Many of you would have received emails or other social media contacts, offering a free copy of a cartoon book by me and Miguel Guerra called Funny Money. The marketing has been “funny” as well, when compared to my normal communications—so much so that many people have assumed it’s a scam.

It’s not: the marketing campaign is at my behest, though the language and marketing methods were set by the firm that first approached me with the idea. Their proposal was to use some “hooks”—including a copy of Funny Money—to get people’s attention, and then to market a set of “Mastermind” lectures by me to paying customers.

Their marketing has been successful, with thus far about 100 people signing up for a set of 9 lectures by me that I repeat every 9 weeks (with improvements as I go along of course). The first sequence of lectures finished at the beginning of February, and I’m giving the second lecture in the sequence—on Money—this week (Thursday at 6pm London time). These are the lectures:

1. When and why did economics go wrong?
2. The role of money in economics
3. Where “Minsky Moments” come from
4. Modelling the economy as a complex system
5. Theories of Value
6. The Economics of Climate Change
7. What should microeconomics actually be about?
8. Modelling with Minsky
9. Analyzing data with Ravel

It’s been a pleasure for me to give a set of lectures again, five years after leaving the university sector, and the discussions with the participants have been first rate as well.

That said, I know some of the marketing has been off-putting, and the firm realises this too now. I fully understand people thinking this is a scam—which is why I’m writing this post, to assure you that it’s not.

The firm is changing their language and methods (originally they only worked through social media like WhatsApp; now they’re including email as well) in response to the critical feedback.

I also have to say that the people that I’ve dealt with in the firm are very decent and ethical. I had an unfortunate experience back in the late 2000s with another marketer who was both incompetent—his ideas never worked—and someone who could have been the inspiration for the Australian comedian Doug Mulray’s satirical song “You Are Soul” (say it quickly).

The history of the cartoon book itself is worth recounting. It is supposed to be the first in 3 books, and was supposed to be marketed by the same firm that published eCONcomics.

Unfortunately they dropped the ball on this one, and the book has sat in limbo. This is a chance to get it out into the wild, and I’m happy to take it. You can get a copy from here:

https://www.stevekeenfree.com/new-funny-money-book-free

This will be followed up by marketing of the set of lectures, and the marketing may still have a “spammy” feel to it—it takes time to re-program the automated parts of their campaign. But it is genuine, and if you accept the offer, the end product is this set of “Mastermind” lectures by me. I hope some of you sign up for it.

On one side, we have Elon Musk as a critic of fiat money. On the other, we have Ford and Edison—the tech-billionaires of their time—as fans of fiat money. Who do you trust?

Neither: you work it out for yourself from first principles. And this is much harder that just ranting about “fiat money” on one side, or “barbarous relic” on the other.

So, if you really want to know what happens when a government spends more than it gets back in taxes, rather than just guessing, then you’re going to have to work out what happens in double-entry bookkeeping, since that is the “quantum mechanics” of money.

Stop me if you’ve heard this before, but the fundamental rules of double-entry bookkeeping are:

• All financial claims are classified as either Assets or Liabilities;
• The gap between your financial Assets—which are your claims on other people—and your financial Liabilities—which are other peoples’ claims on you—is known as your Equity; and
• All transactions are recorded twice, following the rule that Assets minus Liabilities minus Equity equals zero.

Now let’s see how a government deficit works. To make it as simple as possible to follow, I’m going to start without bond sales, and then add them in after we’ve seen how a Deficit works on its own.

When a government spends more than it gets back in taxes, it puts more money into people’s private bank accounts via spending than it takes out via taxes. Therefore, since private bank accounts are part of the money supply, a government deficit creates money.

That’s one entry in the double-entry process. What’s the other? It’s an increase in Reserves—which are both an Asset of the Private Bank themselves, and a liability of the Central Bank.

Figure 2: A Deficit creates money by increasing both Deposits (Liabilities of the Banks) and Reserves (Assets of the Banks)

We therefore need to see the process from the Federal Reserve’s point of view. The Fed is the banker for both the private Banks and the Treasury. The Treasury’s numerous accounts at the Central Bank are lumped together into the “Consolidated Revenue Fund”, or CRF for short. The increase in Reserves shown in Figure 2 is caused by a transfer from the CRF, as shown in Figure 3. Since at present The Fed is shown as having only Liabilities, its equity is negative (this will change when we consider Treasury Bond sales).

Figure 3: The Deficit operation from The Fed’s point of view

The CRF is an Asset of the Treasury, and a Deficit reduces it. How does this affect the Treasury: where does it get the money from?

The short answer is that it doesn’t: instead, the Deficit reduces the financial equity of the Treasury. This is shown in Figure 4. Obviously, even though I’ve shown the Treasury as being in positive equity thanks to the 100 in its CRF account, obviously a sustained Deficit would exhaust this account, and put the Treasury in negative equity overall.

Figure 4: The Deficit from the Treasury’s point of view

This is the step which annoys Elon Musk and other critics of fiat money: the Treasury doesn’t “get the money” from somewhere else: there is no “pot of gold”, no vault, no “Aladdin’s Cave”, by which the Deficit is financed. Instead, the Deficit pushes the government into negative financial equity. This is something that, if any other entity in society did consistently, would lead to bankruptcy.

However, therein lies the clue as to why the government can sustain negative financial equity: a company can do the same, so long as its nonfinancial assets are much larger than its negative financial equity.

A nonfinancial asset is an Asset to its owners, but a liability to no one: things like houses (and even spaceships). The mortgage against your house is a Liability for you and an Asset for the Bank, but the house itself is your Asset and no-one else’s Liability: instead, it is part of your total equity.

So, what are the nonfinancial assets of the government of the USA? This is the point that Edison alluded to when he said that behind government notes and bonds stood the Government itself, and “who is behind the Government? The people.” Figure 5 illustrates this by showing “The USA” as both an Asset of the Treasury and by far the largest part of the Treasury’s total Equity.

Figure 5: The nonfinancial assets of the country dwarf the government’s negative financial equity

The nonfinancial assets of the government and the country back, and far exceed, the Government’s negative financial equity. Deficit-financed investments, if well-chosen and executed—like the Muscle Shoals project that Ford and Edison were campaigning for—end up increasing the value of the country’s nonfinancial assets as well. This is the reason that the American government can maintain permanent financial deficits: because they’re backed by the nonfinancial assets of the country, which have grown with and because of the deficit over time. Over the last 120 years, the average government deficit has been equal to 2.5% of GDP—see Figure 6.

Figure 6: The US government has averaged a 2.5% of GDP deficit since 1900

Far from constituting a burden upon the private sector, the deficit eases the private sector’s financial situation. This is the final piece of the puzzle: what does the government’s deficit do to the non-government sectors? As Figure 7 shows, the government’s red ink becomes the private sector’s black ink: the negative financial equity of the government is, dollar for dollar, the positive financial equity of the private sector.

Figure 7: The government’s red ink is the private sector’s black ink

This can be seen in the initial conditions: the private non-bank sector starts with positive financial equity of 90 (Figure 7), and the banking sector starts with 10 (Figure 2). This positive sum is exactly equal in magnitude to the negative equity of the government sectors: the Treasury starts with plus 100 (Figure 4) and The Fed starts with minus 200 (Figure 3).

What about government debt?

How does government debt—really, government sale of Treasury Bonds—change this picture? It does three things:

• It lets the government’s account at the Fed—the “Consolidated Revenue Fund”—remain positive, so long as Bond sales are equal to the Deficit plus interest on outstanding bonds;
• It lets the Federal Reserve maintain non-negative equity, since it has an essentially limitless capacity to buy bonds off the banks in the secondary market. The Asset it accumulates—government bonds—can now match or exceed its liabilities of Reserve accounts and the CRF; and
• It gives banks an interest income which, customarily, they didn’t earn from Reserves, since—before the Global Financial Crisis—The Fed didn’t pay interest on Reserve balances.

