Readers ask me from time to time to recommend a book from which they can learn about economics.
The problem with reading a book to learn economics that is taught in the universities and practiced in Washington is that economics is now a highly formalized subject based on abstract models and assumptions and has been mathematized. It is not that the subject is totally useless and without any applicability to real world problems. Rather, the problem is that the discipline both lags an ever-changing world and got some things wrong at the beginning. Consequently, learning economics places one inside a box where some of the tools and understanding provided are outdated and incorrect.
For example, every textbook will draw a picture of agriculture as the perfect example of competitive markets in which “no producer’s output is large enough to affect price.” This made sense when one-third of the US work force was on family farms. Today, American agriculture is dominated by corporations and agribusiness. Additionally, part of the disastrous financial deregulation pushed by no-think economists and special interests was the removal of position limits on speculators. Formerly, speculators smoothed agricultural and commodity markets b y buying and selling in order to stabilize price over periods when supply and demand were out of balance. Now speculators can dominate markets and rig prices to the benefit of their profits.
There are many such examples where economics no longer speaks to the real world.
Two other examples will suffice:
Most intelligent people are aware that natural resources are finite, including the environment’s ability to absorb the wastes or pollution from productive activities (see for example, Jared Diamond, Collapse, 2005). But few economists are aware, because economists assume that man-made capital is a perfect substitute for nature’s capital. This assumption implies that there are no finite environmental limits to infinite economic growth. Lost in such a make-believe world, economists neglect the full cost of production and cannot tell if the value of the increases in GDP are greater or less than the full cost of producing it.
Economists have almost universally confused jobs offshoring with free trade. Economists have even managed to produce “studies” purporting to show that a domestic economy is benefitted by being turned into the GDP of some other country. Economists have managed to make this statement even while its absurdity is obvious to what remains of the US manufacturing, industrial, and professional skilled (software engineers, for example) workforce and to the cities and states whose tax bases have been devastated by the movement offshore of US jobs.
The few economists who have the intelligence to recognize that jobs offshoring is the antithesis of free trade are dismissed as “protectionists.” Economists are so dog matic about free trade that they have even constructed a folk myth that the rise of the US economy was based on free trade. As Michael Hudson, an economist able to think outside the box has proven, there is not a scrap of evidence in behalf of this folk myth (see America’s Protectionist Takeoff 1815-1914).
My advice to readers who wish to develop economic comprehension is to begin with the outside-the-box economists who are addressing real issues. For example, Herman E. Daly and John B. Cobb’s For the Common Good is accessible to ordinary readers willing to take the effort to google the definitions of unfamiliar terms. However, the most important development in trade theory is not. Global Trade and Conflicting National Interestsby Ralplh E. Gomory and William J. Baumol (MIT Press, 2000) is apparently even over the heads of professional economists, who prefer to babble on ignorantly about the “benefits of free trade” than to learn what they don’t know. Nevertheless, readers should understand that the case for free trade will never been the same after
its dissection by Gomory and Baumol.
With this preface to the column, I now turn to its subject: economist Michael Hudson. Hudson is tota lly outside the matrix in which economists imprison themselves. Hudson doesn’t live in the artificial reality of economists or shill for corporations and Wall Street.
A person can learn a lot from Hudson. His book, Trade, Development and Foreign Debt (2009) explains how foreign trade and economic development have been used to concentrate economic power in the hands of dominant nations. What is really going on is covered up with do-good verbiage and formal models. In reality, trade and development are ways to colonize countries that think they are independent. (Another good book on this subject is Michel Chossudovsky’s The Globalization of Poverty.)
Perhaps the best place to begin with Hudson is his latest book, The Bubble and Beyond, which should be available within a few days of the appearance of this column. In this book Hudson addresses the crisis in the economy and the crisis in the discipline of economics. From this book you can understand not only the crisis but also why economists have misdiagnosed the crisis and are applying incorrect remedies.
