.20 | -374.3 | -2.10% | -718.5 | -3.96% |
| Unemployed | 5,639.50 | 365.9 | 6.94% | 729.4 | 14.85% |
| Inactive | 15,420.90 | -6.1 | -0.04% | -29.3 | -0.19% |
| Activity Rate | 59.94% | 0.00% | n/a | 0.06% | n/a |
| Unemployment Rate | 24.44% | 1.59% | n/a | 3.15% | n/a |
| 16 to 64 | 30,606.00 | -52.5 | -0.17% | -171.4 | -0.56% |
| Activity Rate | 74.87% | 0.13% | n/a | 0.44% | n/a |
| Unemployment Rate | 24.59% | 1.59% | n/a | 3.17% | n/a |
| Employment Rate | 56.47% | -1.09% | n/a | -2.03% | n/a |
Yet, until now Rajoy Administration has been saying that the marginal decline in GDP estimated by the Bank of Spain for the first quarter was exaggerating economic weakness. Now we have the spectacle of the Spanish government suggesting that the Bank of Spain estimate of a .4% decline in Q1 Spanish GDP is too pessimistic. But in light of these numbers, what kind of GDP decline should one realistically expect when employment falls two percent non annualized in a quarter? At least a four percent annualized decline. more likely much higher. Yet who is talking discussing that as a real possibility in Brussels? Nobody. Everybody remains asleep at the wheel.
For years, the Spanish GDP figures have been hard to square with the underlying collapse in industrial production and rise in unemployment, both of which were more realistically reflecting the scale of the country’s collapse into depression.
When I said a few months ago that the Spanish government was lying about their numbers, I was attacked by a few Spanish readers of this blog, who claimed I was a nefarious hedge fund manager, likely loaded up to the gills with CDSs on Spanish debt who was trying to foment panic. For the record, I have never bought a credit default swap in my life. If anything, I was trying to foment panic because I was horrified by the new ultra austerity stance adopted by the recently elected Rajoy Administration.
Now consider the reality: the economy is crashing, hence the unemployment rate rise. Yet German Chancellor Angela Merkel and the ECB President, Mario Draghi, continue to insist that one can have both fiscal restriction and a lower domestic price level despite the fact that Spain has a non financial private debt to GDP ratio of 230%.
Interestingly enough, Dutch levels of private debt to GDP are even higher, at 249%, the highest in Europe. By contrast, the Italians still have net household savings. So who are the real “profligates” in Europe?.
Those who embrace these ruinous austerity policies will soon be seeing the experiencing much the same kinds of conditions as the Spanish (albeit from less depressed levels) including the moralistic Dutch, whose finance minister has been a crusader in favour of even harsher fiscal rules than those embodied in the Stability and Growth Pact.We have also recently witnessed a big surprise decline in the German consumer confidence index last week as well as a collapse in an Italian retailing sentiment index. The austerity disease is intensifying the crisis, even in the core.
It is inconceivable to me that Super Mario Draghi won’t be changing his tune soon, in spite of what he and the Merkel government are now saying for public consumption. To continue with this present course will not only precipitate a collapse of the euro, but a political collapse across Europe.
There is no question that larger deficits are needed to support aggregate demand at desired levels. However, as all of us who have contributed to this blog have long noted, the problem is the national governments are currently like US states and as such are revenue constrained because they are USERS, rather than ISSUERS of the currency (as opposed to, say, Canada or the US, both of which are sovereign issuers of their own currency).
So relaxing the deficit limits without some kind of ECB funding guarantees can cause markets to abstain from funding the national governments, which creates a solvency crisis of the kind we are experiencing today. Said another way, without the ECB the euro members are currently deep into ‘Ponzi’, as my friend, Warren Mosler has described it. In reality, they have all been in ‘Ponzi” since day one. But it took a crisis of the magnitude of 2008 to make this manifest for the markets.
At some level, the ECB understands that, as it always”writes the cheque” when a systemic crisis pushes the system to the brink. It can be no other way, as it is the sole issuer of the euro. But for the most part, Europe’s policy making elites remain in denial, as they continue to turn away from the one entity that could address the insolvency issue.
And let’s be clear once and for all. The US government does not face the same kind of crisis as the Spanish, the Greeks, the Dutch or even the Germans. The US government has expanded its public debt ratio considerably in recent years but yields remain low and when the ratings agencies downgraded their assessment of the US sovereign debt the demand for it rose. Whither the so-called “bond market vigilantes”?
The Euro governments are in a different camp altogether. All those who actually understand that the member governments are using a foreign currency and thus are not at all like Japan, the US or the UK governments, appreciate that there is default risk attached to the paper issued from the EMU governments.
They also appreciate that with the non-elected eurocrats of Brussels insisting on a decade or more of austerity and implementing fiscal rules that these would ensure a crisis every time there has been a serious downturn in aggregate demand. And with that, the risk of default with government debt has risen. That is what we are seeing today across the euro zone. And in Spain it is writ large.
The mainstream austerity line is trapping Spain (as well, as Greece, Portugal, Italy, Ireland and soon the core of the euro zone) in a dangerous downward spiral of lost income and increased unemployment. I still think Francois Hollande’s likely election could well change the political dynamics in the euro zone, even though he generally buys into the mainstream neo-liberal euro line. Hollande is an “austerity lite” character, as opposed to being a genuine reflationist. But even he cannot be oblivious to the looming political and social dangers which await France, if he continues to pursue the policies embraced by the current President, Nicolas Sarkozy.
So far, Brussels has not let facts get in the way of a good neo-liberal theory, but it’s getting increasingly hard to ignore this emerging horror show.
This post originally appeared at New Economic Perspectives
Tuesday, April 03, 2012
IS ECONOMICS A SCIENCE? SHOULD ECONOMICS BE RIGOROUS?
A New Article by Paul Davidson...
IS ECONOMICS A SCIENCE? SHOULD ECONOMICS BE RIGOROUS?
BY PAUL DAVIDSON, Editor, Journal of Post Keynesian Economics
Many mainstream economists (e.g., Lucas, Cochrane) claim that the characteristics of a “science” require rigor, consistency, and mathematics. So if economics is to be a science it must display these characteristics. Paul Samuelson has added the claim that economists must accept the ergodic axiom in their models in their pursuit of economics as a science on par with physics, astronomy, and chemistry. Efficient market theory possesses all these characteristics. So how is it possible that efficient market theorists did not foresee the financial crisis that started in 2008?
Whether they declare themselves Monetarists, Rational Expectation theorists, Neoclassical Synthesis [Old] Keynesians or New Keynesians, the backbone of their mainstream theories is the efficient market analysis where the future can be known. For “Old” and “New” Keynesians the only thing that prevents efficient markets operating in the short run is the presumption of fixity in nominal wages and prices. [Thus, these “Keynesians” urge government action only because, as John Williamson is always telling me, they are too impatient to wait for the long run.]
To stimulate discussion, I wish to address two aspects of these mainstream economists universal beliefs. The first involves a discussion of the difference between a nonergodic stochastic process and an ergodic stochastic process for “knowing” the future. The second and related aspect involves the use of the deductive axiomatic logical analysis and mathematics by mainstream economists to glorify efficient market theory and the Arrow-Debreu-Walrasian general equilibrium or dynamic general equilibrium as the only way to do real world economics.
For example, to “prove” markets are efficient and the use of the Ricardian equivalence theorem to show that fiscal stimulus policies are useless– at least in the long run– requires the presumption that the economic system is “ergodic”.
Efficient market theory, Arrow-Debreu models, Ricardian equivalence, etc. requires the households, business enterprises, and politicians to possess a significant correct and accurate message of things that are going to happen in the future if they are to make efficient (optimal) decisions today.
Why? Because time is a device that prevents everything from happening at once. Thus decisions made today usually require significant time to elapse before the payoff of the decision occurs. This is true not only for decisions involving investment projects by entrepreneurs, but also for most consumer decisions, such as the purchase of an auto or an ipad, or even a decision as to what restaurant to go to get a good meal for dinner. [How many of us have sometimes been disappointed in the meal we ordered at the restaurant?]
The message of efficient markets, Arrow-Debreu, Ricardian equivalence, etc. is inapplicable to the world of experience because in the real world, households do not have any significantly reliable information about the future, and neither do budgetary policy makers, nor entrepreneurs. The erroneous message based on the assumption of people having significantly reliable knowledge about the future is the result of accepting bad axioms as the basis for mainstream theory. It is not the fault of using the deductive method, rigor, and mathematicsper se. So do not blame the messenger for the message!
THE ERGODIC AXIOM
First, let us take up the ergodic- nonergodic stochastic process distinction. Paul Samuelson [1969] has written that if economists hope to move economics from “the realm of history” into “the realm of science” they must impose the “ergodic hypothesis” on their theory[1]. In other words Nobel Prize Winner Paul Samuelson has made the ergodic axiom thesine qua non for the scientific method in economics. Lucas and Sargent [1981] have also claimed the principle behind the ergodic axiom is the only scientific method of doing economics.
Following Samuelson’s lead, most economists (e.g., Cochrane, Stiglitz, Mankiw, M. Friedman, Scholes, etc) and economic textbook writers either implicitly or explicitly have assumed that observable economic events are generated by an ergodic stochastic process.
