Compassionate economics

Are the words compassion and economics compatible?

Absolutely. If we were to exchange goods and services without interference from legislation which restricts competition we would have an economy with a high degree of equality, fairness, environmental sustainability, peace and compassion.


Major evidence for this comes from the hunters and gatherers who used to inhabit this planet and especially the bushmen of the Kalihari Desert who lived a peaceful and sustainable lifestyle for close to 200,000 years


This writer has come to this conclusion after a lifetime of interest in current affairs and relationships, through a first class degree in economics from the University of British Columbia and lots of informal reading in economics, economic history, history, ancient history and anthropology.


That I feel it necessary to start this book with this question indicates how poorly so many people, including economists, understand economics and money. At least since Marx many people have equated economics with the evils of the current economic system and shut off whenever the word economics is used. This is sad because economics is about the relationships involved in the exchange of goods and services and most of us have to exchange with at least a few people. Money is a tool to facilitate this exchange. Both economics and money involve a lot of distortions of the truth which makes it easy for some people to exploit the rest of us.


team-spirit-2447163_1920As we work through compassionate economics the issue of the resource base hangs over us and makes life difficult for all of us.

Economics professors often start their lectures by drawing a simple x graph on the black board. One line represents the physical side of the economy and the other line represents the financial side of the economy. This is a very important distinction as ignoring it diverts our attention from the reality of economics.

As we mostly discuss economic problems in terms of money we ignore the physical side of the problem. For example, pensions are very important for most of us but we always talk about saving enough money rather than having enough energy and mineral resources. Two things could and probably will happen to most of the money people save for their retirement – inflation or bankruptcy. Our standard of living in retirement will depend upon the quantity of goods and services we are capable of producing relative to the number people making demands on that production. A key factor in this ratio will be the energy and mineral resources we have. There are still lots of these on the surface of our planet but we have consumed the most easily accessable.Those that are left will require a lot of energy to extract and may not be feasible.


The cost of solar energy has recently been falling quickly and has some potential. I also like that solar has the potential for each of us to make decisions about adopting it. It is great that individuals can make these decisions instead of bankers. The down side is that most of our money supply is based on debt and will disappear if a lot of loans have to be written off. I fear a lot of our money is based on loans made to support petroleum.


We need to exchange goods and services because we are social creatures. It may be this is what distinguishes us from animals. In some circumstances it may be possible for an individual to live alone but for most of us we must live with at least one other person and this means living in a relationship. On the Canadian Prairies the early explorers found they needed a female partner for survival because the division of labour was too much for one person. Later the settlers found that during harvest labour requirements were such that they needed to help each other and took turns at several farms. Now, with modern equipment one person can seed, fertilize and harvest up to 7,000 acres. But he still needs a huge support staff of suppliers. These he pays in cash rather than return labour. Economics is about how we exchange goods and services and the relationships which are a part of these exchanges.


Decision making is an important part of compassionate economics. When we make decisions for others we can and often do make those decisions by what is best for us rather than them. As there is no place for exploitation in compassionate economics we should as much as possible exchange goods and services so that individuals can make decisions for themselves. In capitalism bankers and government make decisions about what and how much is to be produced. In socialism bureaucrats in the form of central planners make those decisions. The only way I know to allow individuals to make economic decisions is the perfect competition model upon which the formal study of economics based.

At least since Marx economics has been defined as either capitalist or socialist. Both of these are very vague terms which is good for people who want to control or exploit others but meaningless for those of us who want to understand how we exchange goods and services. The main feature of capitalism as we know it is that governments pass legislation which restricts competition and we call it a market economy. The main feature of socialism is a matrix known as central planning and they say it is “by the people and for the people”. Both concepts are the idealogical equivalent of the stuff through which one would walk if one visited a cattle feed lot.

For four years this guy lived on a British Columbia coastal Indian reserve. One evening a old timer told us about the time consuming process his people used to make themselves a sweet treat,

“Do you still do this,?” I asked?

“No,” he replied. “It is a lot easier to go to Dairy Queen.”

These people did most of their hunting at the local supermarket but they still fished and they still had a few of their old traditions. One of these traditions was the sharing of fish and we had a lot of salmon, halibut, crab and oolichans (a very small, oily and smelly fish.)

It appears that in a lot of hunting gathering cultures sharing mostly with family or clan members was the predominant way of exchange. This is a major difference from our culture where it is assumed the exchange of goods and services should yield a profit. I would like us to plagiarize the hunters and gathers and make sharing the key concept in our economy. This is somewhat radical and would open the door to some major changes in our economy – a guaranteed income policy, a new way of creating money and a zero growth economy. All of these are important for resource and environmental concerns. All of these are important if we are to have a compassionate economy.

One of the major issues we have to deal with is the incompatibility of economic growth and environmental issues such as global warming, pollution, mono culture agriculture, health and overpopulation. The need for economic growth is sold as a fix for unemployment although its main purpose may be to further increase the wealth of the one percent. As compassionate economics is based on sharing rather than profits there is no need for further economic growth. With a guaranteed income scheme people will not need jobs to survive and we can deal with environmental concerns. We will also no longer need to support the greatest of all make work schemes, the arms industry. Lets opt for peace and sharing with all peoples. The goal of compassionate economics is to get the population to a sustainable level and live in peace.

Compassionate economics will allow us to replace our commitment to the work ethic with a commitment to a leisure ethic. In future we should get our self identity from the leisure activities in which we engage whether they be acting in a play, writing a book or even drinking beer.It is relatively easy for me to sit here in a comfortable chair and a nice view out the window and think out solutions to economic problems. But economics involves people with emotions and special interests. A lot of people will find it difficult to see the need for changes and those with special interests will be very vocal in protecting themselves. However I believe the future of most of us is seriousl

It is a pity that so many people shut off when they hear the word “economics.” A few years ago I read a book on green economics which promoted small businesses. I laughed and cried because economic theory is based on the concept of small businesses. One of the key assumptions of economics is that no firm is large enough to influence prices by restricting production and by restricting the quantity purchased.