This overall system is shown in Figure 8. The Deficit creates money for the non-bank Private Sector; interest payments on bonds creates money for the Banking Sector, in the form of interest on bonds.

Figure 8: The systemic view of government deficits and bonds

This situation is eminently sustainable, so long as the Deficit enables the expansion of the society’s nonfinancial assets. This can include obvious infrastructure projects like the Muscle Shoals hydroelectric plant that Ford and Edison tried to get the government to build (which it ultimately did), and also an educated and healthy workforce. This is what Edison was alluding to when he said “Humanity and the soil—they are the only real basis of money.”

I guessed that most people would think that industrialists like Ford and Edison were opposed to fiat money, and in favour of “sound money”—money backed by gold or some other commodity. As this post will show, that is a false belief. These two industrialists were outright fans of fiat money—money created by the government—and critics of both the gold standard and, to some degree, private bank-created money as well.

I decided to find out what the public thought that Ford and Edison would think the best way I could—via a Twitter poll.

It’s hardly a representative sample. Twitter itself is a minority of the public, and people who follow me—and therefore know that I am a proponent of “Modern Monetary Theory” (MMT)—are a much smaller minority still. Moreover, that minority is likely to be biased in favour of people who also prefer fiat money to credit money.

Having hedged my bets in advance, in an outcome that would surprise neither Ford nor Edison, the majority thought that they were opposed to fiat money:

In fact, they were great supporters of fiat money, and outright critics of the gold standard. They wanted the hydro-electric scheme at Muscle Shoals on the Tennessee River to be financed by the Government issuing $40 million in US currency, without backing that currency by either bonds or gold.

When challenged that “in a sense, there would be no security behind this kind of money,” Ford replied that:

“There would be the best security in the world. Here you have a river capable of furnishing 1,000,000 horsepower… This energy is wealth in a productive form. Now, which is the more imperishable the more secure, this power site and its development, or the several barrels of gold necessary to make $40,000,000. This site, with its power possibilities, will be here long after the Treasury Building is a ruin.”

“When the Government needs money it will raise it by issuing currency against its imperishable natural wealth.” (Ford and Edison 1921)

I’ve been informed that Max Keiser thought Ford and Edison were in favour of energy-based currency, and therefore that they’d support Bitcoin:

My reply shows my scepticism. Firstly, Bitcoin uses—and therefore “perishes”—energy, whereas Ford referred to fiat money being backed by the country’s “imperishable natural wealth”—energy and other resources that are still in the ground. Edison made a similar comment—that paper money is based on “Humanity and the soil”:

“What are bills and checks? Mere promises and orders. What are they based on? Principally on two sources—human energy and the productive earth. Humanity and the soil—they are the only real basis of money.”

Secondly, rather than talking about money being backed by some other specific commodity—whether energy or gold—what Ford and Edison were arguing was that a national currency is backed by the non-financial assets of that country: its physical wealth, manifest in its raw materials and its infrastructure, were what gave authority to the financial assets it issued.

Edison even described the use of a fiat currency—a paper currency (in his day), backed only by the power of the Government—as the mark of a civilised society:

“Now, as to paper money, so-called, everyone knows that paper money is the money of civilized people. The higher you go in civilization the less actual money you see. It is all bills and checks.”

When Edison was asked “would not Mr. Ford’s suggestion that Muscle Shoals be financed by a currency issue raise some objection?”, he replied:

“Certainly. There is a complete set of misleading slogans kept on hand for just such outbreaks of common sense among the people. The people are so ignorant of what they think are the intricacies of the money system that they are easily impressed by big words. There would be new shrieks of ‘fiat money’, and ‘paper money’, and ‘greenbackism’, and all the rest of it—the same old cries with which the people have been shouted down from the beginning.” (Ford and Edison 1921)

Those misleading slogans are alive and well today, as evidenced by our modern-day Henry Ford, Elon Musk:

And gold bugs like Peter Schiff:

And cryptocurrency enthusiasts like Max Keiser:

Ford and Edison would have none of that. They echoed Keynes’s description of the gold standard as a “barbarous relic”, and both wanted it abolished. Ford’s opposition to gold has tinges of his anti-semitism to it, in that he saw it as being controlled by bankers who then promoted war to make their control lucrative:

Gold as a metal is all right … But … through its scarcity It has acquired a fictitious value far beyond its value as a useful metal… The people of the world made a mistake which has cost them generations of financial slavery when they consented to making gold a basis for the issuance of currency… because gold is scarce … its total supply can be controlled… There is a group of international bankers who today control the bulk of the world’s gold supply…”

Edison concurred with Ford in being against the gold standard, and sounded just like David Graeber in his analysis:

“Gold is not money until the people of the United States and other nations put their stamp on it. It is not gold that makes the dollar. It is the dollar that makes the gold. Take the dollar out of the gold, and leave it merely [as] yellow metal, and it sinks in value. Gold is established by law. Just as silver was, and gold could be disestablished, demonetized by law, just as silver was. When silver was demonetized the former so-called silver dollar became worth about 50 cents.”

Edison also sounded very much like Stephanie Kelton in The Deficit Myth (Kelton 2020) when he described dollar bills and government bonds as just different forms of government money:

“Then you see no difference between currency and Government bonds?”, Mr Edison was asked.

“Yes, there is a difference, but it is neither the likeness nor the difference that will determine the matter: the attack will be directed against thinking of bonds and currency together and comparing them. If people ever get to thinking of bonds and bills at the same time, the game is up.”

He also made the MMT point that a fiat currency is backed by the authority of the Government which issues it:

“Look at it another way. If the Government issues bonds, the brokers will sell them. The bonds will be negotiable: they will be considered as gilt-edged paper. Why? Because the Government is behind them, but who is behind the Government? The people. Therefore, it is the people who constitute the basis of Government credit. Why then cannot the people have the benefit of their own gilt-edged credit by receiving non-interest bearing currency on Muscle Shoals, instead of the bankers receiving the benefit of the people’s credit in interest-bearing bonds?”

Unfortunately, Ford and Edison’s wisdom here didn’t change people’s minds a century ago, and a century later, we’re still having the same pointless debates. Given their cynicism about the capacity of the public to understand complex issues, I doubt that Ford and Edison would be surprised that the view they championed was still the minority view today. Ford is alleged to have said “It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning”. What he definitely did say, in a ghost-written autobiography, was that:

“The people are on the side of sound money. They are so unalterably on the side of sound money that it is a serious question how they would regard the system under which they live, if they once knew what the initiated can do with it.” (Ford, Crowther et al. 2013, p. 163)

In my next post, I’ll go back to first principles to show that Edison and Ford were right about money and government debt, and Elon Musk is wrong.

Elon Musk has been making a lot of comments on government debt recently, and though I have a lot of respect for what he’s done in electric vehicles and space travel, I couldn’t restrain myself from ridiculing his views on government debt:

That led to another tweeter having a go at me, because obviously someone who knows how to make money knows a lot about money:

But in fact, knowing “how to make money”—in the sense of accumulating vast wealth from being a successful entrepreneur—doesn’t convey any special knowledge about “how to make money”—in the sense of creating money itself. My Exhibit A here is the attitude to government debt of two equally famous entrepreneurs—Henry Ford and Thomas Edison—which was diametrically opposed to Musk’s.