But not Keynes! Keynes [1936, p. 16] suggested the way to understand why classical economic theory (e,g., efficient market theory) is not relevant to the world of experience, when he noted that old economic thinkers were “like Euclidean geometers in a non Euclidean world who discover that apparent parallel line collide, rebuke these lines for not keeping straight. Yet, in truth there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics”. Keynes developed a theory that is more general than classical and mainstream economic theory because it is based on fewer restrictive fundamental axioms[2]. The fewer the number of underlying axioms, the more general the theory. The most important classical axiom Keynes eliminated in his general theory[3] is the ergodic axiom.
This ergodic axiom assumes the economic future is already predetermined[4] . The economy is governed by an existing ergodic stochastic process. One merely has to calculate probability distributions regarding future prices and output to draw significant and reliable statistical inferences [information] about the future. Once self-interested decision makers have reliable information about the future, their actions on free markets will optimally allocate resources into those activities that will have the highest possible future returns thereby assuring global prosperity.
In order to draw any statistical (probabilistic risk) inferences regarding any universe, however, one should draw a sample from that universe. Since drawing a sample from the future economic universe is impossible, the ergodic axiom presumes that the economic future is governed by an already existing unchanging ergodic stochastic process. Consequently, a sample drawn from the past is equivalent to a sample drawn from the future. In other words, calculating the probability distribution from past statistical data sample is presumed to be the same as calculating the risks from a sample drawn from the future.[5] This ergodic axiom is an essential foundation for all the complex risk management computer models developed by the “quants” on Wall Street. If the economy is nonergodic, however, thenthese computer models are weapons of math destruction [For deterministic models, the “ordering axiom” plays the same role as the ergodic axiom in stochastic models.]
For a technical explanation of the difference between ergodic and nonergodic stochastic processes the read should read my book, THE KEYNES SOLUTION: THE PATH TO GLOBAL ECONOMIC PROSPERITY [Davidson (2009)] . For our discussion here we merely need note that, in essence, the ergodic axiom imposes the condition that the future is already predetermined by existing parameters (market fundamentals). Consequently the future can be reliably forecasted by analyzing past and current market data to obtain the probability distribution governing future events. In other words, if future events are assumed to be generated by an ergodic stochastic process (to use the language of mathematical statisticians), then the future is predetermined and can be discovered today by the proper statistical probability analysis of past and today's data regarding market "fundamentals”. If the system is nonergodic, calculated past and current probability distributions do not provide any statistically reliable estimates regarding the probability of future events.
New Keynesians such as Stiglitz accept the ergodic axiom as the basis of the economic system but then add additional ad hoc assumptions to try to tame this presumed knowledge of the future approach to better reflect what they believe is reality. Stiglitz, for example, in his asymmetric information theory assumes that some market participants cannot make the proper statistical calculations because they do not perceive the correct information about the future. In other words, Stiglitz imposes the asymmetric information condition that there are some decision makers who act while lacking the correct information about the (presumed to exist today) probability distribution of future events. Consequently these decision makers (speculative fools?) misread the future and thereby mess up the beauty of the efficient market system.
Nobel prize winner Robert Lucas [1981, p. 287] has boasted that the mainstream theory axioms are “artificial, abstract, patently unreal”. Like Nobel Laureate Samuelson, Lucas insists such unreal assumptions are the only scientific method of doing economics. Lucas insists that “Progress in economic thinking means getting better and better abstract, analogue models, not better verbal observations about the real world” [Lucas, 1981, p. 276]. The rationale underlying this argument is that these unrealistic assumptions make the problem more tractable and, with the aid of a computer, the analyst can then predict the future. Never mind that the prediction might be disastrously wrong.
In the introduction to his bookAgainst The Gods , a treatise that deals with the questions of relevance of risk management techniques on Wall Street, Peter L. Bernstein [ 1996, p. 6] writes:
“The story that I have to tell is marked all the way through by a persistent tension between those who assert that the best decisions are based on quantification and numbers, determined by the [statistical] patterns of the past, and those who based their decisions on a more subjective degrees of belief about the uncertain future. This is a controversy that has never been resolved....to what degree should we rely on the patterns of the past to tell us what the future will be like?”
One would hope that the empirical evidence of the collapse of those “masters of the economic universe “ that have dominate Wall Street machinations for the last three decades has at least created doubt regarding the applicability of the ergodic axiom to our economic world. Even Alan Greenspan in testimony before Congress in October 2008 seems to be having second thoughts although he still has not completely changed his tune. Keynes’s ideas and Soros’s reflexivity concept support Bernstein’s latter group.
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Samuelson, Lucas and others adopted the ergodic axiom because they want economics to be in the same class as the “hard sciences” such as physics or astronomy. For example the science of astronomy is based on the presumption of an ergodic stochastic process that governs the movement of all the heavenly bodies from the moment of the “Big Bang” to the day the universe ends. Accordingly probability analysis using past measurements of the movements of heavenly bodies permit astronomers to predict future solar eclipses within a few seconds of when they actually occur. Nothing Congress, the President of the United States, the United Nations, or environmentalists can do will alter the predetermined dates and time for future eclipses. For example, Congress cannot pass a law outlawing solar eclipses in order to provide more sunshine and thereby enhance crop production. In an ergodic world, all future events are already predetermined and beyond change by human action today. The future movement of the heavenly bodies can be known by anyone who has measured past movements and projected these movements into the future. There are no speculative fools, who suffering from asymmetric information, think Mars is going to crash into the earth.
George Soros has explained why the efficient market theory is not applicable to real world financial markets with a slightly different terminology than Keynes but conceptually in the same way. Soros (2008) wrote: “we must abandon the prevailing [efficient market] theory of market. behavior. ” Soros states that there is a direct connection “between market prices and the underlying realty [that] I [Soros] call reflexivity” .
What is this reflexivity? In a letter to the Editor published in the March 15-21, 1997 issue of The Economist Soros objects to Paul Samuelson insistence on requiring the ergodic axiom to make economics a science. Soros argues the ergodic hypothesis does not permit “the reflexive interaction between participants’ thinking and the actual state of affairs” that characterizes real world financial markets. In other words, the way people think about the market today can affect and alter the future path the market takes; the future is not predetermined. Soros’s concept of reflexivity, therefore, is the equivalent of Keynes’s rejection of the ergodic axiom[6]. Reflexivity means peoples thoughts and actions create the future, while mainstream economists presume the future has already been predetermined and can be discovered by analyzing today’s market fundamentals.
NON EUCLIDEAN ECONOMIC THEORY
In creating a “NonEuclidean” economic theory to explain why these unemployment “collisions” occur in the world of experience, Keynes uses the logical deductive method but he had to deny (“throw over”) the relevance of several classical axioms for understanding the real world. The classical ergodic axiom which assumes that the future is known and can be calculated as the statistical shadow of the past was one of the most important classical assertions that Keynes rejected.
Keynes's general theory is a deductive method of analysis. Keynes’s concept of uncertainty about the economic future requires the economic system to be generated by a nonergodic stochastic process. At the time of his writingThe General Theory, Keynes did not know of the ergodic stochastic theory that was being developed by the Moscow School of Probability in the 1930s. Nevertheless in his criticism of Tinbergen's [econometric] method, Keynes [1939] wrote[7] that Tinbergen's method is not valid for any economic forecasting because economic data “are not homogeneous” over time. Non homogeneity is a sufficient condition for nonergodicity.
Taleb’s Black Swan concept attempts to explain market crashes as an event lying in the far off tail of an ergodic probability distribution. It should be noted that Knight’s vision of uncertainty and Taleb’s Black Swan concept are both based on the ergodic presumption for the economy. Taleb’s Black Swan is an already predetermined outcome but the Black Swan event is so far out in the tail of the ergodic probability distribution that its occurrence is so rare that it is never likely to be observed– except in the long run when we will all be dead. Similarly Knight’s applied his uncertainty concept to an event that is “in a high degree unique”[8] and hence so far out in the distribution as to be observed perhaps only once in several lifetimes.
For Keynes, as well as for Soros, the belief that intelligent people “know” that they cannot know the future is an essential element in understanding the operation of our economic world. For decisions that involved potential large spending outflows or possible large income inflows that span a significant length of time, people “know” that they do not know what the future will be. They do know, however, that for these important decisions, making a mistake about the future can be very costly and therefore sometimes putting off a commitment today in order to remain liquid maybe the most judicious decision possible.
Our modern capitalist society has attempted to create an arrangement that will provide people with some control over their uncertain economic destinies. In capitalist economies the use of money and legally binding money contracts to organize production, sales and purchases of goods and services permits individuals to have some control over their future cash inflows and outflows and therefore some control of their monetary economic future. It also provides other parties (business firms) to engage in money sales contracts with the legal promise of current and future cash inflows sufficient to meet the business firms’ costs of production and generate a profit.
Households and business entrepreneurs willingly enter into money contracts because each party thinks it is in their best self interest to fulfill the terms of the contractual agreement. If, because of some unforeseen event, either party to a contract finds itself unable or unwilling to meet its contractual commitments, then the judicial branch of the government will enforce the contract and require the defaulting party to either meet its contractual obligations or pay a sum of money sufficient to reimburse the other party for damages and losses incurred. Thus, as the biographer of Keynes, Lord Robert Skidelsky has noted, for Keynes “injustice is a matter of uncertainty, justice a matter of contractual predictability”. In other words, by entering into contractual arrangements people assure themselves a measure of predictability in terms of their contractual cash inflows and outflows, even in a world of uncertainty.
UNCERTAINTY, MONEY CONTRACTS AND LIQUIDITY
In their book, Arrow and Hahn (1971, pp 256-7 emphasis added) wrote:
"The terms in which contracts are made matter. In particular, if money is the goods in terms of which contracts are made, then the prices of goods in terms of money are of special significance. This is not the case if we consider an economy without a past or future. . . .If a serious monetary theory comes to be written, the fact that contracts are made in terms of money will be of considerable importance".
