Home > The Economics Profession > The value of simple models, with examples of economic dynamics

The value of simple models, with examples of economic dynamics

Here is a  long guest post – a short paper really –  from the geophysicist Geoff Davies, whose cogent comments on this blog and his essay The Nature of the Beast have added much to the discussions.  By way of introducing this article , he writes:  

 

My perception is that people on this blog know something needs to be done, but many are unclear how to proceed.  There is a lot of debate about methodology and philosophy (e.g. Handtke’s piece in RWER 56) but not a lot of work on improving our understanding.  People seem to struggle to extricate themselves from the neoclassical confusion of mathematics with science.

So drawing on his experience with geophysics, Geoff offers the following as one way forward for economics.

 

The Value of Simple Models, with Examples of Economic Dynamics

Many people, including many heterodox economists, understand that the neoclassical equilibrium approach to understanding economies is futile and misleading [1], because modern economies are far from equilibrium.  The neoclassical prediction of equilibrium or near equilibrium requires a string of patently absurd assumptions.  However the development of better theories seems to be significantly hindered by a feeling that any superseding theory has to be thoroughly quantified before it can be useful, and a feeling that the neoclassical theory has set a benchmark for sophisticated mathematics that must be matched before another theory can be respectable.  Less fundamentally there seems to be a common perception that empirical insights can only be gained through elaborate statistical treatments of observations.

Here I offer some discussion from my experience as a natural scientist, and some examples regarding the Global Financial Crisis, to counter these hindrances.  Useful and relatively simple models can be constructed that can immediately overcome major neoclassical limitations, for example by permitting non-equilibrium behaviour.  The solution of the mathematics can be done using very standard numerical integration methods that are readily available in commercial packages.  Mathematical machismo is not required.  There are also situations in which the empirical lesson is obvious with no analysis, as will be noted here.

I should be clear that there are certainly many modellers who operate outside neoclassical confines, reported for example in Beinhocker’s excellent survey of “complexity economics” [2].  The lessons offered here will not be news to them.    Also some of them are constructing quite complex models that are nevertheless very instructive, such as models with many interacting adaptive agents.  This article is prompted by my reading of some heterodox blog discussions, and is addressed to anyone who may have some difficulty seeing how to move beyond the neoclassical approach.  Nor are the models here are offered as original investigations, though they may lead to such.

General points on quantification and mathematics

Theories do not necessarily even have to be quantified to provide important insights.  I have argued that the recognition of economies as self-organising systems with many possible states already implies three important conclusions:  that economies can be restored to their appropriate place serving society, that there can be a diversity of economic styles rather than a monoculture, and that economies can be compatible with the living world.

Nor does quantification have to be comprehensive or to involve highly sophisticated mathematics to yield useful insights.  Indeed when a field is new, useful insights can often be gained from rather simple models, even from back-of-the-envelope, order-of-magnitude estimates.  Some striking examples of this difference in outlook between physicists and economists are recounted by Waldrop in his excellent book Complexity [3].

Economics is new in this sense, as the recognition of its complexity (in the technical sense) requires that it be thoroughly re-explored and re-conceived.  In the natural sciences quite rough approximations are frequently used in such situations to, in effect, roughly map out the territory.  More careful quantifications can then be appropriate to clarify and refine early findings.  Indeed, unless guided by clear preliminary concepts and rough estimates, a more elaborate quantification can turn out to be a waste of time, or even misleading, if inappropriate parameter values have been used.

An example from my own field is an estimate that a magma ocean, resulting from the collision of two proto-planets, might solidify within only a few thousand years [4].  Even if this estimate is uncertain by one or two orders of magnitude it still makes clear that the magma ocean will freeze much more quickly than the time it takes for the final planet to aggregate, which is tens of millions of years.  That is an important insight.

More basically, neoclassical economists seem to have a fundamental misconception that if they are doing sophisticated mathematics then they are doing science.  This misconception goes back, via Milton Friedman, to the founding work of Walras among others.  In science, mathematics is a very useful tool, but it is only a tool.  In science, a hypothesis is proposed and its implications are compared to observations of the world.  The objective is to find a hypothesis (or theory or story) that provides a useful guide to how the world is observed to behave.  Mathematics is very useful for deducing the implications of a hypothesis, which can then be compared to observations.  It can also be useful for processing observations (e.g. via statistics).  The crucial distinction between mathematics and science is the comparison with observations, and the subsequent judgement as to whether the hypothesis is proving to be a useful guide.  Neoclassical economics seems to have missed this fundamental distinction at the beginning, well over a century ago, and never to have noticed the oversight.