A key feature of a true market economy as described by economic theory is that there are no profits. If there are profits to be made in an industry new firms will enter until prices drop to the point where there are no more profits. Firms can make wages and a return on investment (maybe) but there will be no profits. Thus a perfect market economy with competition is what is needed for a compassionate economy. A lot of people need to be studying formal economics.

It is relatively easy for me to sit here in a comfortable chair and a nice view out the window and think out solutions to economic problems. But economics involves people with emotions and special interests. A lot of people will find it difficult to see the need for changes and those with special interests will be very vocal in protecting themselves. However I believe the future of most of us is seriously threatened and we must at least try for compassionate economics.

 

The next economic crisis: financial or real?

A few people are prepping themselves for the next economic crisis and speculating about what will cause it.  This blogger thinks there are several possible causes.  It is about 99.99 per cent certain there will be another crisis.

Even if somebody does make an accurate prediction it will probably do no good because there are so many vested interests there will be no consensus about the cause and about what to do to prevent it.  However, for some of us there is some fun in trying to think out economic problems and we might be able to improve our understanding of economics.  So, here goes.

The possibilities are for the cause to be within the financial system or for the cause to be within the physical or real side of the economy.  As the two are interconnected it may be difficult to determine just what is happening.

Problems within the financial system relate to money. Either there is too much money or not enough.  Ideally the available money supply needs to be just right for the quantity of goods and services exchanged and as this varies it needs to be flexible.  When there is too much money available there is potential for inflation and this is a problem for people with invested savings as they lose some of their purchasing power.  Deflation is a problem for lenders as the money they have loaned out will have less purchasing power when it is returned, if it is returned.

The really serious problem comes when there is not enough money as this curtails economic activity.  Most of the money supply is based on loans made by the financial industry and involves a multiplier.  When the industry has to write off a large quantity of loans, as with the recent subprime housing crisis, the money supply goes down, again with a multiplier effect.  Without money the exchange of goods and services becomes difficult and lots of people lose their jobs. Big time suffering.

Currently it appears there is lots of money floating around the economy.  Lots of firms are reported to have piles of cash on hand and are probably unable to see investment opportunities.

On the real side of the economy, many people assume there are lots of energy and mineral resources available and therefore no physical restraints on the exchange of goods and services.   This may not be true.

A common argument is that as resources are consumed higher prices will bring on a greater supply which happened with oil and lots of minerals.  The problem is that they also require more energy to extract which reduces the energy available for other activities and at some point the value of the energy exceeds the value of the resources.  This blogger figures there are lots of energy and mineral resources available on the earth’s crust,  but the cost of getting them makes them useless.  This could be changed by technology and the decreasing cost of solar energy will make the high cost of oil irrelevant.

Children, workings in a vegetable garden.

However there may be some economic  disruptions in the transition.  How much oil infrastructure will have to be written of and what would that do to the money supply? Also there are all the other minerals for which there are no clear cheap substitutes.

This guy fears the greatest threat to our economic well-being is from resource restrictions on the physical side of the economy.  An even greater threat is that too many people will not see the problem because they analyse problems only in financial terms and will be looking for solutions on the financial side.  Changes in how much money is available or even in the way in which we create money will not add to the resource base or make it cheaper to extract them.

I fear for the future of my grandchildren.

 

 

 

Recycling is not enough

In this corner of the world recycling is almost universal.  Plastics, glass, metals, compost and drink containers are separated from the rest of the garbage.  Some people also take their own shopping bags to the supermarket.  The exceptions are that we have not mastered the technology of recycling energy and most of us continue to drive a lot

Unfortunately we are still experiencing environmental degradation, inflation and unemployment.  Recycling is not enough.  Its main function is to allow us to feel we are doing something. It allows us to ignore the real issues –  population levels and values.

I believe the most important way in to protect the environment is to reduce the number of people trying to live on this planet.  There are just too many people and I do not like the idea of saying some people should not have the same standard of living as others.  Who is to decide who gets shorted?

I also recognize it is a near impossibility as we cannot tell people not to have sex and not to have children.  What are the consequences of not taking action to reduce the population?  When the Europeans came to North America they brought with them some new diseases and close to 90 per cent of the native population died.  I understand there is some archaeological evidence that there was a similar population reduction in the Mediterranean some millenia ago.  If these precedents hold for us, then there is likely to be one hell of a stench.

We also need to get over our fear of death as so much energy and resources go into prolonging life.  Quite a few years ago The Economist reported that 80 per cent of health care spending is in the last six months of life.  I do not want to go into the 80 per cent and I hope that when my time comes I and those close to me will be able to accept it gracefully.

The other big challenge to protect  the environment deals with values many of which are a part of our committment to economic growth.

According to anthropologist James Suzman who recently published the book Affluence without Abundance, the most successful and long-lasting civilization was that of the Bushmen of the Kalahari desert.  These hunters and gatherers “worked” only ten to 15 hours a week.  As they relocated up to ten times a year they had little interest in material things and their society had high equality.  We cannot all go back to being hunters and gathers but we can choose some of their values and apply them to our daily lives.

If we really want to protect the environment then we should have fewer children, live in place, live a healthy lifestyle, have fewer and smaller toys, drive less, go easy on the travel and work as little as possible.  Recycling may make us feel we are doing something but it is not enough.

 

 

Pensions: Promises and reality

It is difficult for this blogger to get excited about pensions because he grew up to Doris Day singing “Whatever will be, will be“.  I heard that song so many times I still believe it.

There are two things that make pensions difficult.  They are part of a big business and they involve promises to be redeemed  in an unknown future.

This post was inspired by this article in The Economist about pension problems in Taiwan but the ideas here apply anywhere around the world where people rely upon pensions for their future.

Pensions are a problem because we evaluate economic problems in monetary terms and assume there will be no inflation or deflation.  We would get a more accurate evaluation if we did it in physical terms.  The reality is that our future standards of living depend upon the ratio of population to the quantity of goods and services we will be capable of producing. Monetary savings will probably be irrelevant thanks to inflation or bankruptcy.