Back in the early 1920s, these two entrepreneurs joined forces to argue that a huge infrastructure project—the Muscle Shoals hydroelectric plant—using government debt. Their scheme was literally front page news in the Twitter of the day, the New York Times (“Ford hopes to use Muscle Shoals as Step to End Wars“; “Ford Sees Wealth in Muscle Shoals“). An essential feature of Ford’s logic was that the government doesn’t need to borrow money, since it is a money creator:

“Army engineers say it will take $40,000,000 to complete the big dam. But Congress is economical just now and not in a mood to raise money by taxation. The customary alternative is thirty-year bonds at 4 per cent. The United States, the greatest Government in the world, wishing $40,000,000 to complete a great public benefit is forced to go to the money sellers to buy its own money. At the end of thirty years the Government not only has to pay back the $40,000,000, but it also has to pay 120 per cent interest, literally has to pay $88,000,000 for thirty years.

And all the time it is the Government’s own money. The money sellers never created it. They got it from the Government originally. The Government first gave credit, now it must pay for the use of what it gave. Think of it. Could anything be more childish, more unbusinesslike!” (Henry Ford, December 4^th 1921)

Ford’s proposal was that the government should finance the dam’s construction by simply creating the money needed. His argument here—that currency and government bonds are effectively just different forms of government created money—is very similar to the argument that Stephanie Kelton makes today, that bonds and currency are just different forms of government-created money:

This is Kelton from The Deficit Myth in 2020:

“Then why does the government need to borrow? The answer is, it doesn’t. It chooses to offer people a different kind of government money, one that pays a bit of interest. In other words, US Treasuries are just interest-bearing dollars.

To buy some of those interest-bearing dollars from the government, you first need the government’s currency. We might call the former “yellow dollars” and the latter “green dollars.”

When the government spends more than it taxes away from us, we say that the government has run a fiscal deficit. That deficit increases the supply of green dollars. For more than a hundred years, the government has chosen to sell US Treasuries in an amount equal to its deficit spending.

So, if the government spends $ 5 trillion but only taxes $ 4 trillion away, it will sell $ 1 trillion worth of US Treasuries. What we call government borrowing is nothing more than Uncle Sam allowing people to transform green dollars into interest-bearing yellow dollars.”

And this is Ford from the New York Times article in 1921:

“Now, I see a way by which our Government can get this great work completed without paying a nickel to the money sellers. It is as sound as granite. and there is but one thing hard about it. It is so simple and easy that, maybe, home folks can’t see it.

The Government needs $40,000,000. That is 2,000,000 twenty-dollar bills. Let the Government issue those bills and with them pay every expense connected with the completion of the dam… the entire $40,000,000 issued can be retired out of the earnings of the plant.”

“But suppose the contractor would be unwilling to accept that kind of currency in payment?”, he was asked.

“There is not that kind of suppose in the situation at all,” said Mr Ford smiling. “He would take the Government bonds in payment, wouldn’t he? Certainly! Here,” said the manufacturer, pulling a twenty-dollar bill from his pocket, “he wouldn’t hesitate about taking that kind of money, would he? Of course not. Well, what is there behind a bond or this bill that makes it acceptable. Simply this, the good faith and credit of the American people, and twenty-dollar bills issued by the Government to complete this great public improvement would have just as much of the good faith and credit of the American people behind them as any bond or other American currency ever issued.”

So who does Ford sound like here—his fellow entrepreneur Musk, or the MMT advocate Kelton? And which entrepreneur do you trust on this issue?

You don’t: you work it out from first principles instead. This is something that Musk says he does in his engineering, but it’s clearly not what he’s doing when it comes to his attitude to government debt. As it happens, it’s Ford and Edison who did the first principles thinking and got it right, not Elon Musk. I’ll explain that in my next post.

Figure 1: The headlines from the two New York Times articles on December 4th and 6th of 1921

 

I’m developing a set of Mastermind lectures on economics, and the marketing has included video “shorts” from my interview with Lex Fridman. This one, on why socialist economies didn’t innovate as fast as capitalist ones drew a lot of ire on Twitter. The text of that short is:

Innovations: Socialist versus Capitalism

[Under capitalism] You have competitive industries, where you’re trying to take demand away from your rivals. You have Kawasaki versus Honda versus BMW etc. etc.. The way you get demand away from your competitors is by innovating. So what you will get is cycles and booms and slumps, but you’ll innovate and change over time. So, what you find is this huge gap between socialism with volume production but no innovation, and capitalism with innovation. So that was the fundamental failing that Janos Kornai saw: why did socialism not innovate?

Some Twitter correspondents saw Red—so to speak:

Yes, the socialist USSR was the first social system to put a satellite into orbit, and a man into space. But it was also where consumers waited ten years to get the TV set they ordered. It was this failure, rather than its space race successes, that Janos Kornai tried to explain with his model of resource-constrained versus demand-constrained economies.

His argument was that the key constraint firms faced in the Soviet system was of resources: for a range of reasons, they couldn’t get all the inputs they needed to satisfy the demand they faced. Au contraire, Kornai argued, firms in capitalist economies were constrained by demand: they couldn’t sell all they were capable of selling if they used all of their available resources.

Kornai’s analysis compared the standard firm in an idealised socialist economy to the standard firm in an idealised capitalist economy. In the former, the social emphasis was on guaranteeing full employment, and giving workers as high a standard of living as possible. In the latter, the emphasis was on making as much profit as possible, and giving workers as little of the economy’s output as possible.

I can’t possibly due Kornai’s full argument justice here in a blog post (see this freely accessible academic paper for more detail), but the basic point was that the individual firm in a socialist economy had no problem selling its output. Since that applied to every firm, all of them had an insatiable demand for inputs—which could not be satisfied in the aggregate. They were therefore resource-constrained. The easiest way to at least come close to satisfying demand was to avoid the retooling and redirection of resources that innovation required: just produce more of last year’s model every year. Sales were also limited to current output—everything that was produced was sold, so that there were no stocks. Consequently, consumers were rationed not by price, but by queues. You might order a refrigerator one year and receive it a decade later.

In Kornai’s idealised capitalist economy, the problem was an insufficiency of aggregate demand: with wages as low as possible, and numerous firms competing to supply the demand that existed, each firm was demand constrained. Furthermore, unlike their socialist counterparts, capitalist firms can actually go bankrupt (Kornai distinguished between “hard” and “soft” budget constraints, as well as demand and resource constrained firms). Therefore, capitalist firms face pressure to try to ensure that most of the limited demand flows to them, rather than their rivals. The best way to do this is to make your rivals’ products obsolete via innovation.

In practice, this meant that Soviet firms didn’t innovate, while capitalist ones did. I used the example of motorbikes because, as a young man, I saw a striking example of this. My twenties coincided with the golden years of Japanese 650cc motorbikes, and my girlfriend’s brother wanted one—but he couldn’t afford the $3000 price tag. Then he discovered that he could buy a 650cc Soviet motorbike—a “Cossack”—for $650. I helped him unpack the bike when it arrived, and once we’d removed it from its wooden crate, and taken off the oiled rags that prevented it rusting, there was something that Steve McQueen could have ridden in the WWII movie The Great Escape: the 1976 Cossack Ural was a rebadged 1942 BMW—complete with a bicycle-style seat.

 

Figure 1: Photo on Flickr of a 1976 Cossack Ural 650 cc motorbike

The failure to produce both enough consumer goods, and modern consumer goods, was a major factor in the collapse of the Soviet Union—and Kornai, as a Hungarian economist, was attempting to understand this process long before the Soviet Union actually collapsed (the paper I linked was published in 1979).

Figure 2: The abstract to Kornai’s 1979 paper

Another short, on Kruschev’s famous speech at the United Nations where he took his shoe off and banged the table for emphasis as he declared “we will bury you!”, didn’t generate as much Twitter angst. But it covers another reason why the Soviet Union failed as a producer of consumer goods, compared to the West.

Why Khrushchev was wrong

There’s this famous historical incident where Khrushchev, in the United Nations, takes off his shoe and bangs the desk and says “We will bury you!” He literally meant “We’re going to bury you in commodities. We’re going to produce more output than you are”. And he was wrong.

