Economists don't understand accounting

I don't much like Steve Keen, because while his understanding of private sector credit expansion is good, he does not understand how an out-of-sector source is needed for private sector net (not gross) financial assets. In other words, he does not understand how the Government is a currency issuer.

Nevertheless, this observation from a recent talk he gave is interesting:

One part of the discussion that I found quite notable was that, even after showing empirical evidence on the impact that rising and then falling private debt had on the economy both now and during the Great Depression, I couldn’t convince several of the academics in the audience of the importance of private debt: they kept coming back to “one person’s debt is another person’s asset, therefore the level of debt doesn’t matter”. They therefore argued vehemently that the distribution of debt was important, but its aggregate level was irrelevant.

This is the core miscomprehension about debt that economists have. They see bank debt as the same as personal debt -- if I lend $10 to you, then I do not have $10 to spend myself, so the aggregate level of spending money available is unchanged.

However, bank lending does not work like this. If a bank lends $10, the $10 gets deposited in some other bank and is therefore available to lend again, limited only by capital requirements. In this sense, one person's asset is not another person's liability, and the total (gross) quantity of financial assets can expand and contract, while the total (net) quantity of financial assets remains the same.

The latest stupidity: NGDP

The latest dumb idea circulating the orthodox economics blogosphere is NGDP targeting. In this scheme, the Fed, instead of saying "inflation is too high" or "employment is too low" instead says "we want NGDP to be x%". After this proclamation, the economy will start growing at the required rate to hit the declared NGDP target.

Magic, no?

So, what will the Fed do if the economy doesn't suddenly start growing? They will buy more and more Government debt, driving the interest rate further and further out the yeild curve to zero.

"But isn't that just quantitative easing?" you ask.

It is.

"Isn't the Fed doing that now?" you ask.

It is.

"So, what's the difference?"

There is none. But if you believe monetary policy is effective, and you live in a world where it clearly isn't being effective, you've got to do something.

In my view, the Fed fully knows that the economy is growing too slowing and unemployment is too high. They've done everything in their arsenal by bringing the Federal Funds rate to zero, and have gone a step beyond by bringing longer term rates down to zero as well. None of it is working, because changing the duration of outstanding Government debt does not solve the problem of an undercapitalized private sector. The economy needs a larger deficit to start growing again, but economists don't understand accounting, and so do not understand sectoral balances etc.

MMT understands this dynamic very well, and need give no quarter to orthodox macroeconomics, just as oxygen need give no quarter to phlogiston.

Ages ago I read some book on the sociology of philosophy, and the big lesson in it was how all the philosphers you read about knew one another, either directly or indirectly, and how ideological movements compete with one another. If your school of thought is ascendent, then you gain fame by forming a (hopefully) ascendent spliter group. If your school is in decline, you build bridges with those who might think a little different to try and build a bigger tent. And if you are on the outside, you should just be a crank and attach the most dominant group around to try and get their attention, and have them give you credibility by engaging.

The NGDP crowd is a splinter group off orthodox macro. MMT are the cranks. They will not win through accomodation.

Occupy Wall Street

Occupy Wall Street is like a Rorschach test -- people read into it what they want.

A particularly fanciful take on this is from Venkatesh Rao, whose excellent blog I would recommend, but difficult book I might not. (Venkatesh -- if you ever read this, please do not judge the prior comment to harshly. It's more a reflection on the extremely high quality of the blog and the very difficult task you set yourself in the book, not an absolute judgment).

I was not familiar with Sterling's talk at PopTech, so "favella chic" and "dark euphoria" were new to me, and I'm grateful for the introduction.

Rao says, reasonably, that

I am surprised by the number of commentators who have switched from being dismissive to taking it seriously, simply because the thing has grown bigger and angrier, and we happen to be in the run-up for a Presidential election. Call me a cynic, but I don’t think the growth of the movement means squat. Here’s why.

Here's the "here's why", and at this juncture we part company:

It does not matter how many people demonstrate and pour out into the streets. This is not a problem that can be solved by industrial-age collective action models because the problem is the end of the industrial age. One side has collected the trophy and left the field, the other side is still on the field, trying to convince itself the game is still going on. The winners, and ahead-of-the-curve losers, are already setting up the playing field for the new game.