The importance of dynamics, and the role of money and debt

A financial market bubble and subsequent crash is an intrinsically dynamical event.  In other words the market is driven by internal forces or feedbacks that move it through and beyond any perceived “true” value or equilibrium state.  In October 1987, financial market values changed by thirty to forty percent in a single day, though there was no  corresponding external event affecting the real economy.  This demonstrated, starkly and with no analysis required, that financial markets are strongly affected by internal forces, and that they must have been far from equilibrium before, after or both.  Such events clearly cannot be modelled by the equilibrium or quasi-equilibrium concepts that are the foundation of neoclassical economics.  Indeed it must be doubted if the highly volatile financial markets could ever be so modelled.

Money must play a pivotal role in the internal dynamics of economies;  more specifically this applies to token money, which is money without its own intrinsic worth.  This is because token money links the present to the future, so in dynamical terms it operates on the time-derivatives of economic variables.  This can be explained as follows.  If I receive a ten-dollar note I am, in effect, receiving a promise from the community that it can be exchanged, in the future, for ten dollars’ worth of real goods or services.  Thus the token (the ten dollar note) amounts to an implicit social contract between me and my community.  That contract links the present (when I receive the note) to the future (when I spend it, i.e. when I exchange it for real goods or services).

The implicit contract involves a debt (the community owes me) and a corresponding credit (I am owed by the community).  Because token money, like all debt, links to the future, it involves our expectations of the future, which fluctuate within the uncertainty of whether the future will actually deliver.  Before I spend the note, it is merely a token of potential wealth.  If the future does not turn out as we expect, my potential wealth may not be realised.  This is also true of other forms of token money, such as entries in books and bits in computers.  It is also true of other forms of debt, and in this context there is no difference between money and debt:  both involve contracts, implicit or explicit, for delayed payments.  Therefore both money and debt must be included in modelling of the dynamics of an economy, meaning its development in time.

Yet according to Keen [5, 6], the role of money in macroeconomics has been seriously neglected.  Indeed much economic theory ignores both money and debt and treats exchange (the fundamental event of economics) as barter.  Notable exceptions have been Keynes’ qualitative discussion of a revolving fund of finance [7], and the circuit theories of money  initiated by Graziani [8].  Keen has been, according to his claim, the first to show quantitatively how Keynes’ revolving fund of finance works, and the first to show, building on circuit theory, quantitatively that a manufacturer can borrow money and still make a profit [9].

Simple dynamical models of economies

The models by Keen [5], and extensions of them by Davies [10] illustrate the intrinsically dynamic nature of economies, and the role of money in those dynamics.  They also illustrate the value of relatively simple models, and contrast with the opaque complexity and irrelevance of neoclassical equilibrium models.

Keen [5] starts with a simple economy that develops by its own internal workings into a steady state.  This steady state demonstrates how Keynes’ “revolving fund of finance” can work, and also serves as a reference state from which to explore other things.  Keen  goes on to demonstrate how a credit squeeze causes a drop in the bank deposits of business and employees and a rise in unemployment.  He extends this model to demonstrate that a government stimulus directed to households is much more effective in quickly restoring employment and circulating money than is a stimulus directed to boosting bank reserves.  These are potentially important findings from rather simple models.

Davies [10] extends Keen’s model to include property, as well as goods and services, so an asset price bubble might be simulated.  The following examples come from this work.  The methods are explained in detail in the references.

Keen’s economy comprises banks, firms and employees (“workers”).  Firms borrow money from banks and use the funds to manufacture goods.  Those goods are sold to employees and bank personnel.  Employees work for the firms in return for wages, and bank personnel work for the banks, deriving income from the interest charged on loans.  Starting with the firms having no money, this little economy quickly approaches a steady state.  Davies’ version includes housing property and employee mortgages and it comes to an analogous steady state, which is illustrated in Figure 1.

Figure 1.

Figure 1:  Approach to steady state in a simple economy.  Quantities shown are accounting balances:  Firm loans, Firm deposits, Bank transaction account, Employee deposits, Bank “vault” account, total money supply and total employee mortgages.  From Davies [10].

In this example the population is steady and the total amount of money is constant.  The money starts off in the bank’s reserve account.  To avoid common confusions, Keen suggests it is useful to think of paper money, and to regard the reserve money as being kept in the bank’s vault.  The model is started with some of this money already in the possession of employees, through their mortgages (otherwise it takes generations for the mortgages to come to steady state).  However the firms start with no money, and both the Firm Loan and Firm Deposit accounts rise from zero.  As firms take loans the bank vault is further depleted, and as firms conduct their business money flows to employees’ deposit accounts.  The bank’s transaction account also rises from zero as interest charges are added.  After a few years a constant amount of money circulates through the various accounts.