Lex replied “Because fundamentally, in the long term, to bury somebody in commodity production, you have to innovate”, which led into the next clip. But there was reason in Khrushchev’s boast, based on the model that led to the Soviets focusing on building “the means of production”, rather than producing consumer goods.

The model, developed by Grigory Fel’dman, an engineer working for the central planning authority Gosplan, argued that the Soviet economy would grow most rapidly if it focused on producing “the means of production”—machinery—rather than focusing on producing consumer goods. This would mean an initially low level of production of consumer goods, but at some point, the rapid growth of industry would mean that the growth of consumer goods would explode—hence Khrushchev’s “we will bury you”.

The weakness of Fel’dman’s model was that it assumed a limitless supply of labour that could be employed in Soviet factories. This was true in the early days of Soviet industrialisation, and in the aftermath to WWII, both periods where the Soviet system grew far faster than the West.

However, the success of the model undermined its key assumption—that there was a limitless supply of labour. Once full employment was reached, growth slowed down to the rate of growth of the workforce. Fel’dman himself recognised that this was a problem which could only be solved by innovation:

“[Once] the labor force is utilised to the limit, [then] the prediction of technical improvement will be a pressing problem and the forecasting of technical reconstruction will be central to all planning.”

Unfortunately, the Soviets leaders didn’t get the memo. They clung to the vision of “building the means of production” over producing consumer goods, with the result was that labour was diverted from consumer goods production to investment goods production, so that consumer goods output grew even more slowly.

Ultimately, this failure to produce sufficient consumer goods, and failure to keep up with the West in innovation, played a major role in the willingness of the Soviet people to abandon the socialist experiment.

What followed was hardly the dream they had of abundance at last—and mainstream economic theory played a major role in delivering a capitalist hell when the anti-socialist rebels were expecting a capitalist heaven. But that’s a topic for another post.

“I fancy that over-confidence seldom does any great harm except when, as, and if, it beguiles its victims into debt.” (Fisher 1933, p. 341)

The man who penned those words wrote them from bitter experience. Irving Fisher, who is far better known for the statement that “Stock prices have reached what looks like a permanently high plateau“, was the Paul Krugman of his day: the world’s most famous Neoclassical economist.

Fortunately, unlike Krugman, Fisher recovered from this mental illness.

Unfortunately, he didn’t do so until after his belief in the Neoclassical theory of finance—which he developed (Fisher 1930)—effectively sent him bankrupt in The Great Crash of 1929.

Believing that stock prices accurately reflected future earnings, and that leverage plays no role in determining asset prices, Fisher used margin debt to parlay a personal worth of about US$10 million into a US$100 million share portfolio—and then was reduced to penury when the stock market crashed.

I raise this historical anecdote today because margin debt is now at levels that were previously only seen during the height of the Roaring Twenties, from mid-1927 until it all came crashing down with The Great Crash on October 29, 1929—see Figure 1.

Figure 1: Margin debt as a percentage of GDP

The allure of margin debt is that it amplifies your gains: in the 1920s, levered speculators salivated at the prospect of doubling their money every time the stock market rose by just 10%.

The pitfall they ignored was that, when the stock market crashed, the peculiar feature of a margin loan—the “margin call”, which requires the speculator to add more money to return the value of the portfolio to its initial level—kicked in. When the market fell 10% on one day in 1929, most speculators couldn’t make the margin—even after liquidating everything.

When you look at the sheer scale of margin debt in the 1920s, it’s no wonder that the Great Depression ensued afterwards. Right before the crash, the growth in margin debt peaked at 3% of GDP. By the 3^rd quarter of 1930, it was almost minus 6% of GDP—see Figure 2.

Figure 2: Change in margin debt as a percentage of GDP

Fisher the mainstream economist was bewildered by these developments at first. But Fisher the rebel economist finally worked out why this mattered: money borrowed from a bank (even if indirectly via a broker) adds to the supply of money, and to demand for goods and services as well as shares, while debt repaid reduces the money supply and demand just as much. Therefore, the repayment or writing off of debt caused a decline in aggregate demand:

A man-to-man debt may be paid without affecting the volume of outstanding currency j for whatever currency is paid by one, whether it be legal tender or deposit currency transferred by check, is received by the other, and is still outstanding. But when a debt to a commercial bank is paid by check out of a deposit balance that amount of deposit currency simply disappears.(Fisher 1932, p. 15)

This phenomenon hits asset markets particularly hard, because debt is used to buy assets far more than it is used to buy goods and services. New debt—in this case, new margin debt—is a substantial source of the demand for shares, so that the acceleration of margin debt drives change in share prices—see Figure 3.

Figure 3: Margin Debt Acceleration to Share Price Change 1920s-2020s

The tsunami-scale of the collapse of both margin debt and share prices in The Great Crash makes it hard to see how relevant this force still is today, so here are 2 extracts from that chart, Figure 4 for 1975 till 1995 (the era before and after the Greenspan Put) and Figure 5 for 1995 till today (the era before and after Bernanke’s Quantitative Easing).

Figure 4: The relationship from 1975-95

Figure 5: The relationship from 1995 till today

There’s one caveat in comparing margin debt today to back in Fisher’s day: in part thanks to Fisher’s campaign against margin debt during the 1930s, a “margin loan” today allows the borrower to no more than double the value of shares she can buy: a speculator with $100,000 to bet on stock prices can buy $200,000 with a margin loan. In Fisher’s day, the factor was tenfold: $100,000 in cash could be used to buy a $1 million portfolio, with the other $900,000 supplied by the broker.

Given that lesser leverage, the pressure of decelerating margin debt isn’t as severe as in Fisher’s day. But the message that these chart scream is that the current stock market downturn still has a long way to go.

Happy New Year everyone…

Fisher, Irving. 1930. The Theory of Interest: as determined by impatience to spend income and opportunity to invest it (Porcupine Press: Philadelphia).

———. 1932. Booms and Depressions: Some First Principles (Adelphi: New York).

———. 1933. ‘The Debt-Deflation Theory of Great Depressions’, Econometrica, 1: 337-57.

 

I’m in the middle of a large consulting project on economics and climate change, and I’m also developing and delivering a set of seven “Mastermind” lectures, which you would have seen advertised on social media (a marketing firm is handling the messaging, which is why some people have thought it’s not me putting out the messages—technically correct, but as a marketing amateur, I have left the marketing message to the firm). Consequently, I haven’t posted a blog post here for a while: I’ve just been too busy on work that isn’t yet published.

For this reason—and because it’s the festive season, and I’d better give my supporters some sort of present in thanks for another year of supporting me—this blog post outlines the content I’ll give in my next Mastermind lecture, on how money is created. I’ve chosen this topic because a supporter (or a correspondent on Twitter—I can’t remember right now) said that, as an accountant, she needed an accounting explanation of how banks create money to persuade other accountants. So here it is.

I’ll give more details in the lecture next week, but these are the core propositions I’ll cover.

Firstly, money in our society is fundamentally the Liabilities (and short-term Equity) of the banking sector: the “L&E” side of the banking sector’s ledger. Therefore, to create money, you have to increase the L&E side of the ledger. Given that banks are double-entry bookkeeping machines, this is only possible if you also increase the A—for “Assets”—side of the ledger simultaneously, and by the same amount.

This provides an incredibly simple way to work out whether a financial action creates money or not: to create (or destroy) money, a financial action must occur on both the Asset and the Liabilities/Equity side of the banking sector’s ledger.

As I explain in the lecture—and the argument below—there are only 2 fundamental operations that qualify in a domestic economy:

• Banks lend out more than they take back in repayments; and
• Governments spend more than they take back in taxes

There are also ancillary activities that cause money creation or destruction:

• Interest payments on government bonds; and
• Sales of bonds by the banking sector to the non-bank public

My Minsky software is, by far, the best way to illustrate this, because the Godley Tables in Minsky are based on double-entry bookkeeping. I’ll start with bank lending, and then consider government spending.