Yet all mainstream models including the Arrow-Debreu model assumes people enter into “real contracts” i.e., they “know” the future real outcome with at least actuarial certainty of any contract they sign today .Thus intelligent mainstream economists such as Arrow and Hahn in emphasizing the importance of money contracts cannot help but let their common sense intervene in their view of the economy – to the detriment of their logical consistency with their general equilibrium (Arrow-Debreu-Walrasian) model.
Keynes’s liquidity theory provides what Arrow and Hahn call “A serious monetary theory” for domestic and international transactions as a way of coping with an uncertain future.
Money is that thing that government decides will settle all legal money contractual obligations. An individual is said to be liquid if he/she can meet all contractual obligations as they come due. For business firms and households the maintenance of one’s liquid status is of prime importance if bankruptcy is to be avoided. In our world, bankruptcy is the economic equivalent to a walk to the gallows. Maintaining one’s liquidity permits a person or business firm to avoid the gallows of bankruptcy. [Yet as my good Monetarist friend Alan Meltzer has often told me “bankruptcies are good for the health of the capitalist system.”]
Thus, liquidity is at the center of the operations of our monetary economy and therefore financial markets that are well organized andorderly permit decision makers to maintain liquidity in case some unforeseen future event should make it otherwise impossible to meet a future money contractual obligation unless they can readily sell a liquid asset for money in an orderly market. system.”
Keynes provided a NEW way of economic thinking to explain the operations of a monetary economy where entrepreneurs enter into nominal contracts in order to organize production and exchange activities. The sanctity of money contracts is the essence of the capitalist system and Keynes’s liquidity analysis[9].
In Keynes’s analysis, liquidity, i.e., the ability to meet one’s money contractual commitments domestically and internationally becomes an essential foundation for understanding the operation of our entrepreneurial economy. The primary function of well organized and orderly financial and exchange rate markets is to provide liquidity so that holders of financial assets traded on such markets “know” they can make a fast exit and liquify their portfolio at a price close to the previous market price at any time they fear something bad may happen in the uncertain future. With sufficient liquidity, one can always meet one’s money contractual commitments no matter what. The maintenance of one’s liquid position is of prime importance if default and bankruptcy is to be avoided.
Once it is recognized that in a money using entrepreneurial economy decision makers “know” that the future is uncertain (in the nonergodic sense) and can be created in ways not even all decision makers understand, then the demand for liquidity as a security blanket to meet unforeseen possible dire net cash flow problems becomes paramount in decision makers’ plans
In our uncertain economic world, by entering into forward money contracts, decision makers gain some control over their future cash inflows and outflows. If market participants think the future is more uncertain than it was yesterday, then they will try today to reduce cash outflow commitments for goods and services (save more) in order to increase their liquidity position. Faced with this reduction in market demand, businesses will reduce hiring of workers.
BLAMING THE MESSENGER FOR THE MAINSTREAM MESSAGE
If the future is nonergodic, then mainstream economic theory is creating a completely artificial world remote from reality-since the theory requires the ergodic axiom. Keynes [1936, p. 192] noted that classical theorists “offers us the supreme intellectual achievement, unattainable by weaker spirits, of adopting a hypothetical world remote from experience as though it were the world of experience and then lived in it consistently”.
Mainstream economists are not wrong in the need for rigor in economic theorizing. It is not rigor and the use of mathematics perse that creates the useless economic models that make mainstream economists look so poorly. Rigor means that the only valid claims are logical deductions from specified assumptions [i.e., axioms].Consistency and rigor are features of any deductive approach, which draws conclusions from a group of axioms – and whose empirical relevance depends entirely on the validity of the axioms.
Keynes applied rigor to his general theory – but only after he threw out three classical axioms that he felt had no empirical justification. So Keynes required induction in developing his theory to check on the validity of the axioms. Accordingly Keynes did not develop a completely artificial world. Unfortunately Paul Samuelson, who grasped for the Keynes mantle immediately after the Second World War, ignored Keynes general theory. As I point out in my book THE KEYNES SOLUTION; THE PATH TO GLOBAL ECONOMIC PROSPERITY, Samuelson has admitted that he found the General Theory “unpalatable’ end incomprehensible. Samuelson said he merely assumed that the Keynes analysis was simply a Walrasian system with fixity of wages and prices. In so doing Samuelson aborted the Keynes revolution.
Since biblical times humans have tried to understand the world about them and what caused things that humans observed to happen. In general the human mind believes that there must be a cause for any event we observe.
For most of the history of mankind, it was believed that the design of God or the Gods was the cause of anything that happened in the world of experience. Beginning in the 17th century, however, philosophers believed that explanations of events that one observed could be developed on the basis of reasoning of the mind rather than religious belief. This was the beginning of the intellectual movement historians call The Enlightenment or The Age of Reason where order and regularity was seen to come from the human analysis of observed phenomena. The power of reason was not in the possession of truth, but in the acquisition of truth.
Any understanding of the world as humans perceive it always be the creation of the human mind. Reasoning involves the mind creating a deductive theory to explain what people observe happening about them (using inductive views). For example, Sir Isaac Newton saw an apple fall from the bough of a tree to the ground. Newton explained why apples always fall to the ground by the theory of gravity.
A theory is the way humans describe real world observations on the basis of a model that starts with a few axioms (hopefully based on inductive reasoning from the world of experience). An axiom is an assumption accepted as a universal truth that does not need to be proved. From this axiomatic foundation, the theorist uses the laws of logic to deduce conclusions that explains what we observe in the world of experience. All theories are generally accepted in some tentative fashion. Theories are not ever conclusively established and can be replaced when events are observed that are deviations from the current existing theory. Thus, the financial crisis of 2007-2009 should have been sufficient empirical evidence to indicate that the axiomatic basis of the mainstream theory needs to be replaced.
Economic theory is an analytical device where the economic theorist builds a model by starting with some axioms that he/she accepts as a self evident truth. The tools of logical deduction are then used to reach one or more conclusions. These conclusions are then presented to the public as the explanation of economic events that are occurring in the world of experience. The theory can then be used to suggest the cure for any real world economic problems.
Accordingly, it is perfectly acceptable to have rigor and even math in economic models – as both Marshall and Keynes had. But the axioms underlying the model must be thoroughly examined to see if they are applicable to the real world. What Samuelson, Lucas and others have done is impose axioms, such as the ergodic axiom, that have no relationship to the world we live in.
Keynes’s general theory is rigorous and consistent – and once one recognizes that the future is uncertain in terms of a nonergodic stochastic process, then one can understand the self-interest of individuals is to protect themselves from an uncertain future where bankruptcy can occur if one cannot meet one’s money contractual obligations in a capitalist system.
Thus money contracts (inflows and outflows) are used by individuals to protect themselves from adverse unmanageable net cash flows. The purpose of liquid assets[10] traded on organized and orderly financial markets is to provide a security blanket against one’s inability to meet a contractual obligation outflow.
Thus when the market for mortgage backed derivatives that were advertised to be “as good as cash” i.e., perfectly liquid (and triple A rated) collapsed, the loss of so much liquidity caused panic (a reflexivity response) in other markets for assets that had been previously thought to be very liquid. Asset holders in many markets tried to make “fast exits” and the result was a financial collapse and crisis.
In sum, Keynes’s liquidity theory of the operation of financial markets is a rigorous, logically deductive system that appears to be applicable to the real world in which we live and should replace the artificial world model of Lucas and other mainstream economists.
NOTES
REFERENCES
Arrow, K J. and Hahn, F. H.,General Competitive Equilibrium, San Francisco, Holden Day,
1971.
Bernstein, P. L.,Against the Gods, New York, John Wiley,1996.
Davidson, P.,The Keynes Solution: The Path To Global Economic Prosperity,
Palgrave/Macmillan, 2009.
A. Greenspan, October 23, 2008 testimony before the House Oversight Committee.
Keynes, J. M.,The General Theory of Employment, Interest, and Money, Macmillan, 1936.
Lucas, R. E. “Tobin and Monetarism: A Review Article”,Journal of Economic Literature,19,
1981.
Lucas, R. E., and Sargent, T. J. ,Rational Expectations of Econometric Practices, 1981
G. Soros, “Letters to the Editor”.The Economist, March 15-21, 1997 issue
G. Soros (2008) “The Crisis and What To Do About It”New York Review of Books, December
4 issue.
[1].P. A. Samuelson,[1969] “Classical and Neoclassical Theory” in Monetary Theory, edited by R.W. Clower (Penguin Books,, London) p.12.
[2].Keynes [1936, p. 3] stated that the classical economics fundamental axioms are applicable to a “special case....[that] happen[s] not to be those of the economic society in which we live with the result that its teaching is misleading and disastrous if we attempt to apply it to fact of experience”. This “special case” statement is even more applicable today, given the economic austerity discussions in Washington, the UK, Euroland, etc, and the export-led growth , i.e.,, mercantilist, policies pursued by nations such as China who are still enjoying an “economic miracle” in an otherwise depressed global economy.
[3]. Two other axioms that Keynes rejected are 1. Money is neutral (at least in the long run) so that changes in the quantity of money do not affect real outcomes, and 2. Gross substitution is ubiquitous and therefore liquid assets are good substitutes for real capital goods. (See Davidson , 2009).
[4].Consequently, government action today can only delay, but not change the long run optimal solution already predetermined by free markets.