This example illustrates fundamentally non-neoclassical behaviour.  During the initial transient phase, lasting 3-5 years, quantities change rapidly – they are dynamic.  The subsequent steady state is not the same as a neoclassical model equilibrium, because the model is not constrained a priori to reach or approach a steady state, it does so through its internal interactions.  During the initial transient the economy is far from a steady state, and a neoclassical model is not capable of representing this phase.  Furthermore the model can deviate far from equilibrium under the action of internal forces, as two more examples will illustrate.

In a variation on the steady model, the price of property is assumed to rise exponentially, simulating a speculative bubble.  If the money supply is also taken to rise exponentially, and some of the bank’s profit is re-invested in its reserve fund, then an economy with perpetual inflation results, as shown in Figure 2 (note the logarithmic vertical scale, in which exponentials become linear).  This “growth” behaviour is readily induced in the model.  It is true that the growing property prices and money supply are imposed from the outside, but this type of model accommodates these influences just as readily as it accommodates the steady state of Figure 1.

Figure 2.

It is easy to experiment with this model.  One can, for example, keep the money supply constant as property prices increase.  In that case, not surprisingly, the bank vault is soon depleted, but the response of the other variables is also instructive:  firm and employee deposits and the bank transaction account continue to increase, but the firm loans peak and decline.  A recession would soon ensue.

Another experiment was to couple the property price to employee indebtedness.  Although the total of employee deposits was increasing in the model just mentioned, some deposits went into overdraft (not shown here:  more detail is in the reference).  Therefore the rate of increase of the property price was reduced in proportion to the overdrafts.  The result was that property prices peaked and crashed, taking the rest of the economy with them.  The primary variables are shown in Figure 3.

  Figure 3. Primary variables for the case of a property crash.

 
Prices and wages are compared in Figure 4 for the three cases.  Prices are nominal prices for goods, whereas property prices are prescribed as already described.  Wages and unemployment (below) are calculated from a Phillips curve.  The exponential increase in land prices in the inflationary case (Figure 4b) can be contrasted with the peak and decline in the crash case (Figure 4c).  Wages and goods prices both decline in the latter two cases, though in proportion so that real spending power is roughly maintained.  However many employees are heavily in deficit.

  Figure 4. Nominal prices for goods, wages and land prices for the three cases considered. 

Unemployment is dramatically different in the three cases (Figure 5).  It is near 6% in the steady case, only about 2.5% in the inflationary case, but high early and then skyrocketing in the crash case.  It should be borne in mind that the unemployment rate is calculated from an empirical Phillips curve that merely characterises the way economies have behaved over the past few decades.  Further details of these models can be seen in the reference  [10].

Figure 5. Unemployment for the three cases considered. 

The point being made here does not so much concern the details of the models, nor their potential veracity, but rather the relative simplicity of the models and their ability to yield instructive detail on the interactions among the variables characterising the model economy.  They are also readily amenable to experimenting with various assumptions, as these examples illustrate.

In an example of instructive detail, Figure 3 shows that during the crash the bank vault reserves increase as firm deposits and employee deposits crash.  In other words money is withdrawn from circulation, and this will slow the productive economy.  Keen also found that bank reserves increase during his simulated credit crunch.  The important policy implication of this is that it does little good to boost bank reserves, as was done in the United States.  It does more good to boost consumer spending, as was done in Australia.

The mathematics

The mathematics behind these models comprises a coupled set of ordinary, first-order differential equations.  An example is the equation for the balance, ED, in Employees’ deposit accounts.

where t is time FD is the balance in Firms’ deposit accounts, and the other factors are rate constants representing the rate of pay received from Firms, the rate of interest received from the bank, and the rate of consumption expenditure.

Such a coupled set of equations may not easily yield analytical solutions, but it is readily integrated numerically.  Commercial packages such as Matlab, MathCad or Mathematica will do this routinely on a desktop computer.  Analytical solutions can be valuable if they can be obtained without undue simplification, because they reveal the internal interactions of variables explicitly.  However these equations are still simple enough (even though the set of them is quite large in Davies’ models) that the behaviour resulting from numerical integration can be understood fairly readily with careful examination.  Therefore these models can lead to useful insights.