Bank Lending

The absolutely simplest model of bank lending is shown in Figure 1: net lending (which can be positive or negative) is Credit dollars per year, the non-bank public pays Interest on outstanding Loans, and the banks spend on the non-bank public (Spend_Banks).

Figure 1: The basics of bank lending

Notice that Reserves, which are an essential part of the mainstream economic model of banks—the “Money Multiplier”, in which banks lend from Reserves—play no role at all here. In countries where a “Required Reserve Ratio” still exists, banks could be required in the aggregate to borrow Reserves from the Central Bank; but most countries have abolished RRRs, and QE has swamped banks with excess reserves in any case.

A more realistic control on bank lending is that banks may require themselves to not be too heavily geared (though they threw this caution to the wind during the Subprime Bubble). Banks would then have a target Loans to Equity ratio, which controls their lending, but even this can allow for indefinite money creation by bank lending. In Figure 2, I model bank lending as controlled by a target growth rate for loans (_Debt) and a desired Loans to Equity ratio (DE_ratio).

Figure 2: Bank lending controlled by a target loan to equity ratio and target loan growth

It’s possible for lending to continue forever with this control, since the payment of Interest increases the banks’ equity. As the simulation in Figure 3 shows, so long as Interest exceeds Spend, this is a formula for ever-expanding bank-created money and debt.

Figure 3: Ever-expanding credit with a debt to equity driven lending regime

Banks therefore create money by expanding their Assets and Liabilities simultaneously. The situation is rather different for government money creation: governments create money by going into negative equity, which is matched—dollar for dollar—by an increase in the positive equity of the non-government sectors.

Government Taxation and Spending

Though Reserves play no role in bank lending (contrary to mainstream economics), they play an essential role in government taxation and spending. Figure 4 shows that taxation reduces bank deposits and spending increases them—which shouldn’t be controversial, but given the confusion that mainstream economics has caused, it might well be! How can government spending in excess of taxation create money, when—according to economics textbooks—the government has to borrow from the public in order to spend?

Figure 4: Taxation and spending entered against Deposits only

Because the textbooks are wrong, that’s why (as the Bank of England has already said they’re wrong about bank lending—see “Money creation in the modern economy“). As a simple matter of accounting, paying taxes reduces bank deposit accounts, and government spending increases them. Government spending thus creates money.

Now, how do we balance these entries in double-entry terms? The only candidate for balancing the accounts is Reserves: just as net government spending creates Deposits, it also creates Reserves—see Figure 5.

Figure 5: Taxation and spending balanced by matching entries on Reserves

But where do the additional Reserves come from? To see that, we have to complete the modelling of the financial flows between the four sectors in this model: the Banks, the non-bank Public, the Central Bank, and the Treasury. Minsky makes this easy to do, by understanding that every (financial) Asset is another entity’s Liability. All you have to do as a modeler is, when there isn’t an obvious matching Asset/Liability pair into which a flow should go, record it against the entity’s equity instead. This given you Figure 6.

Figure 6: The general model allocating all Assets and Liabilities

To answer the question “where do the additional Reserves come from?”, strictly speaking, they come from the Treasury’s account at the Central Bank—which I’ve described as “CRF” for “Consolidated Revenue Fund”. But without including government bond sales, if spending exceeds taxation for a sustained period, this account will go into overdraft. This is shown in Figure 7, where I’ve made both taxation and spending functions of GDP that are under government control (the real world is far more complicated of course, but this suffices to show the basic structure of government finances). Central Bank liabilities remain constant, but this involves rising Reserves and a negative balance in the CRF.

Figure 7: The model without government bond sales

Is that a problem for the government, in the same way that an overdraft is a problem for a bank customer? No, for the simple and fundamental reason why the government has a unique position in a monetary system: the Treasury, on behalf of the government, owns the Central Bank. If any of us spend without regard to what’s in our bank deposit account, we’ll pretty soon experience punitive interest rates, and ultimately bankruptcy. But the government could continue running a negative balance in its account at its bank for as long as it wished to.

At this point in the model, money creation is the sum of the entries in Deposits and Banks (the short-term equity position of the banking sector). This sum is:

    

Credit is obviously the contribution of the banking sector, which comes from its equal expansion of its Assets and Liabilities. Spend_Gov –Tax is obviously the government’s contribution, and this is identical in magnitude to the change in the government’s equity position, but opposite in sign: the government creates money to the extent to which it creates negative equity for itself. This creates an identical increase in the positive equity of the non-government sectors:

    

This is the key functional difference between private (credit) and government (deficit) money creation: banks create money by expanding their Assets and Liabilities identically, with no effect on their Equity; governments create money by increasing their negative equity.

Many people seem to object to this “on principle”: “The government shouldn’t be in negative equity, dammit!”. But this is just how government money creation works, and since we’re dealing with financial assets—which are one entity’s claims on another entity—then if the government isn’t in negative equity, the non-government sectors must be instead.

Since banks, by law, have to have positive equity (otherwise they are bankrupt), then if the government was also in positive equity (or even zero), the non-bank public would have to be in negative equity. But if the government runs sustained deficits, both the banks and the non-bank public can be in positive equity. This is why it’s vital to look at the entire system, something that mainstream economics does not do (they don’t even model banks in their macro models, so they don’t have a clue how the overall financial system operates).

This especially applies to how they think about government bond sales, which they think involves governments taking money from the public, or adding to the demand for money. No they don’t.

Bond Sales and Bond Interest

Bond sales are mandated in almost all countries, by laws that require the government not to have a negative balance in its CRF (consolidated revenue fund) at the Central Bank. This is normally expressed as a rule that the government has to issue bonds equivalent to the deficit plus interest on outstanding bonds. Some superficial thinkers—and there are a lot of them!—think that this means that the government can’t spend before it raises revenue from taxation and bond sales. But in fact, the dynamics of the system mean that (a) the deficit creates the funds—Reserves—that are used to buy the bonds, and (b) given some net buying of bonds by the Central Bank, and the fact that bonds are sold very frequently—normally at weekly bond auctions—there is always more than enough Reserves (a stock) on hand to cover any deficit spending (a flow), whether bond sales lead, lag, or are contemporaneous with the deficit.

Bond sales add quite a bit of additional complexity to the model—see Figure 8. Three new accounts are needed, for Bank, Central Bank and Public holdings of bonds; interest is paid to Banks and the Public on bonds (though not, normally, to Central Banks—and in the countries where this applies, the interest income is ultimately remitted to the Treasury.

Figure 8: The accounting tables for all sectors

The key transaction here is the sale of bonds by Treasury to the banks, and as noted this is equal to the deficit plus interest payments on bonds—see Figure 9

Figure 9: Primary sales of bonds equals the deficit plus interest on outstanding bonds

The Central Bank is always undertaking what are called “Open Market Operations” (OMO) with banks in order to maintain its target interest rate on bonds, and Central Banks always have substantial holdings of Treasury Bonds in their Assets. In this model, I’m assuming that net Central Bank purchases from private banks are equal to the interest paid on outstanding treasury bonds—see Figure 10. In practice, they can be lower than this, or as high as the total issuance of bonds by the Treasury: the Central Bank has a limitless capacity to buy bonds by crediting the accounts of private banks—their Reserve accounts.

Figure 10: Modelling Central Bank bond purchases equalling the interest on existing bonds

Bond sales to banks precisely counter the deficit and interest payments on outstanding bonds, so that the CRF remains constant; the purchase by the Central Bank of bonds equivalent to the interest payments on bonds means that Reserves grow while the CRF remains constant. The Treasury therefore always has enough funds on hand to finance its spending while maintaining a positive balance in the CRF, as required by law. Banks are also always going to be willing to buy these bonds, because they can swap Reserves—which earn either no interest, or a lower rate of interest than bonds yield (with the rate set by the Central Bank)—for Bonds. They can then trade these bonds, which they do on the world’s largest financial market, and the interest payments from the government partly cover the cost of running the country’s payments system.