We know, or we should know, from experience that the economic growth is fractal in nature rather than linear as we learned in university economics.  Being fractal means there are a series of ups and downs and sometimes major changes in direction.  There is some evidence that we are experiencing a major turning down.  This blogger  believes current economic problems are because we have used up the most easily accessible energy and mineral resources.  Yes, there are lots left but they require so much energy to extract they are mostly useless.  Regardless of what financial people say there may  be some grim prospects. If this analysis is correct the best career and investment is a market garden.

Pensions and other forms of savings are a big business in which sales people earn  commissions and profits on current sales.  They are selling promises for a future they probably will not have to keep.  The reality is that there may not be enough resources to keep them.

To believe in pensions one must have a lot of faith that the world is going to continue as it is for the rest of one’s life.  We can sometimes see into the near future but the further out we look the more blurred is our vision.

Back to Doris Day.

 

Why your savings and pensions are at risk

The fractional reserve way of creating money means a lot of people are at risk of losing all or part of their savings and pensions.

If there is too much money supply in the economy then we have inflation and people with savings or pensions lose some of their purchasing power and those who owe money benefit because they repay their loans with less purchasing power.  Now you know why governments and the people who speak on their behalf promote mild inflation.  This is at least unauthorized taxation if not theft.

pexels-photo-2105902If you have deflation, then people who are owed money win because they are repaid with more purchasing power than they loaned.  The borrowers lose because they have to repay with more purchasing power.

To be fair to everyone we need to manage the economy so that just the right amount of money is available at all times.  At a time when the economy is on a down trend, this is very important as too much money puts us in danger of hyperinflation.

Getting this amount right has long been a challenge to central banks although the common sense answer is fairly simple.  The money supply should vary with the quantity of goods and services we want to exchange and it should be flexible up and down.

The wrench in the simplicity is the fractional reserve way of creating money.  When banks make loans they must (or should) keep a fraction of the amount on reserve for when the depositor wants his/her money returned.  As the amount is only a fraction banks are at risk of a “run” if depositors lose faith.  And because of the fractional reserve there is a multiplier effect involved.  Does not this sound like a set up for a crisis?  The mechanics of this process are a little complex although I have always found it easy to understand. To figure it out I suggest you Google “fractional reserve” or look at my free e book Funny Money: Adapting to a Down Economy or look at the essay Going to Market on this weblog.

The other end of the wrench is  that interest is charged on the loans made by the banks.  Mainstream economists have given little or no thought to the consequences of this. Because all of our money is created by the making of loans, if all the outstanding debt were to be paid off at one time there would not be enough money to repay it all because of the interest.  The charging of interest on the debt/money means there is never enough money available to repay all outstanding debt. Inflation is built into the fractional reserve way of creating money.

The system works only so long as the economy and the money supply continues to grow.  An upset in either means crisis of which we have had many.

The relationship between money supply and economic output is expressed in a formula, MV=PQ, some times known as the quantity theory of money.  Money times the velocity at which it circulates in the economy is equal to a price index times the quantity of goods and services produced.

I get ticked off because this is frequently taken to mean there is a direct, proportional relationship between the money supply and the inflation rate or price level.   Can’t people see there are four variables in this formula?  Total output is an important part of this formula.  If it should happen to go down something needs to happen to another variable.

Our society has a strong commitment to economic growth and a need to keep it growing so that people will not suffer from unemployment.   Some desperate people are trying to stimulate growth by increasing the money supply. This may increase inflation but it will not lead to growth unless we can find inexpensive energy and mineral resources to support it.  I suspect the new American president has  his eye on parks and reserve lands to encourage more economic activity.  He will probably succeed in the short term to be followed by a major economic collapse.

This blogger thinks we need some major economic reforms, not only in our financial system but in our commitment to economic growth.  We need to minimize our production and exchange of goods and services so we are using fewer energy and mineral resources.

A lot  of people operate on faith in our financial system and ignore suggestions we need reform.  I think the risk is so great that prudent people will at least give some thought to these issues.  It is your savings and your pensions and your future that is at risk.

 

 

Please help promote this weblog

Please send the link to this post to your friends and social media.  Promoting a weblog can be difficult.  I get some referrals from LinkedIn.  I used to get quite a few from Reddit but I have been “shadow  banned” for linking to my own weblog.  Self promotion (and free speech?) are serious offenses on Reddit. I figure my strength is in the thinking that goes into the posts and I thank you for helping.  (r/economics   r/libertarian   r/economiccolapse  r/Degrowth )

Pensions and dreams

Many people like to dream about the things they will do in retirement and count on their pensions and savings to make the dreams come true.  For lots of current seniors this has been true but younger people may not get beyond the dream.  All the uncertainties of the economic future come to the fore when one starts thinking about pensions.

One hears two major concerns about pensions:  most  people are not saving enough and too many pensions are based on unfunded liabilities.

The one certainty about retirement futures is that well-being and standard of living will depend upon the quantity of goods and services we are capable of producing and the number of people with whom those goods and services must be shared.  Inflation or bankruptcies could easily wipe out  pensions and savings. In any case an increasing population and people living longer into retirement will put pressure on pensions.

There are two ways we can try to ensure our futures into retirement – we can work our butts off in an attempt to return to economic growth or we can reduce our expectations so that we don’t need so need so many goods and services.  It is possible the second option will be forced upon us.  That may not be all bad.  This blogger knows from experience that canoe camping is a lot cheaper and more enjoyable than the large cruise ships..   I also have to recognize that camping would be a lot less fun if we had to share the lake with 2,000 people at a time.

Most  of us are subject to a lot of media hype about the importance of pensions and saving for retirement.  We should keep in mind that we are in for the long-term while the people selling investments are more interested in their next pay cheque.  What is good for them may not be good for their customers and by the time you find out you may not even remember their name.

Some people are worried about government pensions and see private investments as the answer.  I figure the whole financial system is at risk of either inflation or bankruptcy.

In planning for the future we have to evaluate the potential for a return to economic growth.  If one believes we are going to return to growth then it might  be okay to put a lot of effort into a pension.  .  Personally, I think the best long-term investment at this time is a market garden.