Contrast with a neoclassical approach

Keen [6] has drawn attention to a draft paper by prominent economists Gauti B. Eggertsson (NY Fed) and Paul Krugman (Princeton, NY Times columnist, Nobel Laureate) that attempts to apply equilibrium modelling to the Global Financial Crisis [11].  Their paper illustrates fundamental problems with the neoclassical approach.  Keen gives a detailed critique, and only a few main points will be made here.

Most basically, equilibrium models cannot follow the system through a bubble and crash like that illustrated in Figures 3, 4(c) and 5(c).  They have to make do with before-and-after models.  However the “before” condition was not at equilibrium (otherwise it would not have crashed) so they cannot properly represent it.  Neither is there any assurance that the “after” condition is at any equilibrium.  Indeed, as there has been no fundamental reform, the global financial system is probably moving into another boom and bust sequence, which is intrinsically out of equilibrium.

Next, the models do not include money, or debt of any form, astounding as this seems to an outsider to the field.  The authors reveal a fundamental misconception by stating “Ignoring the foreign component, or looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth – one person’s liability is another person’s asset.”  In the real world, when banks issue money by creating it out of nothing and “loaning” it, the “borrowers” can spend it, even though there is the formality of a book-keeping entry treating the borrower’s debt as a bank asset.  People can also fail to pay back the “loan”, thus creating a problem for the bank.  This is central to the dynamic of a boom and bust.  Keen notes that the authors also reveal their ignorance of Minsky and Schumpeter.

Lacking money, the authors contrive obligations between “impatient” agents and “patient” agents, where what is borrowed is not money, but “risk-free bonds denominated in the consumption good” (whatever that might mean).   They assume there is a ceiling on the amount that impatient agents can borrow and they contrive a crisis by lowering that limit for the second of their two equilibrium models.  Such contrivances are not necessarily a bad thing, if the model is carefully posed to reasonably represent an observed aspect of the world.  They might still be instructive in principle, if carefully interpreted, but in this case the models are so unrealistic that little useful is likely to be learned.

The neoclassical situation can be contrasted with the simple non-equilibrium models presented above.  Analogous contrivances have been used in the cases illustrated in Figures 2 and 3.  In Figure 2, the price of property is assumed to rise exponentially with time.  In Figure 3 the price is assumed to respond negatively to the level of overdraft of employees.  However these models were conceived as steps towards a more satisfactory kind of model.  Although they are already instructive in some respects, they have the potential to do much better.  The land price and the money supply can be made mutually dependent, which creates the potential for an internally-driven instability, and the model will then follow the dynamics that result, however far from any notional equilibrium it may stray.  Neoclassical models can never do that.

Bibliography

1. Davies, G.F., Economia: New Economic Systems to Empower People and Support the Living World. 2004, Sydney: ABC Books.  Pdf available here.

2. Beinhocker, E.D., The Origin of Wealth. 2006, Boston: Harvard Business School Press.

3. Waldrop, M.M., Complexity. 1992, New York: Touchstone. 380.

4. Davies, G.F., Heat and mass transport in the early earth, in Origin of the Earth, H.E. Newsome and J.H. Jones, Editors. 1990, Oxford University Press. p. 175-194.

5. Keen, S. (2010) Solving the paradox of monetary profits. Economics E-Journal 4,  DOI: 10.5018/economics-ejournal.ja.2010-31.

6. Keen, S., “Like a Dog Walking on its Hind Legs”: Krugman’s Minsky Model, 4 March 2011, in Steve Keen’s Debtwatch.  Also in Real World Economics Review Blog.

7. Keynes, J.M., Alternative theories of the rate of interest. Economic Journal, 1937. 47: p. 241-252. http://www.jstor.org/stable/2225525.

8. Graziani, A., The theory of the monetary circuit. Economies et Societes, 1990. 24(6): p. 7-36.

9. Bruun, C. and C. Heyn-Johnsen, The Paradox of Monetary Profits: An Obstacle to Understanding Financial and Economic Crisis?, in Economics Discussion Papers, No 2009-52. 2009.

10. Davies, G.F., Exploring the dynamics of asset bubbles. 2011. 14 pp.  AssetBubbleDynamics (pdf 885 kb).

11. Eggertsson, G.B. and P. Krugman, Debt, Deleveraging, and the Liquidity Trap:  A Fisher-Minsky-Koo approach. 2010, 33 pages, here.

  1. March 14, 2011 at 7:56 pm

    “More basically, neoclassical economists seem to have a fundamental misconception that if they are doing sophisticated mathematics then they are doing science.”