[5].This is equivalent to thinking that drawing the sample of heights from a pygmy tribe in Africa is equivalent to drawing a sample of Swedish citizens’ height.
[6].In place of the rejected ergodic axiom Keynes argued that when crucial economic decisions had to be made, decision makers could not merely assume that the future can be reduced to quantifiable risks calculated from already existing market data. Instead they depended on “animal spirits” since most animals do not know how to calculate the moments around the mean!
For decisions that involved potential large spending outflows or possible large income inflows that span a significant length of time, people “know” that they do not know what the future will be. They do know that for these important decisions, making a mistake about the future can be very costly and therefore sometimes putting off a commitment by maintaining liquidity today maybe the most judicious decision possible.
[7].J. M. Keynes [1939],”Professor Tinbergen’s Method” Economic Journal, 49, reprinted inThe Collected Writings of John Maynard Keynes vol. 14, edited by D. Moggridge [Macmillan, London, 1973].
[8]. F. Knight, (1921), Risk, Uncertainty and Profit (Houghton Mifflin, New York) p.233
[9].The first question for theorists, therefore, is: why are all production and exchange agreements –whether between entities in the same common currency area or between entities in nations that use different monies, sealed with contracts denominated in a specific money? Why are people in the world of experience not like the people of mainstream economic theory, where all contracts are in real terms?
[10]. Keynes has an entire chapter in the GENERAL THEORY entitled “The Essential Properties of Interest and Money” in which he specifically indicates that all liquid assets have certain essential mathematical properties, namely (1) the elasticity of production is zero and (2) the elasticity of substitution between liquid assets and durable producible goods is zero. Keynes specified these elasticity properties by induction via his knowledge of financial markets.
IS ECONOMICS A SCIENCE? SHOULD ECONOMICS BE RIGOROUS?
BY PAUL DAVIDSON, Editor, Journal of Post Keynesian Economics
Many mainstream economists (e.g., Lucas, Cochrane) claim that the characteristics of a “science” require rigor, consistency, and mathematics. So if economics is to be a science it must display these characteristics. Paul Samuelson has added the claim that economists must accept the ergodic axiom in their models in their pursuit of economics as a science on par with physics, astronomy, and chemistry. Efficient market theory possesses all these characteristics. So how is it possible that efficient market theorists did not foresee the financial crisis that started in 2008?
Whether they declare themselves Monetarists, Rational Expectation theorists, Neoclassical Synthesis [Old] Keynesians or New Keynesians, the backbone of their mainstream theories is the efficient market analysis where the future can be known. For “Old” and “New” Keynesians the only thing that prevents efficient markets operating in the short run is the presumption of fixity in nominal wages and prices. [Thus, these “Keynesians” urge government action only because, as John Williamson is always telling me, they are too impatient to wait for the long run.]
To stimulate discussion, I wish to address two aspects of these mainstream economists universal beliefs. The first involves a discussion of the difference between a nonergodic stochastic process and an ergodic stochastic process for “knowing” the future. The second and related aspect involves the use of the deductive axiomatic logical analysis and mathematics by mainstream economists to glorify efficient market theory and the Arrow-Debreu-Walrasian general equilibrium or dynamic general equilibrium as the only way to do real world economics.
For example, to “prove” markets are efficient and the use of the Ricardian equivalence theorem to show that fiscal stimulus policies are useless– at least in the long run– requires the presumption that the economic system is “ergodic”.
Efficient market theory, Arrow-Debreu models, Ricardian equivalence, etc. requires the households, business enterprises, and politicians to possess a significant correct and accurate message of things that are going to happen in the future if they are to make efficient (optimal) decisions today.
Why? Because time is a device that prevents everything from happening at once. Thus decisions made today usually require significant time to elapse before the payoff of the decision occurs. This is true not only for decisions involving investment projects by entrepreneurs, but also for most consumer decisions, such as the purchase of an auto or an ipad, or even a decision as to what restaurant to go to get a good meal for dinner. [How many of us have sometimes been disappointed in the meal we ordered at the restaurant?]
The message of efficient markets, Arrow-Debreu, Ricardian equivalence, etc. is inapplicable to the world of experience because in the real world, households do not have any significantly reliable information about the future, and neither do budgetary policy makers, nor entrepreneurs. The erroneous message based on the assumption of people having significantly reliable knowledge about the future is the result of accepting bad axioms as the basis for mainstream theory. It is not the fault of using the deductive method, rigor, and mathematicsper se. So do not blame the messenger for the message!
THE ERGODIC AXIOM
First, let us take up the ergodic- nonergodic stochastic process distinction. Paul Samuelson [1969] has written that if economists hope to move economics from “the realm of history” into “the realm of science” they must impose the “ergodic hypothesis” on their theory[1]. In other words Nobel Prize Winner Paul Samuelson has made the ergodic axiom thesine qua non for the scientific method in economics. Lucas and Sargent [1981] have also claimed the principle behind the ergodic axiom is the only scientific method of doing economics.
Following Samuelson’s lead, most economists (e.g., Cochrane, Stiglitz, Mankiw, M. Friedman, Scholes, etc) and economic textbook writers either implicitly or explicitly have assumed that observable economic events are generated by an ergodic stochastic process.
But not Keynes! Keynes [1936, p. 16] suggested the way to understand why classical economic theory (e,g., efficient market theory) is not relevant to the world of experience, when he noted that old economic thinkers were “like Euclidean geometers in a non Euclidean world who discover that apparent parallel line collide, rebuke these lines for not keeping straight. Yet, in truth there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics”. Keynes developed a theory that is more general than classical and mainstream economic theory because it is based on fewer restrictive fundamental axioms[2]. The fewer the number of underlying axioms, the more general the theory. The most important classical axiom Keynes eliminated in his general theory[3] is the ergodic axiom.
This ergodic axiom assumes the economic future is already predetermined[4] . The economy is governed by an existing ergodic stochastic process. One merely has to calculate probability distributions regarding future prices and output to draw significant and reliable statistical inferences [information] about the future. Once self-interested decision makers have reliable information about the future, their actions on free markets will optimally allocate resources into those activities that will have the highest possible future returns thereby assuring global prosperity.
In order to draw any statistical (probabilistic risk) inferences regarding any universe, however, one should draw a sample from that universe. Since drawing a sample from the future economic universe is impossible, the ergodic axiom presumes that the economic future is governed by an already existing unchanging ergodic stochastic process. Consequently, a sample drawn from the past is equivalent to a sample drawn from the future. In other words, calculating the probability distribution from past statistical data sample is presumed to be the same as calculating the risks from a sample drawn from the future.[5] This ergodic axiom is an essential foundation for all the complex risk management computer models developed by the “quants” on Wall Street. If the economy is nonergodic, however, thenthese computer models are weapons of math destruction [For deterministic models, the “ordering axiom” plays the same role as the ergodic axiom in stochastic models.]
For a technical explanation of the difference between ergodic and nonergodic stochastic processes the read should read my book, THE KEYNES SOLUTION: THE PATH TO GLOBAL ECONOMIC PROSPERITY [Davidson (2009)] . For our discussion here we merely need note that, in essence, the ergodic axiom imposes the condition that the future is already predetermined by existing parameters (market fundamentals). Consequently the future can be reliably forecasted by analyzing past and current market data to obtain the probability distribution governing future events. In other words, if future events are assumed to be generated by an ergodic stochastic process (to use the language of mathematical statisticians), then the future is predetermined and can be discovered today by the proper statistical probability analysis of past and today's data regarding market "fundamentals”. If the system is nonergodic, calculated past and current probability distributions do not provide any statistically reliable estimates regarding the probability of future events.
New Keynesians such as Stiglitz accept the ergodic axiom as the basis of the economic system but then add additional ad hoc assumptions to try to tame this presumed knowledge of the future approach to better reflect what they believe is reality. Stiglitz, for example, in his asymmetric information theory assumes that some market participants cannot make the proper statistical calculations because they do not perceive the correct information about the future. In other words, Stiglitz imposes the asymmetric information condition that there are some decision makers who act while lacking the correct information about the (presumed to exist today) probability distribution of future events. Consequently these decision makers (speculative fools?) misread the future and thereby mess up the beauty of the efficient market system.
Nobel prize winner Robert Lucas [1981, p. 287] has boasted that the mainstream theory axioms are “artificial, abstract, patently unreal”. Like Nobel Laureate Samuelson, Lucas insists such unreal assumptions are the only scientific method of doing economics. Lucas insists that “Progress in economic thinking means getting better and better abstract, analogue models, not better verbal observations about the real world” [Lucas, 1981, p. 276]. The rationale underlying this argument is that these unrealistic assumptions make the problem more tractable and, with the aid of a computer, the analyst can then predict the future. Never mind that the prediction might be disastrously wrong.
In the introduction to his bookAgainst The Gods , a treatise that deals with the questions of relevance of risk management techniques on Wall Street, Peter L. Bernstein [ 1996, p. 6] writes:
“The story that I have to tell is marked all the way through by a persistent tension between those who assert that the best decisions are based on quantification and numbers, determined by the [statistical] patterns of the past, and those who based their decisions on a more subjective degrees of belief about the uncertain future. This is a controversy that has never been resolved....to what degree should we rely on the patterns of the past to tell us what the future will be like?”
One would hope that the empirical evidence of the collapse of those “masters of the economic universe “ that have dominate Wall Street machinations for the last three decades has at least created doubt regarding the applicability of the ergodic axiom to our economic world. Even Alan Greenspan in testimony before Congress in October 2008 seems to be having second thoughts although he still has not completely changed his tune. Keynes’s ideas and Soros’s reflexivity concept support Bernstein’s latter group.