 

If you liked this post your are invited to comment, press the like button and/or click  one of the share buttons. If you disagree you are invited to say why in a comment.  While I like the idea of sharing this platform, my personality is such that I don’t reply to many comments.

The future of money: inflation, deflation or disappearance into thin air

The future of money has been getting a little attention lately.  It could go one of three ways – inflation, deflation or part of it could disappear into thin air.  Concerns about money probably reflect concerns and uncertainty about where the economy is going.  Frequently behind these concerns lurk people who want a fixed money supply such as gold or bit coin.

This blogger figures money should be defined as a tool to facilitate the exchange of goods and services.  I do not like definitions that make it a store of wealth or a measure of value because these give money an intrinsic value which it does or should not have.  Money should only have value as a tool. 

One of the most important features of money should be the amount available  in the economy needs to be flexible.  It should be able go to up or down  with changes in the quantity of goods and services we want to exchange.  If the money supply is not flexible then as we change the quantity of goods and services then either prices must go up or down or the velocity, the rate at which money changes hands will change.  It is dangerous to assume there will be only growth.

Inflation happens when the money supply increases faster than the rate of economic growth and deflation happens when the money supply goes not keep up with the rate of growth.    Inflation is good for borrowers as the can repay their loans with money which has less real value.  This is one reason governments and their agents want to see mild inflation.  Deflation is good for lenders as they will be repaid with money which has more value.  The ideal should be price stability so nobody loses.

Our understanding of inflation and deflation has been distorted by the long period of economic growth we have just experienced. Most inflation has happened along with growth and most deflation has resulted from banking authorities trying to restrict the amount of money available.  This happened in the 1930s and todays central bankers have sworn to never again let that happen.

There is some evidence that our time of economic growth has terminated.  It is unclear how this will affect prices.  Quantitative easing which is an attempt to increase the money supply has not led to high inflation.  Past hyperinflations have occurred when governments have increased to money supply faster than the economy was capable of growing.  It appears the money created by quantitative easing has led to inflation in the financial markets rather than consumer markets.

Economists generally understand how fractional reserve banking works to increase the money supply but I am not aware of anyone who has thought out the opposite process.  Money that can be created out of thin air can just as easily disappear into thin air.

In fractional reserve banking banks are required to keep a portion of their deposits as reserves for protection against runs. The rest is loaned out and redeposited with the new deposits subject to the same fractional reserve.  The result is that a large proportion of our money supply is  somewhat precarious.  This blogger and many other people on the internet have explained the process.  Just search “fractional reserve banking.”

Central banks can add money to the system by purchasing financial instruments or by changing the reserve requirements.  The could also reduce the money supply by selling financial instruments or by changing the money supply although it is unlikely they will do either under current conditions.

Another way the money supply could be reduced is if the banks suffer large losses.  Any loans the banks have to write off will directly decrease their available reserves.  (The technical term is high powered money.)  This means they will have to decrease their outstanding loans with the same multiplier effect as the money supply was increased.  We will hear about it as a contraction of credit.

So if the banks experience unusually large losses there could be a drastic decrease in the money supply which could have dire consequences.  ( I have read that a number of Canadian and British banks are highly exposed to the energy industry with unsecured loans.)

If a large part of the money supply were to disappear into thin air in the short term a lot of economic activity would come to a screeching halt.  People have in the past used playing cards or candies as a substitute for money.  In the long term the level of activity would depend upon the physical resources available.

People who talk up monetary reform often want a return to a gold standard or facsimile (bit coin).  It is not clear that either of these would correct the problems inherent in the fractional reserve way of creating money.  Nor would they provide the flexibility that is needed in the total amount of money available.

We all think we know everything there is to know about money.  That is a part of what our parents teach us. However, it is a complex subject which few people understand and there are a lot of unknowns, especially if we have to deal with an extended period of low or negative growth.

The gold standard, printing money and getting the right amount

A return to the gold standard and the printing of money to provide a social dividend have recently been suggested on LinkedIn and Reddit as ways to deal with the economic crisis.  The gold standard and the printing of money have been both tried with disastrous results.  To the best of my knowledge the social dividend has not been tried but I see it as a guaranteed annual income and I believe it has a lot of potential – subject to paying attention to the amount of money in the economy.

The problem  with the gold standard is that it can cause recession because it limits the amount of money to facilitate the exchange of goods and services.  The problem with printing money is that it can lead to inflation which wipes out people’s savings.

The key to financial economic nirvana is to have just the right amount of money for the quantity of goods and services a society wants to exchange.  Too much money leads to inflation and too little money leads to deflation and a curtailment of economic activity.   The amount of money needs to be flexible to follow the ups and downs of economic activity.

At several times during their history Americans have tried to follow a gold standard.  Generally the result was depression.  In the 1930s the monetary authorities tried to restrict the amount of money in circulation and the result was depression.  The exception was during the gold rushes of the late 19th century when the newly discovered gold allowed the money supply to increase along with economic growth.

Following the first world war the German Weimar republic had lots of financial obligations.  As the external obligations were requiring gold the government met its internal obligations by printing money.  As the money was printed faster than economic activity increased that country experienced inflation which became hyperinflation.  The result was that the savings of most people became worthless.

The social dividend proposal was a feature of Social Credit which had its origins in England in the 1920s and prospered in Alberta and British Columbia.  At least in British Columbia the social dividend was forgotten and the party became a right of centre business coalition.

To the best of my knowledge the social dividend has not been tried.  I think it should be so long as the amount of money in the economy is close to the amount needed.

Money is something we all use and we teach our children at an early age how to manage their money.  However,  very few people understand the economics of money and especially how money is created. I believe that if we are to resolve economic problems we have to understand the economics of money and banking.  The essay “LETS go to market: Dealing with the economic crisis”  talks about how money is created, some of the problems with fractional reserve money which we currently use and proposes an alternative way of creating money based on Local Exchange Trading Systems.  Also a number of posts on this weblog have dealt with money.  Here they are.

