He who pays the economist calls the tune

If one wonders why economists have had so much difficulty predicting and explaining the economic crisis it might be helpful to look at who pays their salaries. Isn’t there an old saying that he who pays the economist calls the tune?  As most economists work for large corporations, governments or universities (paid indirectly by governments) they have to answer ultimately to chief  executive officers or presidents/prime ministers.

The question then is what do these people want to hear?  Does the chief executive of a major bank want to hear that he is participating in a Ponzi scheme or does the president want to hear that we are going into a major recession and that his voters are going to have to accept a decreasing standard of living?

Probably not.  So economists tend to focus on things that will not be offensive to these people or that will help to support them.

Consider the book Freakonomics by Steven Levitt and Stephen J. Dubner.  This popular book is very interesting but it doesn’t  touch on any of the big economic issues with which we are currently trying to deal.  People who have lost their jobs and homes to the crisis will not find much here to help them.  Nor will the book encourage them to become drug dealers. (Here is the Wikipedia entry on Freakonomics.  http://en.wikipedia.org/wiki/Freakonomics )

Another example is this article ( http://www.economist.com/node/12851150 ) from The Economist, December 30, 2008.  This article lists eight up and coming economists and talks briefly about the work they are doing. None of them are doing research which will help us understand or cope with the current economic crisis.  Here are three quotes from this article which I think help make the point.


They share the same knack for finding ingenious ways to answer unlikely questions, often by plundering forgotten troves of data.


Mr Gabaix made a splash in 2006 when he concluded that the “excessive” pay of chief executives was not necessarily excessive. Compensation may have grown sixfold from 1980 to 2003 not because managers were six times greedier, but because the firms they ran were six times bigger.


What, then, unites these eight young stars and the discipline they may come to dominate? Economists still share a taste for the Greek alphabet: they like to provide formal, algebraic accounts of the behaviour they explain. And they pride themselves on the sophistication of their investigative methods. They are usually better at teasing confessions out of data than their rivals in other social sciences. What defines economics? Economics is what economists do—the best of them, anyway.


So long as the economy was growing it didn.t much matter what questions economists asked and most of their research assumed continued economic growth.  As a student I learned regression analysis with its upward sloping line.  It wasn’t until later that I learned about fractals with their ups and downs.  I speculate the people who sign economists’ pay cheques would not be much interested in economic projections based on fractals.

I believe most people who study economics want to make the world a better place.  Also we tend to think and act in our own short-term interests and for most people that is their pay cheque.  The economists I am criticizing probably believe they are helping make the world better – or would  be if only people would listen to them.  Who is to say one person is right rather than another when it comes to solving deep problems and shaping the future.  Sometimes, to others, our vision of the future is wishful thinking.

What then is the role of economists if not to make accurate forecasts and to solve major economic problems.  Shortly after starting my study of economics I decided economists were the theologians of the twentieth century.  Some of their debates are as relevent as the medieval debate over how many angels could dance on the head of a pin.

I have a theory that we need to believe the things we do are important and necessary.  Sometimes we need people to reinforce this belief.  As most of what we do involves the exploitation of resources we need to believe this is good.  As it becomes more difficult to extract the remaining resources it becomes even more important we have people to help reinforce our work ethic.  The theory is that this is the true role of economists.

Payday loans, slavery and money creation

What is the marginal cost of making a payday loan? Or any other type of loan?  The answer to this question should help to answer a question about interest rates on loans raised in the Buttonwood column of The Economist, November 30, 2013 issue. What interest rates should lenders be allowed to charge?

Unfortunately loans and credit are complicated beyond simple economics because the making of loans is an instrument of exploitation even to the point of slavery and because credit is involved in how we create money.

Economic theory tells us that so long as there is competition the price of a product should be equal to the marginal cost of producing that product.  Therefore for loans the marginal cost would be the cost to the lender of acquiring the money to loan (i.e. the interest paid to the depositor of for payday lenders to their source of funds) plus the operating costs and the cost of loans written off.  The legitimate interest rate to charge on a loan should be easy to calculate and for banks we can compare the rates they pay on deposits and the rates they charge for loans.