The problem is not the end of the industrial age, the problem is a lack of aggregate demand. We have a lack of aggregate demand because finance is mismanaged, both at the industrial level ("Finance industry") and at the Governmental level ("deficit spending" and "financial regulation"). The reason that finance is systemically mismanaged is because the academic paradigm of finance is simply wrong. Economics professors are not good at accounting, they consider it beneath them, so they simply do not know that their macroeconomic models do not follow double-entry bookkeeping and are therefore wrong.

Accountants don't notice that macroeconomics is wrong because they imaginationless grinds.

Venkatesh ends with

"[expect] a reboot the likes of which we haven’t seen since 1776.

Fasten your seat-belts. It is going to get far uglier than the #OccupyWallStreet gang realize."

Maybe, but maybe not. We have a vision of our future, and it's Japan, which never restored aggregate demand after their credit bubble popped in the mid 80s. Does modern day Japan strike you as having experienced a reboot, the likes of which we haven't seen since 1776? When you sip your Daiginjo-shu in Tokyo, are things really all that ugly?

OWS is better thought of as a popular protest, some of which is genuinely seeded by popular disgust with the financial industry and it's government compatriots, and some of which is engineered by reporters, academics, and left wing policy entrepreneurs who want a more Communist version of the Tea Party. The problem is, that this faction has already won--first in the 30s, and then again in the 60s. This, my friends, is the smell of victory.

Nonsense from Meeker

I won't comment on the rest of Meeker's presentation (which was fine but banal--how did Meeker manage to do so well while Blodget flamed out??) but I will draw attention to this slide on America's income statement:



I'm not picking on Meeker here, it is normal and natural to think about a currency issuer's finances the same way one of think of a household if that's the frame supplied by the community of interpretation (to use a Stanley Fish phrase). So, ignore the stock flow inconsistency etc. of the slide and reflect on the fact that, quibbles aside, there's nothing here that Paul Krugman wouldn't sagely nod his head at.

I spoke too soon: Netflix

Seems like Reed has decided to take back his decision to split Netflix into a video streaming business (the future) and a DVD by mail business (the legacy).

I wonder why he changed his mind. I thought the decision to split the company was excellent.

Recapitalize the non-Govt Sector, not the Financial Sector

When you have a credit bubble -- ie. banks make loans that do not get paid back -- then the subsequent credit bust de-capitalizes banks (as they must write down assets and equity) constraining their ability to lend anew.

As the non-government sector needs additional financial assets to grow, if banks cannot lend (capital constrained) then the economy as a whole starts to trouble.

This, in a nutshell, is where the "Too Big to Fail", "We Must Bail Out the Banks" argument comes from, and it is true, as far as it goes.

Nevertheless, there is more to the story. First, if banks were making loans that did not get paid back, then they were not doing their primary job which is to make good credit decisions. Bad credit decisions should be punished, and the owners and operators of such companies should be fired and/or wiped out. This is how markets work. Rewarding such behavior only encourages more bad practices in the future, and people (rightly) start to wonder why we have a financial system at all.

Second, if banks fail, that contraction in private financial asset growth can be balanced by "capitalizing" the rest of the non-Governmental sector directly (through some combination of tax cuts and spending increases -- whatever increases the deficit). Since economists at Harvard and Princeton do not understand that the Government is the sole creator of net financial assets (equity) for the private sector, they do not know that this policy lever is on the table. So we are where we are.

From Macroeconomic Resilience

My policy proposal has three legs all of which need to be implemented simultaneously:

* Allow Failure: Allow insolvent banks and financialised corporations to fail.
* The Helicopter Drop: Institute a system of direct transfers to individuals (a helicopter drop) to mitigate the deflationary fallout from bank failure.
* Entry of New Banks: Allow fast-track approvals of new banks to restore banking capacity in the economy.

The argument against allowing bank and corporate failure is that it will trigger off a catastrophic deflationary collapse in the economy while at the same time crippling the lending capacity available to businesses and households. The helicopter drop of direct transfers helps prevent a deflationary collapse and the entry of new banks helps maintain lending capacity thus negating both concerns.

Sad Day

I had the good fortune of running into Steve Jobs in the flesh right off California Ave about a year ago. I was so thrilled at having a chance to meet the man, and thanking him for all the marvels he created.

And he met my little girl.

So long, Steve.