Money is a highly emotional issue in part because our culture has raised us to believe that our future depends upon our having adequate savings.  As it is so important one would think people would be wanting to understand it and be prepared to consider reforms as there are such emotional costs to losing it.

I believe the fractional reserve way of creating money is a Ponzi scheme and has built into it a mechanism for forcing a continuous increase in the money supply regardless of increases or decreases in economic activity.  As a part of money creation reform we should look at incorporating a social dividend or universal income scheme.

However the money process is reformed an essential feature is that the money supply should be flexible up and down according to changes in the level of economic growth or degrowth.

The quantity theory of money and transforming economists into fairy godmothers

It could be that the quantity theory of money is controversial and often dismissed because it deals with two aspects of economics where we most want to deceive ourselves – money and economic growth.

When I  started to research and think about this post I quickly got so ticked off that I went downstairs to my lathe to transform a piece of firewood into a magic wand for one of my grandchildren.  (Abracadabra.  All economists will become fairy godmothers – in their next reincarnations.)

The theory states that MV=PQ  where M is the money supply, V is the velocity at which the money changes hands,  P is the price level and Q is the quantity of goods and services exchanged.  What gets me ticked off is that this is frequently taken to mean there is a direct, proportional relationship between the money supply and the inflation rate or price level.   Can’t people see there are four variables in this formula?

The value in this formula is in that it explains relationships and shows how the real or physical side of the economy connects to the financial.  It is difficult because there are problems with fractional reserve money and because some people believe (or need to believe) that economic growth will always continue.  I think these are two aspects of economics where some people have psychological problems accepting the truth.    It becomes even more difficult if one tries to use this formula in a computer model as the four variables are difficult if not impossible to measure.

To maintain the equality, if one variable goes up then one or more of the other variables must also change,  For example, if the money supply increases then velocity must go down and/or one or both of the price level or the quantity of goods and services produced must go up.  It could be that during  recent decades the money supply was increasing faster than Q was increasing. We saw the difference as inflation.

The way we create money is a  major problem.

The fractional reserve creation of money works only so long as more and more money is being created.  Bankers create money by making loans. The problem is the interest.  If all loans plus interest had to be repaid at one time there would not be enough money in the system.. This is similar to a Ponze scheme and works only so long as more and more money can be created.

This means there is constant upwards pressure on the M in the formula – until the money creation breaks down and the M goes down suddenly and either prices fall or the quantity of goods and services produced goes down or both.  When the United States was trying to stick to a gold standard there were frequent economic crises because there was not always enough gold to support the amount of economic activity for which there were human and material resources.  The gold discoveries of the 19th century contributed to prosperity because they added to the money supply.

The big problem on the other side of the equation is Q.  A lot of people believe or assume economic growth will continue forever.  I figure Q behaves as a fractal, that is with ups and downs and ups and downs within each up and down – something like the seashore.

Some of the things which drive Q are not likely to be steady.  Discoveries of energy and mineral resources are erratic;  agricultural  production can vary with the weather; and new technology comes in spurts.  I think Q is currently being restrained because we have used up the most easily accessible energy and mineral resources.  We have picked the low-hanging fruit and what is left is going to take a lot of energy to get.

As Q is a fractal its changes in direction are likely to throw the equation out of balance and force one or more of the other variables to adjust.

Prices appear to respond mostly to changes in M or Q.  Sometimes governments decide to try to control inflation with price controls. and this usually causes problems with the balance of the equation.  Inflation is to the advantage of borrowers and deflation is to the advantage of lenders.  To be fair to everyone we need price stability.   As governments are large borrowers it is natural for people concerned with government finances to favor inflation.  Probably the best way to price stability would be to find another way of creating money so that the total is flexible.  Then the money supply rather than prices could respond to changes in the quantity of goods and services produced.

To the best of my knowledge not much is known about velocity.  I understand that in the days of the gold standard people would hoard gold if they were worried about other forms of money.

To call the formula MV+PQ the quantity theory of money is probably a little misleading. It would be better to think of it as the connectivity formula.  As such I believe it is very valuable in understanding what is happening to the economy.

Perhaps if we had more fairy godmothers we would have  a better understanding of what is happening to us.

 

If you liked this post your are invited to comment, press the like button and/or click  one of the share buttons. If you disagree you are invited to say why in a comment.  While I like the idea of sharing this platform, my personality is such that I don’t reply to many comments.

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.

An alien invasion or the consequences of stimulus

With austerity seemingly not working to resolve economic problems and the apparent success of Abenomics and recent announcements that there may be thousands of earth like planets,  it may be time to have a second look at Paul Krugman’s proposal for governments to start preparing for an alien invasion from outer space. On second thought,  the consequences of launching into a major stimulus program may be worse than the slim chance of an invasion.

As there are two sides to the economy, financial and real,  we should look at both of them.

On the real or physical side we need to look at two things – resources and labor reducing technology as the goal of stimulus would be economic growth and full employment.

For there to be economic growth there will need to be an increase in the quantity of goods and services we produce.  The limit on services may not  be clear but regardless of the service economy we all need physical things to survive.    The production of more goods will require more mineral and energy resources and that could be a problem.  There are lots of resources left in the earth’s crust but we have used up the most accessible and those that are left are difficult and require a lot of energy to extract.  That could be a limit on further economic growth.

So what would be the consequences of attempted stimulus on the resource base?  Probably more energy would be required leaving less for other things and probably we would bring forward the timing of a major economic collapse.

Another limit on full employment is labor reducing technology of which we use a lot.  Here I see two questions:  How is the freed up time to be used and who is to make that decision.  Personally I enjoy reading, thinking and writing this weblog and I enjoy wood turning.   I don’t want Paul Krugman telling me and others that we have to spend a lot of time preparing for an alien invasion.   We now have the technology that most people don’t need to spend most of their lives “working”.  I would like to see some sort of universal income scheme which would allow individuals to decide what they want to do with their time.

On the financial side of the economy stimulus means two potential problems – inflation or a financial crash.  A government stimulus program would be trying to increase the production of goods and services.  With limited potential for growth this would put upward pressure on prices.  With all the excess money supply which central banks have been pushing into the economy I wouldn’t want to rule out hyperinflation.