Hudson shows that a central problem is that economic theory ignores the role of debt in the economy. Economic theory also pretends that economic policy, such as the Federal Reserve’s mone tary policy, serves the public’s interest rather than the interests of powerful private interests.
As Lenin and others predicted, industrial capitalism has turned into finance capitalism. Finance capitalism does not finance or create new real investments such as manufacturing facilities. Instead, finance capitalism functions as a rentier. It leverages debt and extracts interest payments (and today taxpayer bailouts for its over-leveraged gambles). Finance capitalism flourishes by converting more and more of society’s resources into payments to itself.
One result is that markets cease to expand and economies cease to grow as austerity is imposed to service the build-up in debt. Austerity pushes economies down as consumption and investment are cut back in order to service debt. Hudson concludes that the result is that bankers now receive the rents (a form of unearned income) that once flowed to the landed aristocracy. Unlike the aristocrac y, who were dispossessed of their rents, the bankers have not been.
Hudson knows the history of economic thought and economic history. Reading The Bubble and Beyond lets readers see how economic ideas developed in ways that leave economists unable to perceive the real character of the problems that are challenging them. Trapped in the matrix that they have constructed for themselves, economists are unable to devise solutions.
Hudson writes that western economies are at a turning point. GDP growth consists increasingly of the build-up of financial overhead. The wealth gains are paper gains, not gains from real plant and equipment, and are increasingly concentrated in the hands of the one percent. Financial earnings are extracted from the earnings of tangible capital and labor. Matt Taibbi captured the point with his imagery of Goldman Sachs as “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel int o anything that smells like money.”
My suggestion is that you read Hudson along with Taibbi’s Griftopia, Nomi Prins’ It Takes A Pillage, Gretchen Morgenson and Joshua Rosner’s Reckless Endangerment, and Daly and Cobb’s For the Common Good. Then if you ever do study economics, you will be armored against being ensnared in the matrix that produces economists as shills for finance capitalism, environmental destruction, and the offshoring of the economy.
Get busy. Reading these books will do you much greater good than playing video games, watching TV or hanging out in bars. Our country needs a larger informed younger generation to replace the smaller informed older generation.
Note to readers: Accompanying my column today is an article in the guest section by Herman Daly (titled: (Nationalize Money, Not Banks”). For those looking for solutions to the banking crisis, this astute and highly experienced economist tells you what can be done.
About Dr. Paul Craig Roberts
Paul Craig Roberts was Assistant Secretary of the Treasury for Economic Policy and associate editor of the Wall Street Journal. He was columnist for Business Week, Scripps Howard News Service, and Creators Syndicate. He has had many university appointments. His internet columns have attracted a worldwide following
Nationalize Money, Not Banks by Herman Daly
We Don’t Have To Be In Financial Crisis
In the article below, Herman Daly, a University of Maryland and former World Bank economist, makes the case for 100% reserves. This reform, once a principle goal of important economists, would terminate the ability of the banking system to create credit to finance its own speculations and return the power over money to the government from private banks.
Herman Daly is one of the few economists who are capable of thinking outside the box and who can devise reforms that benefit the people rather than the vested interests.
Nationalize Money, Not Banks
Emeritus Professor University of Maryland School of Public Policy
If our present banking system, in addition to fraudulent and corrupt, also seems “screwy” to you, it should. Why should money, a public utility (serving the public as medium of exchange, store of value, and unit of account), be largely the by-product of private lending and borrowing? Is that really an improvement over being a by-product of private gold mining, as it was under the gold standard? The best way to sabotage a system is hobble it by tying together two of its separate parts, creating an unnecessary and obstructive connection. Why should the public pay interest to the private banking sector to provide a medium of exchange that the government can provide at little or no cost? Why should seigniorage (profit to the issuer of fiat money) go largely to the private sector rather than entirely to the government (the commonwealth) ?