    I found this as a supplement to the Handtke piece (stumbled to it from Davidson’s comment on “How to succeed as an academic economist.”

    Click to access davidsonpaperword.pdf

    “Is ‘Mathematical Science’ An Oxymoron When Used to Describe Economics?”, Journal of Post Keynesian Economics, Vol 25, No. 4, Summer 2003.

    You people are making me want to go back to school – at 55, why not?

  2. Lucy Honeychurch
    March 14, 2011 at 10:06 pm

    Excellent article. Thank you!

  3. Kim
    March 14, 2011 at 10:46 pm

    This approach may provide some useful insight about the real world if and when its output is tested against independent empirical data. The author has unfortunately left out the most important part of the work. I doubt that most, if any, of the described variables can ever become predictable to any acceptable degree due to their inherent variability but I would love to be proven wrong.

    • March 16, 2011 at 11:21 am

      Kim –
      It’s true these models are not taken to the point of comparison with observations – this is a discussion, not a scientific paper. The immediate point is their relative simplicity. If a model like this can generate a boom and crash that resembles the real-world ones (the objective of further work) then that will be the test of the usefulness of the modelling.
      The short-term objective is not so much prediction as insight. Crashes are intrinsically hard to predict in detail. However if we can better understand the causes and symptoms of booms and crashes then that would be a useful contribution.

  4. Jorge Buzaglo
    March 15, 2011 at 3:31 pm

    The failures of geophysics are these days as relevant as the failures of economics, or more. These days are crisis days for science in general, included the revered science of physics, I think. Science, or more exactly, scientism, has made excessive and unfounded promises. It has lacked of ethical, human insight, in a deep sense. Economics is (or should be) a moral science.

    • March 18, 2011 at 4:30 am

      Jorge,
      Science is not a monolithic group of people, it is a process – often abused, I would agree. At its best science is the attempt to make sense of what we can observe about the world. I would include making sense of the behaviours of economies in that endeavour.

      My conception is that the purpose of an economy is to serve the society we choose to live in, and each society can choose for itself what that is. To quote from my draft manuscript “Our Place”,
      http://betternature.wordpress.com/booksanddownloads/our-place/ :
      “If quality of life is understood to encompass material, social, environmental and spiritual concerns, and if the government sees its role as managing society, with the economy subordinate to and serving society, then the goal of economic management would be more aligned with the goal of enhancing quality of life.”

      And to quote from “The Nature of the Beast”, posted here a few months ago,
      https://rwer.wordpress.com/2010/08/02/how-to-build-a-narrative-linking-the-various-heterodoxies-part-2/
      “if economies and living systems are both forms of complex systems, then there is no reason in principle why an economy cannot be made compatible with living systems.”
      I include human societies in “living systems”.

  5. Dave Taylor
    March 17, 2011 at 3:24 pm

    Thanks, Geoff. As someone else said recently, perhaps the insights economics needs will have to come from non-economists. I found your introduction of logarithmic scales encouraging, as that is the basis of Shannon’s information theory. Giving bankers and CEO’s bonuses in millions (10^6) rather than 6 times what others get is symptomatic of the whole problem of percentage markups.

    Jorge, while I entirely agree with you, isn’t the “deep sense” that no-one is asking for an explanation of what morality is? They seem to take for granted David Hume’s 1740’s “black-box” argument that what is inside it can only be personal feeling. By 1938 Shannon had showed how logic can be effected by electrical switching circuits, and it can now be shown that the brain which has feeling works that way too. By 1948 Shannon and Wiener had shown how error correction after the event is possible not by sacrificing efficiency but by making use of redundant capacity to monitor and put right errors; Wiener called continuous error correction “Cybernetics”, though by 1968 control engineers had become aware that navigation involves learning from the past and anticipating problems in the future as well as steering for a known destination. (See, for example, The Radio and Electronic Engineer 34/6, Dec 1967, pp.323 for a technical interpretation of Keynes).

    As a Christian informations scientist and sometime control engineer I suggest that morality is about conscientious (with-science, well-informed) use of error-correcting logic as well as axiomatic logic, both when selecting and pursuing uncertain goals. Compare that with the traditional morality and confessional practices of pre-Reformation Christianity, and economists firing bullets rather than guided missiles at utopian targets, as described by George deMartino in PAERevew 56.

  6. merijnknibbe
    March 17, 2011 at 6:24 pm

    Geoff, great post.

    but it’s, in my view, not yet enough. We do not only have to change the models (even if that’s quite necessary). We even have to change concepts (or rediscover them).