The other potential financial problem is another crash within the banking system.  The way we create money is a Ponzi scheme which has to crash from time to time.  If inflation doesn’t get us a crash will.

I fear that Krugman was only half-joking.  He wants governments to undertake a massive stimulus program and I fear that could bring forward a major economic collapse.

Austerity appears not to be working either and it is causing problems for lots of people, especially the young.  The challenge then is to find a third way and at this point I must refer you to the essay “LETS go to market: Dealing with the economic crisis” on this weblog.

Oh, oh.  Did I just see an armed flying saucer go by my window?

Which is more likely – deflation or inflation?

Conventional economic wisdom, as illustrated by the cover of last week’s The Economist, says deflation is a major threat.  However, this blogger, ever the contrarian,  figures inflation, perhaps even hyperinflation, is a more likely threat.

 The idea that deflation is a threat appears to be  based on the concept of inflationary expectations and the desire by those who make decisions on behalf of he government to maintain mild inflation to help deal with government debt.

That high inflation is a threat is based on the formula MV=PQ, known as the quantity theory of money although I prefer to call it the connectivity formula as it connects the financial and real sides of the economy.

 The case for deflation is made in the November 9, 2013 issue of The Economist. (http://www.economist.com/printedition/2013-11-09)

The above formula tells us that the money supply times the velocity at which it changes hands is equal to prices, or a price index, times the quantity of goods and services produced.  It is not clear everybody accepts this formula but I think it contains a lot of truth.  If one of the four variables changes then to maintain the equality one or more of the others also has to change.  For example if the quantity of goods and services goes up then the money supply also needs to go up.  If the increase in money supply exceeds the increase goods and services, then velocity must go down or prices must go up.  Through recent decades prices have gone up and we have had inflation.

 The  current economic crisis is probably mostly a crisis in Q.  While there are still a lot of mineral and energy resources in the earth’s crust we have extracted the most easily accessible.  What is left is difficult to extract and requires a lot of energy.  In the past economic growth has covered a multitude of economic sins.  It is not clear that the economy will be able to return to the type of growth we have experienced since the start of the industrial revolution.

 During the depression of the 1930s the monetary authorities deliberately restricted the money supply (a reduction in M) and this led to a reduction in Q, a recession and a number of financial institutions failed.  This time they are not going to make the same mistake and have been trying to increase the money supply calling it quantitative easing. Large amounts of money have been pumped into the economy.  Consumer prices have not increased and it is tempting to say the formula is not valid.   It could be that velocity has fallen (there are complaints that corporations are sitting on piles of cash) and that price increases have been in paper financial instruments.

 We should note that Wikipedia gives four major examples of deflation in American history and all of them involve contractions in the money supply.  Maybe the formula holds.

 If the formula is correct and with all the excess money floating around the economy, then there is quite a bit of  potential for something unpleasant to happen.   If not high inflation, then a financial crisis in which the money supply is reduced.  In either case the paper used for those financial instruments might have been more useful as firewood.

 Inflation is complicated by the fractional reserve creation of money.  As can be seen from the formula the money supply needs to flexible up or down according to variations in the quantity of goods and services produced.  But our money supply is created when banks make loans upon which interest is charged. Rather than flexibility there is pressure for the money supply to increase continuously.  The result is a Ponzi scheme which collapses from time to time.  Oops, here comes another financial crisis.

 The goal should be price stability or a zero inflation rate.  As loans are in nominal terms when prices go up people who have borrowed benefit at the expense of those who have loaned the money.  If you are a lender, the higher the inflation rate, the more purchasing power you lose.  Deflation works the opposite way, in that a borrower has to repay more purchasing power.  As governments are major borrowers it is hardly surprising that those who set economic policy are anxious for moderate inflation.  Inflation is a tax if not theft.

 Those  charged with setting government economic policy fear that low inflation could easily slip into deflation.  That would  make repaying government debt more difficult and in the past deflation has been associated severe recession.  The difference this time is that there is lots of money available to facilitate the exchange of goods and services.  Hyperinflation would wipe out a lot of savings, fortunes and pensions.

 Whatever happens it looks as if there is a lot of potential for increasing economic chaos.

Government debt default and the money supply

A United States debt default will hit the economy as a reduction of government spending and it could also  hurt by forcing changes in the money supply.

The first thing to say about debt is that there is so much of it around the world that there is a high probability most of it will be written off either by defaults of inflation.  This debt is not so much borrowing from children as a transfer of purchasing power within this generation, some/most of which will never be returned. And those with the most are likely to lose the most but will still probably be more comfortable than the rest of us.

The second thing to say is that the probable root  cause of the economic crisis is in the real side of the economy as well as the financial sector.  We have used up most of the easily accessible energy and mineral resources and those that are left take a lot more work to extract.

If the United States defaults  some of its debt the government will have less money to spend.  As government spending is a component of gross domestic product there will be a reduction in economic activity.  Government spending currently makes up about 20 percent of GDP but only a small part of this will likely be cut immediately.

The effect of a debt default on the money supply is more complex and uncertain.  A drastic reduction in the money supply would bring a lot of economic activity to a halt.

Money is based on loans issued by the banks, involves fractional reserves (they are required to keep a percentage of deposits as reserves)  and dependant upon what is called high powered money which is subject to a multiplier because of the fractional reserves. (for and explanation of how money is created see these links, one, two.)  In a default one issue would be how much the losses fall upon institutions subject to fractional reserves because losses would reduce their reserves.  A reduction in their reserves would bring down the quantity of loans they could make – by a multiplier.  Thus the money supply in the economy would be reduced and without money the exchange of goods and services becomes difficult.

Under normal circumstances a reduction in the money supply would mean a reduction in the real economy.  But the real economy is already in trouble as noted above.

At this point I need to remind you of the formula MV=PQ.  The money supply times its velocity or the rate at which it changes hands is equal to prices or a price index times the quantity of goods and services.