 

Figure 11: The full model, showing that Reserves more than equal the annual deficit

Conclusion

Frankly, none of this should be controversial: it is, as shown in this post, simply a matter of accounting. The controversy comes from mainstream “Neoclassical” economists—aided and abetted by Austrian economists, gold bugs, and the like—not understanding how the monetary system works, because they don’t understand double entry bookkeeping—let alone. think in terms of it when modelling the economy.

Instead, thanks to their ignorance, we have endless “crises” over debt ceilings, too much private credit money creation thanks to too small government deficits, austerity crippling economies as it results in governments not investing sufficiently in infrastructure and welfare, and “puzzling” low growth rates for economies that thought that austerity would unleash private sector creativity, when in fact it hampered it by reducing the growth of the money supply.

Will the collective We ever understand this? Frankly, I doubt it. I’ve witnessed decades of delusion on these issues, and I reckon I’ll witness years more, despite the success of MMT in getting good sense on money creation into the public debate.

Merry Xmas and Happy New Year everyone. Here’s hoping, against experience, that 2023 won’t be worse than 2022.

A recent episode of the Debunking Economics podcast annoyed quite a few people, and I couldn’t be happier.

The episode, shown and linked in the graphic below, considered the sustainability of the economic growth that capitalism has spawned over the last 250 years (hint: it isn’t), and as part of it, I took a swipe at Neoclassical economics. A listener tweeted the following excerpt, where I assert that Neoclassical economists don’t have a decent theory of technological change:

And that’s when the fun began on Twitter, with Pontus Rendahl of Cambridge University UK and Gauti Eggertsson of Brown University, USA both weighing in on my lamentable knowledge of economic literature:

I had a dig at Eggertsson for his zero knowledge of the literature on endogenous money (Eggertsson and Krugman 2012) but that’s beside the point here, which is why do economists—including me—frequently not read large slabs of the economic literature?

Eggertsson and Rendahl both imply that, in my case, it’s sheer lack of knowledge. But the reality is much more interesting and revealing about why economics is not a science. It is more like a band of competing religions, where each religion reads its own texts obsessively, but has no idea what the texts of other religions are. So Christians read the Bible, Muslims read The Koran, but very few Muslims read the Bible, and fewer still (I expect) Christians read the Koran.

In economics, the dominant religion is Neoclassical economics, and the main minority religion is Post-Keynesian economics (Austrian economics is best regarded as a more realistic—and anti-modelling—offshoot of Neoclassical economics). Rendahl and Eggertsson are both Neoclassicals, and they were having a go at me for—so they thought—not knowing of the endogenous growth literature spawned by the work of Paul Romer.

They are wrong, for two reasons.

Firstly, there’s a twist to the religion analogy for economics. Except for a handful of converts, believers in one religion are born, raised and educated in it. But in economics, given that it gets taught in universities rather than churches, the economic religion with the dominant population gets to teach everybody. That is Neoclassical economics, and it dominates teaching at all but a dwindling handful of universities. To become a member of a rival economic religion—be it Post-Keynesian, Austrian, Marxist, Evolutionary, Behavioural, whatever—you first have to endure an inculcation in Neoclassical economics. So, while almost no Neoclassical economist reads non-Neoclassical works, non-Neoclassical economists have at the very least endured several years of undergraduate inculcation in Neoclassical economics.

Secondly, because I’m the ornery bastard who decided to take Neoclassicals on with my book Debunking Economics, I have read a ridiculous volume of Neoclassical works—more, I expect, than most Neoclassical economists themselves. They are incredibly ignorant of even their own religion’s history, because they disdain the history of economic thought so much that they don’t even learn their own history.

Therefore, I am quite aware of Paul Romer’s work on endogenous growth theory (Romer 1990)—and I hold Romer in much higher regard than I do most Neoclassical economists. He is someone who has pushed the boundaries of the Neoclassical paradigm, and he has also been scathingly critical of the mess that Neoclassical economics is in these days, in a brilliant working paper entitled “The Trouble with Macroeconomics” (Romer 2016).

So, why do I nonetheless not take his model of endogenous growth seriously?

There are two primary reasons. The first is its Neoclassical foundation. Romer went to great lengths to situate his work within the school of economics he knew at the time, and that of course was Neoclassical economics, where you have to integrate your element into the fundamentally equilibrium-dominated corpus of Neoclassical economics. Figure 1, which reproduces, the overview paragraph in his paper, is peppered with the concept of “equilibrium”.

Figure 1: An extract from Romer’s endogenous growth model paper

The second is that, at much the same time as Romer was developing Neoclassical endogenous growth theory, the great (but sadly neglected, even by Post-Keynesians) economist Richard Goodwin was developing a Post-Keynesian approach to precisely the same issue (Goodwin 1990).

The insights of the two men were similar, but the framing of their analysis couldn’t have been more different. Whereas Romer shoehorned his insights into the equilibrium fetish of mainstream economics, Goodwin was specifically looking for system that were locally unstable, but globally stable: where the point equilibria were repellers, rather than attractors of the system, but where nonlinearity far from equilibrium meant that the models stayed within realistic bounds:

This, despite the obsession Neoclassicals have with equilibrium, is the real world. Economists have failed to find chaos in economic data (as an ambivalent review of Goodwin’s book pointed out) because of the tests they have applied to it, not because it doesn’t exist. As I have shown in The New Economics: A Manifesto, chaotic dynamics arise from a simple macroeconomic model derived from the definitions for the employment rate, the wages share of GDP, and the private debt to GDP ratio (Keen 2021, pp. 97-100). The resulting model is a relative, if not quite a twin, of Lorenz’s original model of chaotic dynamics in the weather (Lorenz 1963).

Even if this were not true, this is the 21^st century, not the 19^th. The excuse that the original Neoclassicals had then for doing equilibrium analysis was valid—even if their deductions from it were false:

If we wished to have a complete solution of the problem in all its natural complexity, we should have to treat it as a problem of motion—a problem of dynamics. But it would surely be absurd to attempt the more difficult question when the more easy one is yet so imperfectly within our power.” (Jevons 1888, p. 93)

But in the 21^st century, we have software systems which can easily handle far-from-equilibrium behaviour. There is no need to shoe economic phenomena into an equilibrium framework. Here, for example, is Goodwin’s model of endogenous growth in Minsky, the Open Source system dynamics tool I have developed for economic modelling:

 

 

Figure 2: Richard Goodwin’s model of innovation-driven growth

 

Therefore, while I appreciated Romer’s work, he ended up “putting lipstick on a (Neoclassical) pig”. The model still had to generate equilibrium outcomes, and for that reason, the pigs liked it. But they also weren’t particularly willing to put the lipstick on, because, like so many attempts to generalise Neoclassical economics, it forced outcomes that Neoclassicals don’t inherently like. Romer summarized this problem here:

Once the cost of creating a new set of instructions has been incurred, the instructions can be used over and over again at no additional cost … Most models of aggregate growth, even those with spillovers or external effects, rely on price-taking behavior. But once these three premises are granted, it follows directly that an equilibrium with price taking cannot be supported. (Romer 1990, p. S72. Emphasis added)

Since then, there are models in which Neoclassicals want non-price-taking behaviour: DSGE models (which without exception did not predict the Global Financial Crisis) rely on one sector of an economy exhibiting price-setting behaviour (monopoly or “imperfect competition” in the Neoclassical taxonomy), while the rest exhibits the typical “well-behaved” competitive, price-taking behaviour. So, some models in this family might well use Romer’s endogenous growth model to generate the price-setting sector.