    Take (only one example) the concept of ‘capital’ (I mean physical capital, not financial capital). I really think that we have to change this (back) into: capital and land, ‘land’ including resources. Sounds nice, and green. And it is nice, and green. But changing this concept has major (no: decisive) influence on theory on growth and distribution and even our idea of property.

    In every textbook, the neo-classical formula Y = a.f(K,L) can be found. Production is the result of combining labor with capital and technology (the a in the formula), with capital receiving the just share of capital (profits) and labor receiving the just share of labor (wages).

    Try to change this with: (Y minus depletion of resources) = b.f(Capital, Land, Labour). Suddenly, it becomes important who owns ‘land’ when we talk about income shares – and who profits from depletion of resources. And that’s not just theory: in quite a number of countries, resources like gas or coal are owned by ‘the state’. In some others, by individuals.

    Similar stories can be told for labor, unemployment, inflation, money. Not just the definitions but even the concepts often have to be changed.

    Your approach is necessary – but not enough!

    • March 18, 2011 at 4:08 am

      Thanks Merijn.

      And I completely agree that it’s not enough. I like your extension of the old, limited notions to include natural resources. I’ve taken it a bit further still, at least conceptually:
      “To bring an innovation successfully to market requires knowledge, effort and, if more than one person is required, leadership. So perhaps it is the confluence of knowledge, leadership, effort, leisure, physical resources (if required) and (possibly) money that generates innovation.”

      That’s a quote from my manuscript Our Place http://betternature.wordpress.com/booksanddownloads/our-place/
      which is undergoing major revision (much of it will taken into “The Nature of the Beast”.

      Economies are put in a much broader context (of society, history, evolution, life) in Economia, which is downloadable:
      http://betternature.wordpress.com/booksanddownloads/economia/

  7. shivz
    March 18, 2011 at 9:07 pm

    Luckily, I don’t know what neo-classical economics is. What I do know is that I never received a ten dollar note – that is, without working for it. Indeed, I know people who receive money without working, but then, I know also that the work was done by others.

    What I mean is that Davies’ very first premise is, to say the least, questionable. He says that by getting the note, I receive “a promise from the community that it can be exchanged, in the future, for ten dollars’ worth of real goods or services”, but he fails to note that,

    (a) those goods and services were/are produced by someone who, most probably, was paid already for their production;
    (b) there is no such thing as a contract between the ‘community’ (i.e., the State) and its members/citizens/subjects (ultimate proof is the State’s unquestionable power to print money at will, or ‘at need’ if you like); and
    (c) except for a contract of sale (not being, I presume, Davies’ intention), no explicit or implicit contract in the world could guarantee the quantity of goods and services that could be purchased with my ten dollar note (this is implied by Davies as well, but then, what kind of ‘contract’ is it?).

    Hence, the following mistake: “The implicit contract involves a debt (the community owes me) and a corresponding credit (I am owed by the community)”, meaning thereby, if I am not mistaken, that by receiving or being paid a tenner, no matter what for, or from whom, the ‘community’ owes me real goods and services, for “both [money and debt] involve contracts, implicit or explicit, for delayed payments.”

    There is no question about the contractual nature of credit/debt, but does the possession of money have anything to do with contractual liability? Indeed, upon ‘receiving’ (i.e., earning) a ten dollar note, I expect the ‘community’ to enable me to purchase goods and services at the then known prices, but there is no obligation on the part of the community to do so – in matters under its control, let alone those beyond its control.

    Therefore, the question is not whether someone, or some entity, owes me anything just because I happen to possess a ten dollar note, but the rationale behind such expectation. Mine is quite simple: I ‘received’ the tenner for contributing to the availability of the ‘real goods and services’, knowing that in my community this is the norm for all or most members, or in other words, that the rationale of money is labour and technology – of men and men-made machines, not the printing presses.

    New (printed) money is not a dirty word, theoretically and practically (particularly, money printed on the bsis of tehcnological progress), but claiming that “firms borrow money from banks and use the funds to manufacture goods” is to say a lot and nothing at the same time. If, for example, firms get from the banks all the money they need, what is the socio-economic rationale of profit? Just to pay dividends to shareholders and bonuses to managers (for what Keynes so aptly called, and praised, ‘riotous living’)?

    One gets the impression that for Davies, ‘dynamics’ is indissolubly connected to money-creation out of nothing; that the notion of employing earned income (say, my ten dollar note), or business profit, as capital, is nothing but an archaic, useless stuff.