In an attempt to stimulate the economy central banks have been using “quantitative easing” to inject more high powered money into the financial system so the banks will have more money to lend.   If the above formula is correct then there should have been a reduction in velocity or an increase in prices (inflation) or economic activity.  It may be that velocity has fallen but there is little evidence that inflation or GDP has increased.

If the formula is correct then something has to have happened to one of the other variables.   One possibility is that at least some of this extra money has gone into the financial markets and inflation has hit stocks.  If this is correct, then a reduction in money supply could hit the financial sector.

So there you have it a U.S. default would probably lead to a reduction in economic activity and it could also cause problems in the financial markets.  I just had a horrible thought.  What would happen if a lot of the major countries were to default at the same time?

Immigration to solve economic problems?

One has to challenge the idea that rich countries need immigration to improve public finances and to meet the needs of an aging population.  This argument surfaces from time to time in Canada and is now being promoted by the UK’s Office of Budget Responsibility.  The problem is that some people make two major mistakes in economic analysis.  They analyze economic problems in financial terms and they assume economic growth will continue forever.

jetxee_people_near_a_blackboardWhen my economics professors stood at the blackboards they often drew an x-shaped graph.  For the macro economists one line represented the financial aspect of the economy and the other the real or physical aspect.  It is an important distinction and one that is forgotten when we get away from the blackboard.  Ultimately the economy depends upon the resources we use to look after ourselves.  To analyse the economy we need to be aware of what agricultural, energy and mineral resources we have with which to work.

We have problems using financial terms because of the way in which we create money.  It is a sort of Ponzi scheme which collapses from time to time.  Also the purchasing power of any sum of money varies because of inflation or deflation.  Thus it is difficult to use financial terms to evaluate what is happening on the real side of the economy.

Another problem with claims we need immigration to pay our bills is the assumption that economic growth will continue forever and that population drives economic growth.

It is certainly a big mistake to assume economic growth can continue forever.  We have used the most easily accessible agricultural,  energy and mineral resources and it takes more energy to retrieve those remaining.  We see this in increasing prices. (Marginal cost to use the economics term).  As more energy is needed to retrieve the same quantity of resources, the potential for economic growth goes down.

If population were a driver of economies, why aren’t India, China and Africa the richest parts of the world?

Immigration is a difficult issue because it often involves humanitarian and racist issues.  There may be humanitarian reasons for encouraging immigration, but this weblog focuses on economics and it is not clear we should see immigration as a solution to current economic problems.  It could be that immigration will put additional stress on economic resources and make problems worse.

Pensions or a cruise?

A columnist for The Economist says people should ensure their pensions are adequate before they think of a world cruise.  I think the world cruise should come as soon as possible and worry about the gas bill later.

It could be that we have conflicting conflicts of interest in these recommendations.  One of my stepsons and his wife are entertainers on a cruise ship and the columnist probably has friends in the investment industry and gets some of his income from advertising and subscriptions from the industry.  You can read the column here.

Retirement is important for a lot of people.  A few years ago it was fashionable to plan for retirement at the age of 40 or 50.  Now that columnist is suggesting people may have to work beyond normal retirement age in order to have the lifestyle they desire.

Retirement planning is easy when the economy is growing and everyone believes that growth will continue.  But when growth ends all those plans and savings are likely to fall apart.  There are three things that can happen to savings and retirement funds:  inflation can wipe out their value, firms can fail or governments can decide to give haircuts.  It is not clear that there will soon be a return to economic growth.  Given the current economic uncertainty, any one of these could happen at any time.

The columnist suggested that inflation-linked government bonds  “should be the building blocks  of a pension portfolio.”  This ignores that most governments are carrying more debt than they will ever be able to repay.  When the Ponzi scheme explodes a lot of people will find their dreams destroyed.

In the meantime, those in the investment industry are doing short-term well out of all those people worried about their retirement income.

So far the economic crisis has mostly hurt young people.  If or when it hits older people and they can no longer afford cruises the cruise industry will have a surplus of ships.  They may then have lots of work for an Italian cruise captain with some experience at decommissioning ships.  I encourage people to take a cruise before he gets called back to work.

Here’s a Irving Berlin/Fred Astaire song from 1936: “Let’s face the music and dance”  or cruise.

The morality of austerity and inflation

Somebody on LinkedIn has asked if austerity is a morality issue.

Of  course austerity is a morality issue but so is inflation.

Austerity is a moral issue because it inflicts unemployment and hardship on some people.  Inflation is a moral issue because it is a form of theft in that it reduces  the purchasing power of savings and pensions.  The opposite to austerity is government stimulus spending but it is not clear we can have stimulus without inflation.

So the challenge is to design a way of exchanging goods and services and a money system to facilitate that exchange such that there is no inflation or deflation.  To do this we will have to first challenge all sorts of motherhood issues with regard to money, work and economics.

 

If you liked this post your are invited to comment, press the like button and/or click  one of the share buttons. If you disagree you are invited to say why in a comment.  While I like the idea of sharing this platform, my personality is such that I don’t reply to many comments.

Bitcoins, gold and pyrite

Bitcoins and gold may have some speculative value but as a solution to economic problems or as a form of money they are on a par with pyrite

As I understand bitcoins their main feature is that the supply of them is intended to be finite.  This will make them great for speculators but as a form of money they come with the same problem as gold and that is that the amount of money in an economy needs to be flexible.  Through history there have been a number of situations where authorities have tried to limit the money, sometimes by trying to force a gold standard, and the result has been serious depression.  I wonder if bitcoins were invented in part because gold is in limited supply.

circleBitcoinProbably the increasing interest in  bitcoins is a psychological reaction to economic uncertainty and fears of hyperinflation which would wipe out the savings and pensions of a lot of people.  Given that the economic crisis is based on problems in the resource base gold and bitcoins may not be useful.  A better hedge would be a market garden.

Another feature of bitcoins is that they can be used online anonymously .  This makes them great for illegal transactions.   No wonder some regulators are saying bitcoins should come under their jurisdiction.

So far as I can see the main use of bitcoins is for speculation.