Is there not a better away? Yes, there is. We need not go back to the gold standard. Keep fiat money, but move from fractional reserve banking to a system of 100% reserve requirements. The change need not be abrupt—we could gradually raise the reserve requirement to 100%. Already the Fed has the authority to change reserve requirements but seldom uses it. This would put control of the money supply and seigniorage entirely with the government rather than largely with private banks. Banks would no longer be able to live the alchemist’s dream by creating money out of nothing and lending it at interest. All quasi-bank financial institutions should be brought under this rule, regulated as commercial banks subject to 100% reserve requirements.
Banks cannot create money under 100% reserves (the reserve deposit multiplier would be unity), and banks would earn their profit by financial intermediation only, lending savers’ money for them ( charging a loan rate higher than the rate paid to savings or “time-account” depositors) and charging for checking, safekeeping, and other services. With 100% reserves every dollar loaned to a borrower would be a dollar previously saved by a depositor (and not available to the depositor during the period of the loan), thereby re-establishing the classical balance between abstinence and investment. With credit limited by saving (abstinence from consumption) there will be less lending and borrowing and it will be done more carefully—no more easy credit to finance the leveraged purchase of “assets” that are nothing but bets on dodgy debts.
To make up for the decline and eventual elimination of bank- created, interest-bearing money, the government can pay some of its expenses by issuing more non interest-bearing fiat money. However, it can only do this up to a strict limit imposed by inflation. If the government issues more money than th e public voluntarily wants to hold, the public will trade it for goods, driving the price level up. As soon as the price index begins to rise the government must print less. Thus a policy of maintaining a constant price index would govern the internal value of the dollar. The external value of the dollar could be left to freely fluctuating exchange rates.
Alternatively, if we instituted John M. Keynes’ international clearing union, the external value of the dollar, along with that of all other currencies, could be set relative to the “bancor,” a common denominator accounting unit used by the payments union. The bancor would serve as an international reserve currency for settling trade imbalances—a kind of “gold substitute”.
The United States opposed Keynes’ plan at Bretton Woods precisely because under it the dollar would not function as the world’s reserve currency, and the US would lose the enormous international subsidy that results from all countries having to hold large transaction balances in dollars.
The payments union would settle trade balances multilaterally. Each country would have a net trade balance with the rest of the world (with the payments union) in bancor units. Any country running a persistent deficit would be charged a penalty, and if continued would have its currency devalued relative to the bancor. But persistent surplus countries would also be charged a penalty, and if the surplus persisted their currency would suffer an appreciation relative to the bancor.
Keynes’ goal was balanced trade, and both surplus and deficit nations would be expected to take measures to bring their trade into balance. With trade in near balance there would be little need for a world reserve currency, and what need there was could be met by the bancor. Freely fluctuating exchange rates would also in theory keep trade balanced and reduce o r eliminate the need for a world reserve currency. Which system would be better is a complicated issue not pursued here. In either case the IMF could be abolished since there would be little need for financing trade imbalances (the IMF’s main purpose) in a regime whose goal is to eliminate trade imbalances.
Returning to domestic institutions, the Treasury would replace the Fed (which is owned by and operated in the interests of the commercial banks). The interest rate would no longer be a target policy variable, but rather left to market forces. The target variables of the Treasury would be the money supply and the price index. The treasury would print and spend into circulation for public purposes as much money as the public voluntarily wants to hold. When the price index begins to rise it must cease printing money and finance any additional public expenditures by taxing or borrowing from the public (not from itself). The policy of maintaining a constant price index effectively gives the fiat currency the “backing” of the basket of commodities in the price index.
In the 1920s the leading academic economists, Frank Knight of Chicago and Irving Fisher of Yale, along with others including underground economist and Nobel Laureate in Chemistry, Frederick Soddy, strongly advocated a policy of 100% reserves for commercial banks. Why did this suggestion for financial reform disappear from discussion? The best answer I have received is that the great depression and subsequent Keynesian emphasis on growth swept it aside because limiting bank lending to actual savings was too restrictive on growth, which became the big panacea. Also there is the obvious vested interest of commercial banks in retaining the privilege of creating money and lending it at interest.
Now suppose for a moment that aggregate growth has begun to increase environmental and social costs faster than production benefits, thus be coming uneconomic growth. There is much evidence that this is the case. Then a financial constraint on growth (balancing investment with abstinence) would be much needed, and 100% reserves would be a good way to accomplish it. If, however, growth remains the summum bonum of the economy, then we will inevitably borrow against our hoped for larger future income to finance the investments needed to produce it.
Financing investment by saving would require less present consumption, which many will deem to be an unacceptable drag on growth. But real growth has encountered the biophysical and social limits of a “full world.” Financial growth is being stimulated ever more in the hope that it will pull real growth behind it, but it is in fact pushing uneconomic growth- — growth of ”illth.” Since illth is negative wealth it can hardly redeem the growing debt that is financing it.
The original 100% reserve proponents mentioned ab ove were in favor of aggregate growth, but wanted it to be steady growth in wealth, not speculative boom and bust cycles. Soddy was especially cautious about uncontrolled physical growth, but his main concern was with the symbolic financial system and its disconnect from the real system that it was supposed to symbolize. The result was confusion between wealth and debt. One need not advocate a steady-state economy to favor 100% reserves, but if one does favor a steady state the attractions of 100% reserves are increased.
How would the 100% reserve system serve the steady-state economy?
First, as just mentioned it would restrict borrowing for new investment to existing savings, greatly reducing speculative growth ventures—for example the leveraging of stock purchases with huge amounts of borrowed money (created by banks ex nihilo rather than saved out of past earnings) would be severely limited. Down payment on houses would be much higher, and consumer credit would be greatly diminished. Credit cards would become debit cards. Long term lending would have to be financed by long term time deposits, or by carefully sequenced rolling over of shorter term deposits. Growth economists will scream, but a steady-state economy does not aim to grow, for the very good reason that growth has become uneconomic.
Second, the money supply no longer has to grow in order for people to pay back the principal plus the interest required by the loan responsible for the money’s very existence in the first place. The repayment of old loans with interest continually threatens to diminish the money supply unless new loans compensate. With 100% reserves money becomes neutral with respect to growth rather than biasing the system toward growth by requiring more loans just to keep the money supply from shrinking.
Third, the financial sector will no longer be able to capture such a large share of the nation’ s profits (around 40%!), freeing some smart people for more productive, less parasitic, activity.
Fourth, the money supply would no longer expand during a boom, when banks like to loan lots of money, and contract during a recession, when banks try to collect outstanding debts, thereby reinforcing the cyclical tendency of the economy.
Fifth, with 100% reserves there is no danger of a run on a bank leading to a cascading collapse of the credit pyramid, and the FDIC could be abolished, along with its consequent moral hazard. The danger of collapse of the whole payment system due to the failure of one or two “too big to fail” banks would be eliminated. Congress then could not be frightened into giving huge bailouts to some banks to avoid the “contagion” of failure, because the money supply is no longer controlled by the private banks. Any given bank could fail by making imprudent loans, but its failure, even if a large bank, woul d not disrupt the public utility function of money. The club that the banks used to beat Congress into giving bailouts would have been taken away.
Sixth, the explicit policy of a constant price index would reduce fears of inflation and the resultant quest to accumulate more as a protection against inflation. Also it in effect provides a multi-commodity backing to our fiat money.
Keynes bancor scheme or a regime of fluctuating exchange rates would automatically balance international trade accounts, eliminating large surpluses and deficits. Thus, there would no longer be any need for the International Monetary Fund and the austerity its “conditionality” imposes on weaker economies.
To dismiss such sound policies as “extreme” in the face of the repeatedly demonstrated failure and fraud of our current financial system is quite absurd. The idea is not to nationalize banks, but to nationalize money, which is a natural public utility in the first place. The fact that this idea is hardly discussed today, in spite of its distinguished intellectual ancestry and common sense, is testimony to the power of vested interests over good ideas. It is also testimony to the veto power that our growth fetish exercises over the thinking of economists today.