    • March 18, 2011 at 11:17 pm

      Shivz-
      I certainly didn’t mean to imply that I “received” a ten dollar note without earning it. As I think you understand, if I work and then I’m given a piece of paper for my contribution, I expect eventually to get more than the piece of paper for the work I contributed. So you say
      “Indeed, upon ‘receiving’ (i.e., earning) a ten dollar note, I expect the ‘community’ to enable me to purchase goods and services at the then known prices”.

      And your last paragraph is not what I believe or mean to say.

  8. Dave Taylor
    March 21, 2011 at 10:04 am

    Shiv has clearly forgotten all the gifts of ten dollars’ worths we receive from our families, and communities which educate us.

    This is one of those situations where you need to look at the facts critically and repeatedly until a gestalt shift enables one to see an alternative interpretation which has been there all along.

    First, on the issue of contracts, our community’s agent the Government as of now underwrites bank loans by recreating its reserves as bonds, the repayment of which it can (as now) legally if not morally enforce, whether or not Shiv recognises that as a contract he has made.

    Second, bankers – as of now agents of those who have anything to bank – either resupply credit already earned, or contractually lend it: usually against some security against non-repayment, but ultimately on the security of government bonds and legal title to property.

    Third, looking at these arrangements in the long term, they began with the government exchanging bonds for money with which to pay for public service not yet given, and the banks issuing promises with which to pay for goods not yet owned. But whereas government bonds are written off more or less as its public service is performed, as of now money capital (plus interest) is returned to the bank and cumulatively recycled. It thus increases at a far faster rate than goods and services, permitting price inflation to control consumption and blow speculative bubbles in massive credit-funded trade with legal titles to other people’s high-value securities (property, businesses, stocks and shares and derivatives thereof).

    Looking long-term at the people these arrangements are supposed to serve, given that all of us reach adult-hood massively in debt to our parents and/or the community which supports them, whether ten dollar bills ever represent more than a fluctuation in our “student loans” is one thought. Another is whether, after all, household management is a system based on giving rather than borrowing, where we can rarely repay specific benefactors but (after the manner of a hitch-hiker), keep the system going by giving lifts in our turn, to those who need them. Applying that to traders, when I offer him my authorised credit note, isn’t I who am offering a promise that my ten dollars has or will be earned, and he who gives me credit of real substance?

    By now I’ve had my gestalt shift. What I now see is the bankers authorising credit, traders giving it, workers regenerating what has been consumed and money returned to the bank having already served its purpose. Whether or not it is now traditional, the double entry bookkeeping whereby banks take advantage of our (and seemingly, Government) naivety to create the illusion that THEY are lending us recycled credit of substantial value – so that WE owe them – strikes me as an abuse of trust. In an honest system, banks would write off credit authorisations once they had been properly used.

    Had Governments any common sense, they would issue livelihoods in the form of automatic rations of credit, reduce banking to accounting for their proper use, make international traders responsible for their own balance of trade, finance the stock exchange with Monopoly money, and facilitate the doing of what needs doing by generally relegating competition to the playing fields, where the law of the jungle can be transformed into an ethos of self-discipline and intelligent cooperation.

  9. March 22, 2011 at 1:18 pm

    Another simple model, with references to the false hope and flawed theory that has given rise to the misleading Classical Demographic Transition Model.

    http://www.panearth.org/GPSO.htm

    We are routinely presented with plenty of factoids, figures and statistics. Where is the scientifically-driven evidence regarding the population dynamics and unbridled, skyrocketing growth of the human species on Earth?

    As humanity’s most luminous beacon of truth, science provides us with a last best hope for the survival of life as we know it on Earth. We must make certain that scientific evidence is never downplayed, distorted and denied by religious dogma, politics or ideological idiocy.

    Let us not fail for another year to acknowledge extant research of human population dynamics. The willful refusal of many too many experts to assume their responsibilities to science and perform their duties to humanity could be one of the most colossal mistakes in human history. Such woefully inadequate behavior, as is evident in an incredible conspiracy of silence among experts, will soon enough be replaced with truthful expressions by those in possession of clear vision, adequate foresight, intellectual honesty and moral courage.

    Hopefully leading thinkers and researchers will not continue supressing scientific evidence of human population dynamics and instead heed the words of Nobel Laureate Sir John Sulston regarding the emerging and converging, human-driven global challenges that loom ominously before humankind in our time, “we’ve got to make sure that population is recognized…. as a multiplier of many others. We’ve got to make sure that population really does peak out when we hope it will.”