But in most of the rest of the Neoclassical lexicon, Romer’s insight is ignored. Models like Nordhaus’s DICE, for example, have a standard production function with exogenous technical change. This is where Eggertsson’s dig at me on Twitter is actually informative:

One wonders what economists he is actually asking. His undergraduate students? Reveals approximately zero knowledge about the literature on growth.

There is indeed a Neoclassical literature on growth—just like there is a Neoclassical literature on wage bargaining, on finance, on utility pricing, etc., and even on climate change—unfortunately (Lenton et al. 2021; Keen 2020). There are economists who spend their whole careers in one of these fields, writing numerous papers extending this aspect of the Neoclassical literature. But these sub-fields of Neoclassical economics never change the core message of Neoclassical economics, because in many ways they are inimical to the core.

Neoclassicals want to believe that (most) markets are competitive (as they define competition), because only if markets are competitive does a “supply curve” exist. They want a production function with constant returns to scale, and incomes based on marginal products, because otherwise their theory of income distribution breaks down. So these literatures exist, and are each voluminous, but the core Neoclassical method is unaffected by them.

Consequently, there is a rich literature of Neoclassical endogenous growth theory models, just like there is a rich literature of crime thrillers, and horror stories, and even love stories, in fiction. But has Neoclassical economics been fundamentally transformed by Romer’s work? Not in the slightest. The vast majority of Neoclassical models don’t apply his insights, just as the vast majority of novels aren’t horror stories.

Lastly, there is a positive contribution of mine that points out a weakness, not just in Neoclassical economics, but in Romer’s attempt to plug a hole in it by providing an endogenous theory of technical change. This is the role of energy in production—something that Rendalh’s contribution to this Twitter debate unintentionally highlighted:

Yes, there is a lot of technological development directed at reducing energy consumption. But when you look at the aggregate global data, there is a quite literally one for one relationship between energy and GWP (Gross World Product, the global extension of Gross Domestic Product):

And even between change in energy and change in GWP:

Why is that? Because “labour without energy is a corpse, while capital without energy is a sculpture” (Keen, Ayres, and Standish 2019, p. 41): energy is an essential input to both labour and capital, without which no work can be done. Therefore, the correct way to think about production is that machines and workers together help transform the energy we find in the environment into useful work.

A Cobb-Douglas Production Function—the mainstay of Neoclassical macroeconomic modelling today—has no role for energy. But if you replace both Capital and Labour with the number of each, times the annual energy consumption of each, times how efficiently they turn that energy into useful work, you get an expression involving the amount of energy that an unskilled worker can put into production (effectively, about 100 watts an hour maximum), times the energy consumption level of the “representative machine” at any given time in history, times the labour and capital components of the Cobb-Douglas Production Function:

    

This is an alternative explanation to the one that Romer provided for growth in output thanks to technical change: that putting more energy into output has been the primary form that technical progress has taken. Of course it has taken human ingenuity to enable that increased energy consumption, but the manifest cause of rising per capita living standards has been rising energy consumption per head.

This, unlike human ingenuity, can go backwards—and if climate change forces us to consume far less energy, this could collapse precipitously. When this happens—I no longer think that it is a question of “if”—then Romer’s model’s explanation for the resulting decline in GWP would have to be a decline in ingenuity. But the real cause will be a drop in energy consumption per capita.

Eggertsson, Gauti B., and Paul Krugman. 2012. ‘Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo approach’, Quarterly Journal of Economics, 127: 1469–513.

Goodwin, Richard M. 1990. Chaotic economic dynamics (Oxford University Press: Oxford).

Jevons, William Stanley. 1888. The Theory of Political Economy ( Library of Economics and Liberty: Internet).

Keen, Steve. 2020. ‘The appallingly bad neoclassical economics of climate change’, Globalizations: 1-29.

———. 2021. The New Economics: A Manifesto (Polity Press: Cambridge, UK).

Keen, Steve, Robert U. Ayres, and Russell Standish. 2019. ‘A Note on the Role of Energy in Production’, Ecological Economics, 157: 40-46.

Lenton, Timothy, T. J. Garrett, M. Grasselli, Steve Keen, Devrim Yilmaz, and Antoine Godin. 2021. “Economists’ erroneous estimates of damages from climate change.” In. Arxiv.

Lorenz, Edward N. 1963. ‘Deterministic Nonperiodic Flow’, Journal of the Atmospheric Sciences, 20: 130-41.

Romer, Paul. 2016. “The Trouble with Macroeconomics.” In.

Romer, Paul M. 1990. ‘Endogenous Technological Change’, Journal of Political Economy, 98: S71-S102.

 

There’s a popular belief that capitalism succeeds because it enables the best product in any industry to survive, while the poorer products lose out. There’s also a popular belief that the market leads to “lock-in”: an inferior concept will come to dominate a product space, and improvement becomes impossible because all subsequent developments are forced to conform with it.

Both beliefs are true. At a high level, capitalism certainly outdid socialism in product innovation. Janos Kornai gave the most sophisticated explanation, that socialist economies were “resource constrained” while capitalist ones were “demand constrained”.

To paraphrase Kornai’s argument, the relentless pressure on centrally-planned Soviet factories to increase the volume of output each year meant that innovation was ignored—just produce last year’s model in more volume. Capitalist firms, however, compete against each other for a limited number of customers, and often the firm that innovated the most would win the battle, and prosper—to the benefit of consumers.

But within capitalism, an inferior technology—like the QWERTY keyboard I’m typing this post on—can dominate because, once it developed as a standard layout for typewriters, all typists learnt on it, and it became impossible to introduce an alternative.

The QWERTY keyboard became the standard when mechanical keyboards didn’t move fast enough for typists’ fingers, and keyboards designed for speed of typing would jam. QWERTY put some frequently typed characters—like “a” and “e”— where the weakest fingers would have to type them, thus slowing typists down and avoiding keys jamming.

With computer keyboards today, jamming is no longer an issue, but we’re stuck with QWERTY. No capitalist firm will produce a keyboard with a more intuitive layout, because a computer without the familiar QWERTY layout would be ignored by consumers. The real-world fact that a capitalist has to satisfy the market to succeed puts a break on how much a piece of technology can change.

There’s another real-world fact that has frustrated me over the years—and it’s striking me again now, as I have been forced to abandon my favorite program for doing mathematics, Mathcad.

This is that, because a product is proprietary under capitalism, it’s possible for great software to be bought by a company whose management doesn’t understand it. Seeing just the dollar signs from a product’s customers, an ambitious company can buy the rights to software, and then ruin it. Ultimately, that ambitious company may well die, which is no great loss. But the great software they bought out and then accidentally killed dies with them.

I saw a lot of this in the 80s and 90s, because I was Software Editor at two Australian computing magazines, firstly Australian Computing, and then Your Computer.

The first great microcomputer database program, dBASE, was designed by the aerospace engineer Wayne Ratliff as a side gig to help him make money on the American football pools. It was bought by a company called Ashton-Tate—which is now defunct. The Wikipedia page https://en.wikipedia.org/wiki/Ashton-Tate tells a very colourful tale of its rise and demise, but one detail it leaves out is that Ratliff wanted to move dBase from its clunky foundations to an advanced approach to databases known as the Entity-Relationship (E-R) model.

Ashton-Tate’s management wouldn’t let him, and instead insisted that he increase the number of files the program could handle from two at a time to ten. Ratliff refused, and left the company. Ashton-Tate went ahead, and dBASE ultimately failed, because what it needed was a better way of organizing data—which is what the Entity-Relationship model Ratliff wanted to introduce would have provided.