A Chicago plan for reforming banks

This week I came across a couple of articles about the Chicago  Plan for reforming banks and I like it because it proposes changing the way in which we create money and gets rid of the evils of fractional reserve money.

This plan was proposed in the 1930s by some economists from  Chicago and suggests banks be reorganized into two separate identities.  One type of bank would only accept deposits which would be kept 100 per cent with a central bank.  This type of bank would probably have to charge fees for looking after the deposits but they would be safe (except from inflation which would probably be less of a problem – or haircuts.)  No more fear of bank runs.

bankThe second type of bank would be a financial intermediary in that it would make loans based on 100 per cent equity deposits of its customers.  As all deposits would be equity, customers would know there are risks of a loan not being repaid.

As most, if not all,  bankers would see immediately, this would be the end of outrageous Wall Street profits.  Under the current system bankers make huge profits by taking for themselves  the premiums from risky loans but when the risk becomes reality somebody else takes the losses because the money creation feature of banks makes them too important to fail.  People putting money into a loan making business would know the risks and expect the returns to compensate.  The end of fractional reserve money creation would also do away with the leverage which allows bankers the profits from creating money on which they charge interest.

According to the Chicago Plan governments would create the money supply at zero interest.  This would be good in that interest charges would not be built into money creation thereby  reducing the potential for inflation.       My concern is that governments make decisions for political rather than economic reasons.  To me a national LETS (local exchange trading system)  would be preferable way to create money because the amount of money in use would depend upon the collective decisions of individuals.  For the sake of price  stability it is essential that the money supply should be flexible up and down.

When I wrote my essay “LETS go to market: Dealing with the economic crisis” I didn’t put a lot of thought into how to organize banking with a national LETS money system.  I didn’t know it then but the creators of the Chicago plan had already done that.

Why stimulus spending is a bad idea

Sadly, stimulus spending as an economic cure may make things even worse than they are.   It probably will not provide the results its promoters want although it will likely lead to a more egalitarian but poorer economy because there is a possibility it would lead to some heavy-duty inflation.

The ideal way to deal with the economic crisis requires  a major change in economic thinking and values starting with the way in which money is created.  Some ideas are in my essay “LETS go to market: dealing with the economic crisis.”  Of course this is not a realistic proposal. Its implementation would require a dictator with a strong and loyal military and this is contrary to my belief that decision-making should be made by individuals.

chovynz_Money_Bag_IconThat leaves austerity or stimulus.

The basic problem is that we have used up a big chunk of the easily accessible resource base.  There may be lots of energy and minerals left in  the surface  of the planet but they are so difficult and expensive to extract we cannot expect continued economic growth.

If this is a correct analysis then austerity will be forced upon us regardless of what we do.  The real challenge is to cope with austerity with a minimum of human suffering.   The problem with austerity as it is being promoted is the selfishness and meanness of those promoting it on the backs of people who are less fortunate.

But what about stimulus?  At least since Keynes, many economists have and continue to believe the way to get economic growth going is via government stimulus.

There is some evidence the depression of the 1930s was made worse because the banking authorities restricted the amount of money in the economy.   Once governments started spending (works and war) and the money supply was allowed to increase the depression came to an end.  This time  central  banks have been trying to stimulate the economy by creating more money to facilitate more economic activity.  It isn’t working  because the resource base won’t support more economic growth  although only a few people see that as the reason.

So what is likely to happen if the Keynesians get a turn at trying to solve the crisis.

There are two difficulties.

The first is that stimulus will be a transfer of purchasing power from those who now have it to others because the debts incurred will eventually be written off either by default or by inflation.  Cyprus isn’t the only country whose savers are likely to be hit.

The puzzle is why with all the quantitative easing and no matching growth in output we haven’t had inflation.  The answer:  there is anecdotal evidence that the banks and corporations are sitting on piles of cash presumably because they don’t  see profit opportunities.

Governments don’t worry about profits so if the money goes instead to governments for stimulus, it will be spent.  There will be more money chasing the same quantities of goods and services and prices are bound to go up.    Inflation provides an indiscriminate haircut to everyone with monetary savings or investments.  If it gets out of control a lot of people will lose their pensions or their fortunes.  It will solve the inequality about which many people have been worrying.  It would also be a neat revenge against those people who want austerity on the backs of poor people although a lot of innocent people would be hurt.

The second problem with stimulus is that if it succeeds in increasing the output of goods and services it will also use up more of the remaining mineral and energy resources and bring forward the timing of a major crash of civilization.  I would like the goal of economic policy to be to minimize overall  human suffering rather than to increase it.

I am not worried about an economic collapse for my own sake, but I do have six young grandchildren.   Perhaps we should post a job opening for a benevolent dictator.

Why stimulus is not working

At least since Keynes conventional economic wisdom has been that the cure for an economic depression is government stimulus spending – even if it means increasing the government debt.  Recently, some people, especially  those who will lose their savings from inflation or if debt has to be written off, have been fighting plans for stimulus spending.

There are other reasons to be leery of stimulus spending.  It isn’t working and it could bring forward an even more serious economic collapse.

To explain this we have to go to the blackboard of an economics classroom where the professor draws an x-shaped graph.  One line represents the financial side of the economy and the other line represents the physical aspect.  The problem is that we measure the physical side in financial terms and tend to forget this distinction as soon as we get away from the blackboard.

polettix_stone_age_wheel_1For stimulus to work there has to be adequate energy and mineral resources to support the increased economic activity.  When Roosevelt implemented the New Deal and when we undertook the Second World War there were still loads of resources.  Now we have used up the most easily accessible energy and minerals.   What’s left requires a lot more work and energy to extract.  Putting more energy into extracting resources is taking away from the standard of living most of us want.

The other problem with stimulus spending is that it will use up even more of the existing resources and make the economic crisis even worse.

If stimulus is going to make things worse, what do we do?  After all people are suffering from the crisis. I think the answer is to drop our commitment to economic growth and the consumer society.  The economic task should be to see that everyone has adequate food, shelter. clothing,  hobbies and entertainment.  It is important to be able to communicate but I’m not certain it is necessary for everyone to have a micro cell phone.

%d bloggers like this: