Hiding from the economic crisis

Why are interest rates so low?  It’s a question which has apparently been occupying a couple of North America’s top economists but this blogger sees the discussion as a screen hiding some very important economic issues.such as the root cause of the economic crisis and values which will guide us in trying to  find a solution.

On the surface the answer is simple.  Interest rates are the price of money and are determined by supply and demand.  They are low  because that is where the two balance.  They appear low because we are used to high returns on our investments and are reluctant to give them up.  There is no reason why interest rates could not be zero and maybe they should be.

To understand the root cause of the economic crisis we need to go into a macro economics classroom and watch the lecturer draw his basic diagram on the blackboard.  It is in the shape of an”x” with one side representing the financial side of the economy and the other the real or physical side.   This is important.  As we measure the physical part of the economy in financial terms it is easy to forget the distinction and analyze economic problems only in financial terms.  We need to ask what is happening to the physical side of the economy because it could be that is where the problem is.

This blogger figures the problem is with the resource base.  There are lots of energy and mineral resources left on this planet but we have exploited the most easily accessible.   Those that are left take a lot of time and energy to extract and this is causing a lot of economic problems.  It could even force us into negative growth.  This is a much more serious problem than why interest rates are low.  It is also an extremely difficult problem because it challenges some deeply held beliefs and values.  It’s a lot easier to talk about why interest rates are low.

Some ideas about how to fix the economy are included in the essay “LETS go to market: Dealing with the economic crisis” on this weblog.  A major feature of that essay is a proposal to change the way in which we create  money.

The emotions surrounding money make it a such a difficult subject that few people understand the economics of money and banking. This is unfortunate as money is so essential to how we exchange goods and services.  I encourage you to take a look at the essay.

While I prefer to see low interest rates as a symptom rather than the problem here are  some observations.

Money should be considered a tool to facilitate exchange rather than as a commodity with a value of its own As the quantity of goods and services we want to exchange varies up and down  so does the amount of money supply we need,  If there is too much money there will be inflation and if there is too little money there will be deflation.   Some people believe there should be mild inflation but this reduces the value of savings and should be  considered theft.

Quantitative easing has been an attempt to stimulate economic activity by increasing the money supply.  It has resulted in a rising stock market but has done little for the real economy.  That has to be a sign of a serious problem which has not been identified.

The way in which we create money, known as fractional reserve banking, is a heavy-duty problem because it is based on loans on which interest must be paid.  If all debts had to be repaid at one time there would not be enough money in the economy.  It is a Ponzi scheme on a grand scale and it is no wonder we experience frequent financial crisis.  For more on this topic see these previous posts on this weblog.

I believe we are facing a serious economic problem in that it is not clear there can  be a return to economic growth.  Dealing with this will require some major changes in our way of life.  It is disappointing that two of our most well-known economists are protecting us from having to deal with this with a frivolous argument. It’s as if they are playing in the turkey poo on animal farm and producing gobbledygook.

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.

What will be left for our grandchildren?

Should we feel sorry for our grandchildren who will have to repay the massive debts we have been building up?  Probably not but we should feel sorry for our grandchildren who will have to survive on mineral and energy resources which are difficult to extract.

Debts can suffer fatalities from three causes: bankruptcy, inflation or government haircuts.  Considering current economic conditions  there is some possibility the current debt load will be written off before our grandchildren even understand the word.  If and when this happens there will be considerable  economic turmoil.

I believe economies should be analysed first and mostly in physical terms rather than money terms.  This way we can see some underlying trends and problems which can easily be hidden behind financial terms.

Currently we are probably dealing with problems in both sides of the economy.  We have used up the most easily accessible energy and mineral resources and the marginal cost of accessing what is left is going up.  At the same time the fraction reserve way of creating money in which interest is charged on the money supply is a Ponzi scheme which frequently breaks down.  Financial crises have long been a  feature of our economy.

If one analyses the economy only in phyiscal terms we are not living beyond our means as we produce everything we consume.  In this respect there can be no borrowing from the future.  What we are doing is using resources which won’t be available to our grandchildren at a reasonable cost.

A major financial collapse will have a devastating effect on our exchange of goods and services.  It is quite likely our grandchildren will have to pick up the pieces from a financial collapse.  What is more certain is that they will have to cope with our having used up the most easily accessibe energy and mineral resources.  There will be lots left for them but these resources will require a lot of energy to extract.  That will be enough of a burden to impose upon them.

 

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.

A universal income scheme

I believe we should have a collective responsibility to ensure everyone has the opportunity for a standard of living similar to most others.  I also believe our technology is such that everyone should not have to work throughout their lives, that subsidies should be given to consumers rather than producers, and that there is a need to change the way in which we create money.

I have been asked by a member of LinkedIn to elaborate on the collective responsibility.  The other things are important to the answer.

In some small-scale societies the collective responsibility takes the form of a sharing economy where people share their food and other production with relatives, clan members or anyone who needs it.  We probably need something a little more formal and impersonal.  One way would be a universal income scheme.  Milton Friedman proposed a negative income tax which is a good place to start a discussion.

The key to our high-tech society is the number of people for whom each agricultural worker can produce enough food.   That is clearly somewhat high which means the rest of us can be doing other things.  Sometimes it seems what most of us do is to work  to keep the military-industrial complex going.

Subsidies to producers distort prices and interfere with the efficiency of the economy.  Therefore subsidies should be given to consumers.  A universal income scheme would be a fair way to do this.  I see this as being good for the environment and as a transfer of decision-making from government and bankers  to individuals.

I believe the most funny of all money creation schemes is the fractional reserve banking system.  Interest is charged on the money created, bankers are very powerful and too important to let fail, and it is all a Ponzi scheme.  One alternative could be to take  the concept of the Local Exchange Trading System (LETS) and expand it into a National Exchange Trading System (NETS)  It would probably be feasible to include a national income scheme into this type of money creation.

With the world economy in trouble and with so many indications the slide will continue for some time more and more people, through no fault of their own, are going to find themselves unemployed and without an income.  Thus it gets more and more important for us to live up to our collective responsibility to ensure everyone has the opportunity for the same standard of living as everyone else.

Some of the ideas in this post are included in the essay “LETS go to market: Dealing with the economic crisis” on this weblog.

The gold standard, money and stability

Thanks to a Republican senator and the dynamics of that party we are hearing calls for a return to the monetary gold standard.

I see this as a reaction to economic events most people don’t understand and the fact even fewer understand how money works in the economy.  We look for explanations which relieve ourselves of responsiblity.  Therefore the economic crisis is the fault of former president Nixon who took the United States off the gold standard in August 1971.

In these uncertain economic times we are looking for stability and what can be more stable and solid than gold.   Never mind that since 1971 there have been major fluctuations in the price of gold and there were economic problems before then.  Going back onto the gold standard in search of stability would probably introduce even more instability into the economy.

We start this analysis with the formula

MV=PQ
where:

M= the money supply
V= the velcoity at which money changes hands
P= the price level
Q= the total of goods and services produced in the economy.

Some people doubt the validity of this formula but to me it appears to have a lot of logic and common sense.  It is an important tool for understanding the the financial world connects with the physical economy.   The important thing is that if any one item goes up or down then something else also has to change.

Probably most of the people who want a return to the gold standard are concerned about inflation which treatens to wipe out their savings.

If we were to go back onto the gold standard that would in effect be trying to hold M steady.

Thus if the Q were to go up or down then either the V or the P would have to go up or down.  It it would most likely be the P then we would have inflation or deflation when what we really want is price stability.  Going back to the gold standard would probably increase instability.

But the gold standard people are right to focus on changes in the M in the equation.  The thing is that for there to be price stability the M has to be easily variable and that takes us to my favorite topic – how we create money.

Let’s not go into that now.  Let’s just say that the way we create money is a Ponzi scheme which works only when there is economic growth, an increasing M, and that my essay “LETS go to market: dealing with the economic crisis” proposes another way of creating money which would be easily variable.

 

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 Ponzi scheme of creating money

The first time I used “Ponzi scheme” to describe the fractional reserve process of creating money I feared I was skating on thin ice. It’s a rather strong term with which to describe a process which most of the people who don’t understand how it works (and those who do) consider to be motherhood.  However, it has in the past (the depression of the 1930s)and almost certainly will in the future cause a great deal of human suffering.

Therefore it was with some relief that I discovered that Richard Heinberg says the same thing in his book The End of Growth: Adapting to Our New Economic Reality (P. 33)

I like his way of explaining the problem.  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.

The system works only so long as there is continued economic growth and a continuously increasing supply of money which means more and more debt.  The problems come when economic growth slows or stops and some of that debt has to be reduced.  As there is not enough money to repay it the purchasing power of the debt is reduced  by  the failure of financial institutions or the drop in prices of assets such as housing.  (The purchasing power of money can also be lost to inflation.)

Heinberg sees a need for a new way to create money and directs our attention to  local currencies such as a Local Exchange Trading System. (LETS).  That too made me feel good as my own proposal for money is to expand the LETS into a National Exchange Trading System.  For more on this and an explanation of fractional reserve banking see my essay “LETS go to market: Dealing with the Economic Crisis” on this web log.

A credit/money bubble and the financial crisis

The Buttonwood column in this week’s Economist discussed a book by Richard Duncan which proposes a quantity theory of credit and suggests the current financial crisis results from the collapse of a credit bubble

That Mr. Duncan would talk of a “credit bubble that would end in collapse” is surely a step towards understanding financial crises.

I am not sure there should be a distinction between credit and money because money is created when bankers make loans. As there is a fractional reserve system involved the bulk of our money supply is credit.  Thus the quantity theory of money and the quantity theory of credit are basically the same thing.

We could just as easily say the money bubble ended in collapse.

A further complication is that all this credit/money involves interest charged on those loans.

I am not aware of any economist who has tried to think out the implications of charging interest on the loans that make up the money supply but I suspect it is a big problem.  It seems to be something like a Ponzi scheme and Ponzi schemes eventually collapse.

A more detailed look the problems of money creation  is a part of the essay “LETS go to market: Dealing with the economic  crisis” on this weblog.

 

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 European and world-wide economic crisis

Probably the best (and politically impossible) way to deal with the European and the world-wide economic crisis would be to write off all debt and start over with a new way of creating money – one that is not based on debt.  There is so much debt now that it is hard to see that it can ever be repaid.

If there is any such thing as funny money it has to be the money we now use which is based on fractional reserves and debt.  Throw in the interest which is charged on the debt-money and we have a ponzi scheme.  So long as there is steady economic growth it sort of works but as soon as there is an economic slowdown or decline it crashes.

I have tried to explain how money is currently created and some of the problems in an essay “LETS go to market: Dealing with the economic crisis” posted on this  weblog.  I also propose an alternative way of creating money based on the Local Exchange Trading Systems currently being used in several locations around the world.

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