That failing, along with Microsoft’s strategy of bundling a database (Access) along with its word processor Word and spreadsheet Excel, ultimately killed the whole end-user database model. Now enterprises use some variety of SQL for large-scale transactions data, while end users … use columns and rows in Excel, which is a downright primitive way of storing data.

The list of programs which befell this fate of death by bad management is huge. And because, when I was a Software Editor, I could get any program I wanted for free, I felt these deaths severely, because these were the programs that I chose to use myself.

A leading Australian hacker once visited my office, and stood transfixed in awe at the shelves of computer software that I had. I humble-bragged “What’s the matter, haven’t you seen that much software before?”. He floored me with the riposte of “No, but I’ve never seen that much legal software before.”

Ventura Publisher (desktop publishing) … Framework (outline processor/integrated software) … TK/Solver (flexible data analysis) … Advanced Revelation (advanced database) … The Magician (graphics) … AskSam (free-form database) … PC Express (multi-dimensional analytic database) Ultimately, I’ve been forced to abandon them all, because management stuffed them up. I now use inferior programs, which outlived these great programs because they had something else going for them—market size in the case of Microsoft’s offerings, an unbreakable market share in the case of other more niche programs.

This week, reluctantly, I’m adding Mathcad to that list. Mathcad is a mathematics program which emulated the blank sheet of paper on which mathematicians work. You entered equations exactly as a mathematician would, and Mathcad calculated, analysed, and graphed them for you.

Then in 2006, Mathcad was bought about by a company called Parametric Technology (PTC). It decided to redesign the program from the ground up, and offer a new program called Prime.

But PTC didn’t bother with maintaining backwards compatibility: Prime couldn’t load Mathcad files natively, and for coming on two decades now, it has failed to offer features in Prime that existed in Mathcad. Two key features for me were an easy data-importing system called the Data Wizard, and the capacity to have 2 vertical axes on a graph. The former made it easy to load data into Mathcad, the latter made it a cinch to produce graphs like the one below, with two different data series plotted on two axes so that, despite their very different values, it’s easy to see the relationship between the two series.

Figure 1: A two-axes graph in Mathcad. 15 years after PTC started developing Prime, it still doesn’t offer double-axis graphs

Over a decade later, PTC still haven’t added these features to Prime. Mathcad power-users like myself got around this problem by continuing to use Mathcad, even though the last release (version 15) came out over a decade ago. But at the end of last year, PTC announced that they were no longer going to support Mathcad: if you needed to move your copy-protected version from an old to a new machine, tough: after December 2021, it can’t be done.

PTC might have thought it was forcing diehards like me to finally adopt Prime, but there’s one more thing they’ve done as well: Prime is now subscription based, and unless I pay a fee every year, it won’t run (a cut-down free version still works, but the comprehensive tool I’d prefer to use is now defunct). So, I have to pay a fee to a company that, in my opinion, ruined a great piece of software, and now wants to charge me an annual fee for not providing features that I regard as essential.

Well bugger that. Instead, I’m adding Mathcad to my collection of great ideas killed by bad management, and I’m going to have to find alternatives to do less well what Mathcad did well all by itself.

There’s a freeware program called SMath Studio that enables the free-form mathematics work I used to do in Mathcad; I’m going to have to learn how to drive Mathematica for symbolic logic—it’s more powerful than Mathcad, but also far harder to learn; and sometime soon I’ll be releasing my own program—called Ravel—to handle the analysis and graphing of economic and financial data that I used to do with Mathcad.

Figure 2: A sneak peek at Ravel

I’m therefore going to have to devote brain cells and time to learning SMath Studio and Mathematica, which for a while is going to reduce my productivity on the economic and environmental issues that I’d prefer to think about. So please bear with me as I learn how to drive these not-so-great programs, as bad management forces me to throw another great program onto the scrapheap of software that capitalism has killed.

As a close friend and colleague of Michael Hudson (Hudson 2004, 2018), I was aware of much of the content of David’s Debt: the First 5000 Years (Graeber 2011) before I read it. But David weaved the tale of debt into the recorded history of humanity in a way that made it revelatory, even to cognoscenti like Michael and me.

He communicated the true tale of how money did not spring out of barter, but evolved out of debt, better than anyone before him. His quirky, bemused writing style took that tale to a huge popular audience, bigger than any in economics since the heyday of J.K. Galbraith—and David was arguably the wittiest public intellectual since JK.

My personal debt to David is for his exposition of the evolution and role of credit throughout history. As a non-mainstream economist, I have always rejected the economic textbook myth of barter. But though I failed to succumb to the standard pedagogical brainwashing that rinses thoughts of money from the minds of mainstream economists, I lacked the knowledge of where and when this pivotal human social construct originated.

David provided that knowledge, and showed how the chains of private debt which enslave us today emanated out of the glue that binds us together as social animals.

The famous intuition by Robin Dunbar, that humans lived in groups of about 150, indicated that this was about the maximum number of interpersonal relations that one human mind could track. Pre-sedentary-civilisation societies were bonded by the human desire to be well regarded. This created many networks, including those of interpersonal debt: who had done a favour to you, to whom did you owe a favour?

Once agriculture allowed the development of much larger communities, the role of keeping track of debts was institutionalised. Originally this was within the priesthood of the society’s religion, which made the religious community a focal point in commercial as well as ideological life. In our time, the banks have taken on that role—and abused it more than most priesthoods would contemplate doing.

David’s vision enabled me to see our modern financial institutions as a continuity, and a perversion, of that quintessential human trait, of keeping track of our debts. What we have now is an institution that wishes to create more such debts, for its own profit. Whereas religions extolled the virtue of not being in debt—”neither a borrower nor a lender be“—supported Jubilees (Hudson 2018), and railed against the practice of usury, banks encourage the creation of debt, champion the creditor over the debtor, and have pushed interest-based financing into every corner of our lives.

This aspect of modern society is what gave David’s historical detective work such contemporary significance. Those of us who understand the role of private debt in capitalism—and David was one of that tiny band—know that it is the explosion of private debt, and not of government debt, that has caused almost all of capitalism’s periodic financial crises (Vague 2019). And yet in contrast with reality, mainstream economics ignores private debt, with its fiction that banks are “mere intermediaries” who take in the deposits of savers and lend them out to borrowers, and rails against government debt.

The former is a fallacy, the latter is a farce. Banks are not intermediaries between savers and borrowers, but are instead the originators of both debt and debt-based money. The government does not borrow from the public when its spending exceeds taxation revenue, but in fact creates money for the public which, unlike credit money, does not come with a debt obligation for the public itself.

But because this fallacy and this farce are believed by much of the public, and most politicians and journalists, skyrocketing levels of private debt have gone unnoticed, while their demonising of government debt has led to far too little fiat-based money being created—which further drives the public into private debt.

Figure 1: Private debt has almost always been higher than government debt, and its booms and busts are the root causes of economic turmoil, to which government debt rises in response

I thought I would always have David’s voice to join with mine, Michael Hudson’s, and the small band of monetary realists, in fighting against this fallacy and this farce. His sudden death in 2020 was, for me personally, the most shocking event in that systemically shocking year. We’ll soldier on regardless, but we’ll soldier less well without him, and with far less panache and wit than we would have done, had he continued to be one of our number.

Graeber, David. 2011. Debt: The First 5,000 Years (Melville House: New York).

Hudson, Michael. 2004. ‘The Archaeology of Money: Debt versus Barter Theories of Money’s Origins.’ in L. Randall Wray (ed.), Credit and state theories of money: The contributions of A. Mitchell Innes (Edward Elgar: Cheltenham, U.K).

———. 2018. …and forgive them their debts: Lending, Foreclosure and Redemption From Bronze Age Finance to the Jubilee Year (Islet: New York).

Vague, Richard. 2019. A Brief History of Doom: Two Hundred Years of Financial Crises (University of Pennsylvania Press: Philadelphia).