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Samuelson, Lucas and others adopted the ergodic axiom because they want economics to be in the same class as the “hard sciences” such as physics or astronomy. For example the science of astronomy is based on the presumption of an ergodic stochastic process that governs the movement of all the heavenly bodies from the moment of the “Big Bang” to the day the universe ends. Accordingly probability analysis using past measurements of the movements of heavenly bodies permit astronomers to predict future solar eclipses within a few seconds of when they actually occur. Nothing Congress, the President of the United States, the United Nations, or environmentalists can do will alter the predetermined dates and time for future eclipses. For example, Congress cannot pass a law outlawing solar eclipses in order to provide more sunshine and thereby enhance crop production. In an ergodic world, all future events are already predetermined and beyond change by human action today. The future movement of the heavenly bodies can be known by anyone who has measured past movements and projected these movements into the future. There are no speculative fools, who suffering from asymmetric information, think Mars is going to crash into the earth.
George Soros has explained why the efficient market theory is not applicable to real world financial markets with a slightly different terminology than Keynes but conceptually in the same way. Soros (2008) wrote: “we must abandon the prevailing [efficient market] theory of market. behavior. ” Soros states that there is a direct connection “between market prices and the underlying realty [that] I [Soros] call reflexivity” .
What is this reflexivity? In a letter to the Editor published in the March 15-21, 1997 issue of The Economist Soros objects to Paul Samuelson insistence on requiring the ergodic axiom to make economics a science. Soros argues the ergodic hypothesis does not permit “the reflexive interaction between participants’ thinking and the actual state of affairs” that characterizes real world financial markets. In other words, the way people think about the market today can affect and alter the future path the market takes; the future is not predetermined. Soros’s concept of reflexivity, therefore, is the equivalent of Keynes’s rejection of the ergodic axiom[6]. Reflexivity means peoples thoughts and actions create the future, while mainstream economists presume the future has already been predetermined and can be discovered by analyzing today’s market fundamentals.
NON EUCLIDEAN ECONOMIC THEORY
In creating a “NonEuclidean” economic theory to explain why these unemployment “collisions” occur in the world of experience, Keynes uses the logical deductive method but he had to deny (“throw over”) the relevance of several classical axioms for understanding the real world. The classical ergodic axiom which assumes that the future is known and can be calculated as the statistical shadow of the past was one of the most important classical assertions that Keynes rejected.
Keynes's general theory is a deductive method of analysis. Keynes’s concept of uncertainty about the economic future requires the economic system to be generated by a nonergodic stochastic process. At the time of his writingThe General Theory, Keynes did not know of the ergodic stochastic theory that was being developed by the Moscow School of Probability in the 1930s. Nevertheless in his criticism of Tinbergen's [econometric] method, Keynes [1939] wrote[7] that Tinbergen's method is not valid for any economic forecasting because economic data “are not homogeneous” over time. Non homogeneity is a sufficient condition for nonergodicity.
Taleb’s Black Swan concept attempts to explain market crashes as an event lying in the far off tail of an ergodic probability distribution. It should be noted that Knight’s vision of uncertainty and Taleb’s Black Swan concept are both based on the ergodic presumption for the economy. Taleb’s Black Swan is an already predetermined outcome but the Black Swan event is so far out in the tail of the ergodic probability distribution that its occurrence is so rare that it is never likely to be observed– except in the long run when we will all be dead. Similarly Knight’s applied his uncertainty concept to an event that is “in a high degree unique”[8] and hence so far out in the distribution as to be observed perhaps only once in several lifetimes.
For Keynes, as well as for Soros, the belief that intelligent people “know” that they cannot know the future is an essential element in understanding the operation of our economic world. For decisions that involved potential large spending outflows or possible large income inflows that span a significant length of time, people “know” that they do not know what the future will be. They do know, however, that for these important decisions, making a mistake about the future can be very costly and therefore sometimes putting off a commitment today in order to remain liquid maybe the most judicious decision possible.
Our modern capitalist society has attempted to create an arrangement that will provide people with some control over their uncertain economic destinies. In capitalist economies the use of money and legally binding money contracts to organize production, sales and purchases of goods and services permits individuals to have some control over their future cash inflows and outflows and therefore some control of their monetary economic future. It also provides other parties (business firms) to engage in money sales contracts with the legal promise of current and future cash inflows sufficient to meet the business firms’ costs of production and generate a profit.
Households and business entrepreneurs willingly enter into money contracts because each party thinks it is in their best self interest to fulfill the terms of the contractual agreement. If, because of some unforeseen event, either party to a contract finds itself unable or unwilling to meet its contractual commitments, then the judicial branch of the government will enforce the contract and require the defaulting party to either meet its contractual obligations or pay a sum of money sufficient to reimburse the other party for damages and losses incurred. Thus, as the biographer of Keynes, Lord Robert Skidelsky has noted, for Keynes “injustice is a matter of uncertainty, justice a matter of contractual predictability”. In other words, by entering into contractual arrangements people assure themselves a measure of predictability in terms of their contractual cash inflows and outflows, even in a world of uncertainty.
UNCERTAINTY, MONEY CONTRACTS AND LIQUIDITY
In their book, Arrow and Hahn (1971, pp 256-7 emphasis added) wrote:
"The terms in which contracts are made matter. In particular, if money is the goods in terms of which contracts are made, then the prices of goods in terms of money are of special significance. This is not the case if we consider an economy without a past or future. . . .If a serious monetary theory comes to be written, the fact that contracts are made in terms of money will be of considerable importance".
Yet all mainstream models including the Arrow-Debreu model assumes people enter into “real contracts” i.e., they “know” the future real outcome with at least actuarial certainty of any contract they sign today .Thus intelligent mainstream economists such as Arrow and Hahn in emphasizing the importance of money contracts cannot help but let their common sense intervene in their view of the economy – to the detriment of their logical consistency with their general equilibrium (Arrow-Debreu-Walrasian) model.
Keynes’s liquidity theory provides what Arrow and Hahn call “A serious monetary theory” for domestic and international transactions as a way of coping with an uncertain future.
Money is that thing that government decides will settle all legal money contractual obligations. An individual is said to be liquid if he/she can meet all contractual obligations as they come due. For business firms and households the maintenance of one’s liquid status is of prime importance if bankruptcy is to be avoided. In our world, bankruptcy is the economic equivalent to a walk to the gallows. Maintaining one’s liquidity permits a person or business firm to avoid the gallows of bankruptcy. [Yet as my good Monetarist friend Alan Meltzer has often told me “bankruptcies are good for the health of the capitalist system.”]
Thus, liquidity is at the center of the operations of our monetary economy and therefore financial markets that are well organized andorderly permit decision makers to maintain liquidity in case some unforeseen future event should make it otherwise impossible to meet a future money contractual obligation unless they can readily sell a liquid asset for money in an orderly market. system.”
Keynes provided a NEW way of economic thinking to explain the operations of a monetary economy where entrepreneurs enter into nominal contracts in order to organize production and exchange activities. The sanctity of money contracts is the essence of the capitalist system and Keynes’s liquidity analysis[9].
In Keynes’s analysis, liquidity, i.e., the ability to meet one’s money contractual commitments domestically and internationally becomes an essential foundation for understanding the operation of our entrepreneurial economy. The primary function of well organized and orderly financial and exchange rate markets is to provide liquidity so that holders of financial assets traded on such markets “know” they can make a fast exit and liquify their portfolio at a price close to the previous market price at any time they fear something bad may happen in the uncertain future. With sufficient liquidity, one can always meet one’s money contractual commitments no matter what. The maintenance of one’s liquid position is of prime importance if default and bankruptcy is to be avoided.
Once it is recognized that in a money using entrepreneurial economy decision makers “know” that the future is uncertain (in the nonergodic sense) and can be created in ways not even all decision makers understand, then the demand for liquidity as a security blanket to meet unforeseen possible dire net cash flow problems becomes paramount in decision makers’ plans
In our uncertain economic world, by entering into forward money contracts, decision makers gain some control over their future cash inflows and outflows. If market participants think the future is more uncertain than it was yesterday, then they will try today to reduce cash outflow commitments for goods and services (save more) in order to increase their liquidity position. Faced with this reduction in market demand, businesses will reduce hiring of workers.
BLAMING THE MESSENGER FOR THE MAINSTREAM MESSAGE
If the future is nonergodic, then mainstream economic theory is creating a completely artificial world remote from reality-since the theory requires the ergodic axiom. Keynes [1936, p. 192] noted that classical theorists “offers us the supreme intellectual achievement, unattainable by weaker spirits, of adopting a hypothetical world remote from experience as though it were the world of experience and then lived in it consistently”.
Mainstream economists are not wrong in the need for rigor in economic theorizing. It is not rigor and the use of mathematics perse that creates the useless economic models that make mainstream economists look so poorly. Rigor means that the only valid claims are logical deductions from specified assumptions [i.e., axioms].Consistency and rigor are features of any deductive approach, which draws conclusions from a group of axioms – and whose empirical relevance depends entirely on the validity of the axioms.
Keynes applied rigor to his general theory – but only after he threw out three classical axioms that he felt had no empirical justification. So Keynes required induction in developing his theory to check on the validity of the axioms. Accordingly Keynes did not develop a completely artificial world. Unfortunately Paul Samuelson, who grasped for the Keynes mantle immediately after the Second World War, ignored Keynes general theory. As I point out in my book THE KEYNES SOLUTION; THE PATH TO GLOBAL ECONOMIC PROSPERITY, Samuelson has admitted that he found the General Theory “unpalatable’ end incomprehensible. Samuelson said he merely assumed that the Keynes analysis was simply a Walrasian system with fixity of wages and prices. In so doing Samuelson aborted the Keynes revolution.
Since biblical times humans have tried to understand the world about them and what caused things that humans observed to happen. In general the human mind believes that there must be a cause for any event we observe.
For most of the history of mankind, it was believed that the design of God or the Gods was the cause of anything that happened in the world of experience. Beginning in the 17th century, however, philosophers believed that explanations of events that one observed could be developed on the basis of reasoning of the mind rather than religious belief. This was the beginning of the intellectual movement historians call The Enlightenment or The Age of Reason where order and regularity was seen to come from the human analysis of observed phenomena. The power of reason was not in the possession of truth, but in the acquisition of truth.
Any understanding of the world as humans perceive it always be the creation of the human mind. Reasoning involves the mind creating a deductive theory to explain what people observe happening about them (using inductive views). For example, Sir Isaac Newton saw an apple fall from the bough of a tree to the ground. Newton explained why apples always fall to the ground by the theory of gravity.
A theory is the way humans describe real world observations on the basis of a model that starts with a few axioms (hopefully based on inductive reasoning from the world of experience). An axiom is an assumption accepted as a universal truth that does not need to be proved. From this axiomatic foundation, the theorist uses the laws of logic to deduce conclusions that explains what we observe in the world of experience. All theories are generally accepted in some tentative fashion. Theories are not ever conclusively established and can be replaced when events are observed that are deviations from the current existing theory. Thus, the financial crisis of 2007-2009 should have been sufficient empirical evidence to indicate that the axiomatic basis of the mainstream theory needs to be replaced.
Economic theory is an analytical device where the economic theorist builds a model by starting with some axioms that he/she accepts as a self evident truth. The tools of logical deduction are then used to reach one or more conclusions. These conclusions are then presented to the public as the explanation of economic events that are occurring in the world of experience. The theory can then be used to suggest the cure for any real world economic problems.
Accordingly, it is perfectly acceptable to have rigor and even math in economic models – as both Marshall and Keynes had. But the axioms underlying the model must be thoroughly examined to see if they are applicable to the real world. What Samuelson, Lucas and others have done is impose axioms, such as the ergodic axiom, that have no relationship to the world we live in.
Keynes’s general theory is rigorous and consistent – and once one recognizes that the future is uncertain in terms of a nonergodic stochastic process, then one can understand the self-interest of individuals is to protect themselves from an uncertain future where bankruptcy can occur if one cannot meet one’s money contractual obligations in a capitalist system.
Thus money contracts (inflows and outflows) are used by individuals to protect themselves from adverse unmanageable net cash flows. The purpose of liquid assets[10] traded on organized and orderly financial markets is to provide a security blanket against one’s inability to meet a contractual obligation outflow.
Thus when the market for mortgage backed derivatives that were advertised to be “as good as cash” i.e., perfectly liquid (and triple A rated) collapsed, the loss of so much liquidity caused panic (a reflexivity response) in other markets for assets that had been previously thought to be very liquid. Asset holders in many markets tried to make “fast exits” and the result was a financial collapse and crisis.
In sum, Keynes’s liquidity theory of the operation of financial markets is a rigorous, logically deductive system that appears to be applicable to the real world in which we live and should replace the artificial world model of Lucas and other mainstream economists.
NOTES
REFERENCES
Arrow, K J. and Hahn, F. H.,General Competitive Equilibrium, San Francisco, Holden Day,
1971.
Bernstein, P. L.,Against the Gods, New York, John Wiley,1996.
Davidson, P.,The Keynes Solution: The Path To Global Economic Prosperity,
Palgrave/Macmillan, 2009.
A. Greenspan, October 23, 2008 testimony before the House Oversight Committee.
Keynes, J. M.,The General Theory of Employment, Interest, and Money, Macmillan, 1936.
Lucas, R. E. “Tobin and Monetarism: A Review Article”,Journal of Economic Literature,19,
1981.
Lucas, R. E., and Sargent, T. J. ,Rational Expectations of Econometric Practices, 1981
G. Soros, “Letters to the Editor”.The Economist, March 15-21, 1997 issue
G. Soros (2008) “The Crisis and What To Do About It”New York Review of Books, December
4 issue.
[1].P. A. Samuelson,[1969] “Classical and Neoclassical Theory” in Monetary Theory, edited by R.W. Clower (Penguin Books,, London) p.12.
[2].Keynes [1936, p. 3] stated that the classical economics fundamental axioms are applicable to a “special case....[that] happen[s] not to be those of the economic society in which we live with the result that its teaching is misleading and disastrous if we attempt to apply it to fact of experience”. This “special case” statement is even more applicable today, given the economic austerity discussions in Washington, the UK, Euroland, etc, and the export-led growth , i.e.,, mercantilist, policies pursued by nations such as China who are still enjoying an “economic miracle” in an otherwise depressed global economy.
[3]. Two other axioms that Keynes rejected are 1. Money is neutral (at least in the long run) so that changes in the quantity of money do not affect real outcomes, and 2. Gross substitution is ubiquitous and therefore liquid assets are good substitutes for real capital goods. (See Davidson , 2009).
[4].Consequently, government action today can only delay, but not change the long run optimal solution already predetermined by free markets.
[5].This is equivalent to thinking that drawing the sample of heights from a pygmy tribe in Africa is equivalent to drawing a sample of Swedish citizens’ height.
[6].In place of the rejected ergodic axiom Keynes argued that when crucial economic decisions had to be made, decision makers could not merely assume that the future can be reduced to quantifiable risks calculated from already existing market data. Instead they depended on “animal spirits” since most animals do not know how to calculate the moments around the mean!
For decisions that involved potential large spending outflows or possible large income inflows that span a significant length of time, people “know” that they do not know what the future will be. They do know that for these important decisions, making a mistake about the future can be very costly and therefore sometimes putting off a commitment by maintaining liquidity today maybe the most judicious decision possible.
[7].J. M. Keynes [1939],”Professor Tinbergen’s Method” Economic Journal, 49, reprinted inThe Collected Writings of John Maynard Keynes vol. 14, edited by D. Moggridge [Macmillan, London, 1973].
[8]. F. Knight, (1921), Risk, Uncertainty and Profit (Houghton Mifflin, New York) p.233
[9].The first question for theorists, therefore, is: why are all production and exchange agreements –whether between entities in the same common currency area or between entities in nations that use different monies, sealed with contracts denominated in a specific money? Why are people in the world of experience not like the people of mainstream economic theory, where all contracts are in real terms?
[10]. Keynes has an entire chapter in the GENERAL THEORY entitled “The Essential Properties of Interest and Money” in which he specifically indicates that all liquid assets have certain essential mathematical properties, namely (1) the elasticity of production is zero and (2) the elasticity of substitution between liquid assets and durable producible goods is zero. Keynes specified these elasticity properties by induction via his knowledge of financial markets.
Sunday, March 18, 2012
Ye Ol’ Rationality…
Ye Ol’ Rationality…
Hi… Name’s ‘Rationality’__and I’ve been around a long time, but I don’t think you realize just how long, or who I truly am__so, let me see if I may clear up this mystery a bit, just a bit. You may have me confused with my younger brother/sister ‘Reason’__No__I am not ‘Reason’__not even close__I am ‘Ratio-Logic’ leaning toward ‘Wisdom-Logic’. First off, my younger sibling thinks more about the reasons for things; whereas, I think more about the ‘Universal Mechanics’ of things, based on only the existing facts__My younger brother/sister thinks more about beliefs, opinions, feelings and judgments of such, and I more about the logical interactions of intellectual ideas and their effects, all the way from the community, state, national and international levels, but even more importantly__to the fully ‘Universal Level’. I’m in no way meaning my younger brother/sister is not just as important as I, as s/he certainly is, since s/he more thinks about the deeper, necessary and important issues of personal, family and moral community relationships, much closer to the heart, personal compassion, empathy and honesty, even though I also do consider this, but less so. We’d certainly have a far less rational world without the kind help of my younger brother/sister, and many of his/her still younger siblings, brothers, sisters and cousins alike…
‘Rationality’ is the hardest essence agent to write about, as it requires the use of rationality, or at the least some form of general cognition__whether psychological, rhetorical or logical and rational, to even begin to speak about the subject of self-rationality. The second problem is ‘Rationality’ attempts to approach the mountain-top heights of ‘Moral Wisdom’, while holding itself to some semblance of humility, not to drift into that oh so useless area of the omniscient ego, which is just as much an enemy to itself, as it also is to its younger sibling and cousin, ‘Reason’ and ‘Rhetoric’__which all, when taking the ball too far over the scrimmage line, have the habit of drifting far too far into that all too useless area of the irrational omniscient ego. Few realize both sides must be balanced by each other’s differences, along with as much middle-mental-state outside or inside support, as can be mustered__such as natural law, morality, aesthetics, esthetics and ethics__as without these extra supports, it’s far too easy to drift off the proper course of civil discourse, and on out into the barren areas of the dark egos… Whether ‘Rationality’, ‘Rhetoric’ or ‘Reason’__none of us want to be caught in the darkness__as we can’t see in the darkness__we all like the light of illumination…
And, this brings up a question; Why isn’t ‘Universal Moral Wisdom’ a more talked about subject these days, as it was years ago…? Have people become incapable of seeing above the personal, family, community, national and international levels__into the ‘Universal’? Or, what is it…? ‘Rationality’ looks at politics and law, and sees nothing but debates and arguments, or where philosophers and other intellectuals are concerned, nothing but dialectic and dialogic levels reaching no higher than the personal to the international, or as could be stated ‘The U.N.’, ‘W.T.O.’ and ‘The International Courts’ of settlements, whether law, politics or money__and never reaching into the thoroughly ‘Universal Rationale…’ Has the world of citizens completely forgot, there’s a higher level than the ‘International?’ Do they think the mind stops at the borders of the ‘International?’ This just isn’t being very creative, in my opinion. Is it because the last few hundred years’ philosophies, academicians and psychologies, etc., have totally convinced everyone on Earth, that ‘Universal Moral Wisdom’ is some foolish metaphysical utopian non-sense, or something even more dire? Can’t people any longer separate the simple metaphysical from the truer form of honest ‘Universal Thinking?’__where metaphysical has more to do with context, meaning, motives and intents, and ‘Universal Moral Wisdom’ has far more to do with the entire history of the nations’ and planet’s ‘Common Laws’ and ‘Rationality’ combined, over time, as a truly workable ‘Visual Effects Logic’ of our real world’s total actions, over time. Have people totally forgot how to ‘Reason’ and ‘Rationalize’ law’s, politics’ and economies’ goals and effects into real conceptual ideas contributing to our future betterments of our ‘Political Actions…?’
Let’s just take a quick look at one powerful ‘Universally Rational Example’__to see if we can make some sense of this. We all know there’s a major and dangerous problem developing between ‘The Western Religions’, politics and economies; and that of ‘The Muslim East’s Religious Views’__but, how many have truly looked for a ‘Higher Than International Solution?’ ‘Oh, everybody’s brains just quit working right here'__Well, let me help you out, if I may... We presently have a global problem of the ‘International Thinking’ on top, squashing most all ‘The Important Individual Thinking’ on the bottom__It’s like a pressure-cooker, where the entire world is fighting for resources, in an ever decreasing shortage of global resources, including thinking resources, and people limiting themselves to the false heights of ‘International Thinking’ is forcing the pressure-cooker to near global explosion of severe head-butting, and most likely, somewhere out in the near future, nuclear head-butting__but, does this truly need to be? If we can recover a bit of our ‘Universal Thinking’ of years’ gone by__I don’t think so. OK__we have an oil shortage, or is it really a refinery shortage? ‘News-Flash’__It’s really a refinery shortage__so, where’s the most sensible location on Earth, to place new oil refineries, to reduce Global and mainly Mid-East tensions? Israel__Think about it. If new oil-refineries, enough to over-supply all the needy nations of the Earth, were placed in Israel, just what do you think that would do to the Mid-East dynamic of ‘Radical Islamic Thought and Power?’ ‘Radical Islam’, instead of hating Israel, as much as they presently do, just may be awakened to the fact, that should the ‘Free-World’s’ supply of fully refined oil-products depend on keeping Israel safe, long out into the World’s future__they just may have to do some serious soul-searching re-thinking about that ‘Big Ol’ Satan of the West, America’ defending Israel, and wake up and realize, NOW, the entire ‘Free-World’s’ supply of fully refined oil-products and market-price dynamics would depend on Israel being protected and kept safe, by ‘Even’ such enemies as Al-Qaeda and Iran__as the ‘Dynamic of Global Protection’ would then be such a ‘Great Community of Nations’ ‘oil-necessity-locked’ against them, unless they changed their thinking toward such a new state of ‘Dynamic Universal Moral Wisdom’s, New Necessities of Self-Survival…’
The seemed ‘Great Satan’ can protect himself/herself in just such a way__Is this not a useful example of ‘New Universal Thinking…?’__’All for one, and one for all’__and yet, it simply seems to be the old, sufficiently applied to the new…
Tuesday, February 21, 2012
Europe Passes the Last Exit. A Great Crisis Lies Ahead...
Author: Fabius Maximus
Summary: Today Europe’s leaders have the last opportunity to avoid a great crisis. Will they continue to demand increasing austerity of the Greek people, pushing them further on a path devoid of hope and leading to poverty and political collapse? Or will they realize the folly of their actions?
Contents
The German people drew the wrong conclusion from their post-WWI experience. They saw the damage from the Weimar hyperinflation of 1921-1924, probably an inevitable result of the WWI settlement. They suffer amnesia about the Weimar deflation which brough Hitler to power (see A lesson from the Weimar Republic about balancing the budget). It’s sounding a fire alarm while the ship sinks. Now they repeat in different form Weimar’s mistakes of 1929-32, imposing a crippling austerity on the PIIGS while striving to balance their own budget — almost certain to result in recession and deflation (for description of this process see Debt – the core problem of this financial crisis, which also explains how we got in this mess).
The PIIGS nations grow weaker, the eurozone economy slows, and the centrist political parties lose support to extremists. Greece leads this parade, but the other PIIGS – and France — follow in its path. We can only guess at how this plays out, but it probably ends badly.
Today’s meeting of Europe’s Finance Minsters looks like the last chance to change course. Like all previous opportunities, they will almost certain drive by this last exit. They are ill-equipped to do otherwise, much like 13th century priests treating the Plaque on the basis of Scriptural precepts.
The series of posts last Fall forecast a resolution – a crisis-driven policy change — in the near future. Three months later nothing has happened. Europe leaders continue to improvise with sh0rt-term measures, while Europe — especially the PIIGS – grow weaker. Each passing month reduces their ability to avoid a crash. The devotion of Europe’s leaders — both in the North and South – to the unification project exceeds my expectations, but no longer appears rational. Perhaps they do not see the cost in broken lives. Perhaps they do, but do not care. Perhaps they value the shining dream of a future Europe more than blasted lives of proles. Collateral damage.
Next are several articles report from the Greece, the front lines of Europe, watching their society crack under the stress.
(3) “Can a return to the drachma save Greece as unemployment soars?“, Ambrose Evans-Pritchard (Business Editor), The Telegraph, 19 February 2012 — “Greece’s unemployment bomb has detonated. After a deceptive calm, the surge in job losses since last summer is shocking even for those who never believed that combined fiscal and monetary contraction could possibly lead to any result other than ruin.” Excerpt:
(5) An explanation of what’s happening and likely consequences
Summary: Today Europe’s leaders have the last opportunity to avoid a great crisis. Will they continue to demand increasing austerity of the Greek people, pushing them further on a path devoid of hope and leading to poverty and political collapse? Or will they realize the folly of their actions?
Contents
- The last exit before disaster
- “Can a return to the drachma save Greece as unemployment soars?”
- “Restructuring Greece Within the Euro is Illusory”
- Letter from Archbishop of Greece Ieronymos to the Prime Minister of Greece
- An explanation of what’s happening and likely consequences
- Other posts about the crisis in Europe
The German people drew the wrong conclusion from their post-WWI experience. They saw the damage from the Weimar hyperinflation of 1921-1924, probably an inevitable result of the WWI settlement. They suffer amnesia about the Weimar deflation which brough Hitler to power (see A lesson from the Weimar Republic about balancing the budget). It’s sounding a fire alarm while the ship sinks. Now they repeat in different form Weimar’s mistakes of 1929-32, imposing a crippling austerity on the PIIGS while striving to balance their own budget — almost certain to result in recession and deflation (for description of this process see Debt – the core problem of this financial crisis, which also explains how we got in this mess).
The PIIGS nations grow weaker, the eurozone economy slows, and the centrist political parties lose support to extremists. Greece leads this parade, but the other PIIGS – and France — follow in its path. We can only guess at how this plays out, but it probably ends badly.
Today’s meeting of Europe’s Finance Minsters looks like the last chance to change course. Like all previous opportunities, they will almost certain drive by this last exit. They are ill-equipped to do otherwise, much like 13th century priests treating the Plaque on the basis of Scriptural precepts.
- Myopically focused on the need to protect politically powerful banks,
- seeing Europe as a morality play rather than the product of cold laws,
- believing in a mixture of pseudoeconomic economic myths (eg, confidence fairies, invisible bond vigilantes and the curative power of austerity), and
- unwilling to recognize their own role in creating this crisis.
The series of posts last Fall forecast a resolution – a crisis-driven policy change — in the near future. Three months later nothing has happened. Europe leaders continue to improvise with sh0rt-term measures, while Europe — especially the PIIGS – grow weaker. Each passing month reduces their ability to avoid a crash. The devotion of Europe’s leaders — both in the North and South – to the unification project exceeds my expectations, but no longer appears rational. Perhaps they do not see the cost in broken lives. Perhaps they do, but do not care. Perhaps they value the shining dream of a future Europe more than blasted lives of proles. Collateral damage.
Next are several articles report from the Greece, the front lines of Europe, watching their society crack under the stress.
(3) “Can a return to the drachma save Greece as unemployment soars?“, Ambrose Evans-Pritchard (Business Editor), The Telegraph, 19 February 2012 — “Greece’s unemployment bomb has detonated. After a deceptive calm, the surge in job losses since last summer is shocking even for those who never believed that combined fiscal and monetary contraction could possibly lead to any result other than ruin.” Excerpt:
A variant of this lies in store for Portugal as its “internal devaluation” starts in earnest. The young Schumpeterians in charge of the Portuguese economy insist otherwise — cocksure that shock therapy will triumph without the cushion of debt relief and devaluation — but events have a habit of demolishing dreams.(3) “Restructuring Greece Within the Euro is Illusory“, Der Spiegel, 20 February 2012 — Opening:
In November alone 126,000 Greeks lost their jobs in a country of 11 million, equivalent to three and a half million Americans in a single month. The unemployment rate jumped from 18.2pc to 20.9pc. This has not yet fed through into social breakdown. Greeks receive unemployment support for an average of thirty weeks, with a ceiling of €454 a month, according to Professor Manos Matsaganis from Athens University. Those with civil service tenure are placed on labour reserve for two years at half their basic pay, or a third of their actual pay. Once these cushions are exhausted, Greeks are on their own. The monthly ratchet effect will then become painfully evident.
… Dimitra Noussi, who runs two homeless shelters and a soup kitchen for the City of Athens, said the crunch comes once people have been unemployed for five or six months and cannot pay the rent. Most fall back on the kinship network but there comes a point when critical mass overwhelms even this cultural backstop.
… One can see why the high priests of the EU Project wish to prevent elections taking place in April. The political centre is disintegrating, with the once triumphant PASOK party down to 9pc in the polls and New Democracy at 18pc – each party reduced to a pro-Memorandum rump after the mass expulsion of dissidents, and each stunned almost senseless.
The latest best-seller is the Greek translation of Heinrich Winkler’s “Weimar 1918-1933: History of the First German Democracy”, narrating how an indebted Germany pursued the same deflation policies under the Gold Standard as Greece is now pursuing under EMU — with the same results. The book culminates in the Reichstag elections of July 1932 when the Nazis and Communists between them won half the seats, and Weimar died. Such parallels are always inexact. The radical parties of Syriza and the Democratic Left are not authoritarian. Yet their ascendancy surely threatens to shatter the existing order. “If we achieve a Left-dominated government, we will politely tell the Troika to leave the country, and we may need to discuss an orderly return to the Drachma,” said Syriza MP Theodoros Dritsas, choosing his words carefully.
The news that Iceland has regained its investment grade rating — with unemployment down to 6pc – comes as a timely reminder that countries can indeed go it alone and live to tell the tale. Though of course, Iceland’s debts are in sovereign krona, not Mr Schäuble’s euro, and Iceland exports a lot of aluminium.
Mr Papademos warns that default and EMU-exit would lead to “uncontrollable economic chaos”. But is that not already the case? No Greek bank has been able to issue a letter of credit accepted anywhere in the world since November. Large Greek companies are having to relocate their headquarters to Bulgaria in order to conduct basic trade.
The “drachma risk” has already killed investment. Greece is suffering the anticipated consequences of EMU exit without the benefits, so it might as well lance the boil, impose capital controls, and create a new banking system (as Iceland did). Such catharsis might start to unlock €60bn of cash savings in gold, dollars, German euro notes (letter`X’, Greece`Y’), and such-like, sitting in the proverbial mattress. Foreign investors might start to nibble again, once the Greek exchange rate reflects reality at around seven Chinese yuan.
Europe’s finance ministers plan to approve a second bailout for Greece on Monday but Hans-Werner Sinn, the head of Ifo, a top German economic think tank, warns that the money will only help international banks — not the Greeks. He argues that Greece can only solve its crisis if it quits the euro.(4) Letter from Archbishop of Athens and All Greece Ieronymos to the Prime Minister of Greece
SPIEGEL: The finance ministers of the euro zone want to approve a new bailout for Greece this Monday. Can the additional €130 billion ($172 billion) save Greece?
Sinn:No, and the politicians know it can’t. They want to gain time until the next election. I think we’re wasting time by doing this. … Because Greece’s external debt is rising with every year that passes until it leaves the currency union. We’re getting ever further away from solving the problem. The basic problem is that Greece isn’t competitive. The cheap loans that the euro brought the country artificially raised prices and wages — and the country has to come back down from this high level.
SPIEGEL: So the euro countries shouldn’t approve the aid?
Sinn: They should give them the money to ease their exit from the currency union. The Greek government could use the money to nationalize the country’s banks and prevent the state from collapsing. The state and the banks must continue to function through all the turmoil that an exit will entail.
SPIEGEL: This turmoil would hit the population hard.
Sinn: Yes, undeniably. But the turmoil would only be temporary, it would last one to two years perhaps. This time would have to be bridged with the financial aid from the international community. But the drachma will immediately depreciate and the situation will stabilize very quickly. After a short thunderstorm, the sun will shine again.
SPIEGEL: How would a euro exit help Greece in concrete terms?
Sinn: It would become competitive again. Because Greek products would rapidly become cheaper, demand would be redirected from imports towards domestically produced goods. The Greeks would no longer buy their tomatoes and olive oil from Holland or Italy but from their own farmers. And tourists for whom Greece has been too expensive in recent years would return. In addition, new capital would flow into the country. The rich Greeks who deposited so many billions, possibly hundreds of billions of euros, in Switzerland would see the falling property prices and wages and would have an incentive to start investing in their own country again.
SPIEGEL: Does the exit from the euro zone entail Greece going bankrupt?
Sinn: No, quite the reverse. The bankruptcy forces the exit. The Greeks will immediately leave if they don’t get any more international aid because the bankruptcy couldn’t be managed within the euro system. The state would be insolvent and the banking system too. The entire payments system would fall apart. The chaos can only be avoided if Greece leaves and the currency depreciates immediately.
SPIEGEL: Does that mean Greece should be forced to leave?
Sinn: No, no one should force anyone. But at the same time Greece doesn’t have the right to receive permanent assistance from the other euro countries, and Greece’s creditors aren’t entitled to have the debt repaid by the international community. Everyone has to earn their standard of living themselves, and those who choose to earn money from risk must bear that risk.
SPIEGEL: If Greece were to exit the euro zone, would the tough austerity measures still be necessary?
Sinn: In this case, savings really only refer to a reduction in debt growth. The economist only refers to savings if debt is actually repaid. Greece is nowhere near doing that. But it’s true that Greece has gotten used to the flow of cheap credit from abroad, and that it’s politically impossible to cut wages to the extent needed to make the country competitive.
…
SPIEGEL:Why are the euro-zone countries so adamant that Greece must remain in the currency?
Sinn:This isn’t really about the country. The Greeks are being held hostage by the banks and financial institutions on Wall Street, in London and Paris who want to make sure that money keeps on flowing from government bailout packages — not to Greece, but into their coffers.
SPIEGEL: What about the contagion that a bankruptcy or a Greek exit would involve? Financial markets may speculate that other countries will suffer a similar fate as Greece.
Sinn: There may be contagion effects. But I think this argument is being instrumentalized by people who are worried about losing money. People keep on saying “the world will end if you Germans stop paying.” In truth only the asset portfolios of some investors will suffer.
Homelessness and even hunger – phenomena seen during the [Second World] war – have reached nightmare levels … A sense of patience among Greeks is running out, giving way to a sense of anger, and the danger of a social explosion can no longer be ignored.The full text in Greek is on the website of the Archdiocese of Athens.
… We must all understand the feeling of insecurity, desperation and depression in every Greek home. This, unfortunately, is continuing to causes suicide among those who can no longer stand the drama in their family and the suffering of their children. … We are being asked to take even larger doses of a medicine that has proven to be deadly and to undertake commitments that do not solve the problem, but only temporarily postpone the foretold death of our economy … And what is likely to follow are more painful, more unjust measures in the same hopeless and unsuccessful course of our recent past.
(5) An explanation of what’s happening and likely consequences
- Fetters of the mind blind us so that we cannot see a solution to this crisis, 1 April 2009
- A lesson from the Weimar Republic about balancing the budget, 10 February 2010
- All about deflation, the quiet killer of modern economies, 19 July 2010
- Government policy errors as a cause of the Great Depression, 1 November 2008
- The simple explanation of why night falls over Europe, 9 December 2011
- Explaining the gold standard, the Euro, Default, Deflation, and Hyperinflation, 12 December 2012
- The post-WWII geopolitical regime is dying. Chapter One , 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
- Can the European Monetary Union survive the next recession?, 11 July 2008
- The periphery of Europe – a flashpoint to the global economy, 8 February 2010
- A great speech by the PM of Greece. How soon until an American President says similar words?, 3 March 2010
- Governments cannot go bankrupt, 2 April 2010
- The EU does Kabuki for Greece. Is it the next domino to fall?, 14 April 2010
- About the Euro crisis: the experts are wrong; the German people are right., 7 May 2010
- Former Central Bank Head Karl Otto Pöhl says bailout plan is all about ‘rescuing banks and rich Greeks’, 20 May 2010
- The Fate of Europe, nearing the point of decision, 13 September 2011
- Europe drifts towards the brink of a cataclysm, 26 September 2011
- Delusions about easy fixes for Europe, dreaming during the calm before the storm, 30 September 2011
- Every day the new world emerges, yet we see it not. Like today, as Europe begs China for loans, 15 September 2011
- Is Europe primed for chaos, as it was in July 1914?, 7 October 2011
- We see the outlines of the next cure for Europe. Will it work?, 14 October 2011
- Today Europe’s leaders took another step towards the edge of the cliff, 27 October 2011
- Where to from here, Europe? Some experts share their views., 8 November 2011
- Status report on Europe’s slow re-birth (first, the current system must die), 10 November 2011
- Europe begins its endgame. Watch and learn, for Europe’s problems are the world’s., 11 November 2011
- Looking ahead to see the new shape of Europe, 22 November 2011
- Hot news! The Wehrmacht failed to take Greece. Now Germany tries again, with a different method., 28 January 2012
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