It appears the need for credit is almost universal at least in large-scale economies.  I’m not sure about hunting and gathering groups which practice a sharing economy.  It appears there has always been a need for short-term lending of the type done by payday lenders.

The problem is that the making of loans can be an instrument of exploitation.  One of the quickest ways to get control over a person is to lend them some money.  In peasant societies people borrow to put on funerals and weddings and if they cannot repay they sometimes find themselves in slavery.

In our own society there are probably lots of people with dreams of doing something other than the daily employment but they are unable because of their debt load.  All this consumer debt works as an instrument of social control for the one percent.  So long as we are in debt we work to support their goals and interests rather than for our own.  If a person wants to be truly free one should try to live without  borrowing.

As for payday loans Mr./Mrs./Miss/Ms Buttonwood says:

“Provided the terms of the loan are made clear, then it should be up to borrowers to decide whether to accept the costs involved. An interest rate is simply the price of money.”

Once again this is simple economics without the human factor.  For many people there are times when  it may not be easy “to decide whether to accept the costs involved.”

The other complication with lending is that our money supply is based on fractional reserve loans by financial institutions.  As money is essential for the exchange of goods and services it is also essential that we carry a debt load.  Says Buttonwood

“But businesses and consumers are positively encouraged to borrow. Indeed, when debt growth slows, as it has in recent years, an air of panic develops about how to get it going again.”

There are a number of problems with the fractional reserve method of creating money, most of which have been discussed elsewhere on this weblog and especially in the essay “LETS go to market: Dealing with the economic crisis.”  Basically it is a Ponzi scheme which is urgently in need of reform.

The reform proposed in that essay, a national Local Exchange Trading System (LETS) should also help with the need for short-term credit.  It would be a lot less exploitive as no interest would be charged and control over the money supply would be in the hands of all people.  A national LETS system would transfer a lot of economic decision-making from bankers and governments to individuals.

There are consumer loans and there are business loans.  Loans are a transfer of purchasing power from one person  to another and interest is compensation for the transfer.  A LETS system  should take care of the need for short-term consumer  credit.  The compensation for business loans should come out of the profits in which case they should be considered equity.

Back to the question of caps on interest charged on payday loans.  Is it the role of government to prevent some of its citizens from exploiting others?  If yes, then governments should limit interest  rates  charged (marginal cost is a guideline) or find another way of creating money so that the need for short-term consumer credit is easily satisfied.

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This columnist from The Economist is encouraging theft

This post is to accuse the Buttonwood columnist in The Economist of encouraging the theft of people’s savings.

In the Nov 30th 2013 issue he/she says “Debt needs to be reduced by default, inflation or financial repression (keeping interest rates as low as possible).”

Lots of others including economists concerned with government policy make similar statements.

The problem is that one person’s debt is another person’s savings.  Therefore when debt is reduced by default or inflation it is going to take away from somebody’s savings.  This might be more visible if loans were made directly from a saver to a borrower without the financial intermediation of banks.

It might also be easier to understand if we were to define money as something representing purchasing power.  Thus a loan is a transfer of purchasing power from the lender to the borrower.  If the loan is not repaid because of default or is reduced by inflation then the lender has lost some of his/her purchasing power.

Some people might say the losses from default are carried by financial institutions.  This is true only if the banks are making excess profits.  If they are not making excess profits and maybe even if they are the losses are most likely to be spread over all their depositors in the form of reduced interest payments.

Of course people who owe lots of money, especially governments, benefit from inflation because they don’t have to repay as much purchasing power.  The ideal should be price stability – zero inflation and zero deflation.

However it happens default or inflation reduces the purchasing power previously owned by savers.  To me this is theft by or on behalf of borrowers.

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