    Sir John goes on, “what we want to do is to see the issue of population in the open, dispassionately discussed…. and then we’ll see where it goes.”

    In what is admittedly a feeble effort to help John Sulston fulfill his charge to examine all available scientific evidence regarding human population dynamics, please give careful consideration to the following presentation and then take time to rigorously scrutinize the not yet overthrown science from Russell Hopfenberg and David Pimentel regarding human population dynamics and human overpopulation.

    http://www.panearth.org/GPSO.htm

    Please accept this invitation to discern the best available science of human population dynamics and human overpopulation; discover the facts; deliberate; draw logical conclusions; and disseminate the knowledge widely.

    Thank you.
    Steven Earl Salmony
    AWAREness Campaign on The Human Population,
    established 2001
    Chapel Hill, NC
    http://sustainabilityscience.org/content.html?contentid=1176
    http://sustainabilitysoutheast.org/

  10. Dave Taylor
    March 23, 2011 at 12:11 pm

    With respect, Steven, the Dismal Science got its name from Malthus being aware of the scientific evidence on population and arguing it was best to let nature take its course, as there was nothing we could do about it. That reflects Hume’s as against Bacon’s conception of science – what you see is all you get – whereas Bacon realised the significance of experiment and education in making new things possible. It also reflects the view of those trained in the dominant Humean and older Aristotelian traditions, who mistake that for education, so that the “sensory” majority – be it of religious, politicians, ideologues (salesmen) or scientists – never grow up sufficiently to understand what they have missed.

    Since Religious Dogma seems to be your primary concern, let me reinterpret those as “working hypotheses”, based variously on tradition, Humean scientism and real science. Catholic scientists have focussed on how real people think and reproduce, to discover what can be done about the findings of generalised population dynamics – apart from selling condoms and merciless slaughter of the innocent by means like abortion, eugenic extermination and war. They have found rhythms of reproduction which facilitate the application of instinctive and Aristotelian self-discipline to sexual self-control. The largely successful incest taboos show what can be achieved where the majority have had sufficient education to understand the need for self-control.

  11. shivz
    March 26, 2011 at 8:56 pm

    Geoff Davies and Dave Taylor,

    I wish you were referring to specifics.

    1. I quoted Davies saying that “firms borrow money from banks and use the funds to manufacture goods”, and asked: “If firms get from the banks all the money they need, what is the socio-economic rationale of profit? Just to pay dividends to shareholders and bonuses to managers?” (being only one issue arising out of Davies’ statement).
    If the socio-economic function of profit is more than that, then, Davies would probably want to reconsider his statement.

    2. Davies says: “I certainly didn’t mean to imply that I ‘received’ a ten dollar note without earning it. As I think you understand, if I work and then I’m given a piece of paper for my contribution, I expect eventually to get more than the piece of paper for the work.”
    True and understandable, but regrettably, he chose to ignore the heart of the matter, namely, the rationale of such expectation. I, on my part, could not be more explicit, namely, “the rationale of money is labour and technology – of men and men-made machines, not the printing presses”, or any mode of credit creation, I would add.
    Had Davies addressed the issue itself, he might have realised that people work for that piece of paper because they assume that it is backed by physical bread that is already offered for sale in the shops.
    Schumpeter — favourably mentioned by Davies –, realised (1934) that much by explaining his ‘abnormal credit’: “In one sense no goods and certainly no new goods correspond to the newly created purchasing power. But room for it is squeezed out at the cost of previously existing purchasing power”.
    The bread in the shops will be, indeed, a little bit squeezed, but the point is that no one would agree to accept that piece of paper without assuming that the bread is there (I maintain that there should not be any squeeze if the newly created purchasing power is based on, or happened to be issued simultaneously with, technological progress).

    3. In my comment I specifically asked: “There is no question about the contractual nature of credit/debt, but does the possession of money have anything to do with contractual liability?”
    Instead of addressing this question, Taylor speaks about the contractual obligation of governments to pay their debts. The obligation is surely there, but unlike individuals, governments can default, ‘restructure’, or impose a haircut, leaving no legal remedy whatsoever to its citizens-creditors, for this is, after all, what sovereignty is all about.
    Davies’ and Taylor’s treatment of ‘contract’ is, to my mind, too loose, confusing social contracts philosophies (e.g., Hobbes’ “Leviathan” and Rousseau’s “Du Contrat Social”), with contracts made between members, like contracts of loan.
    My contention is that the mere possession of currency (cash) does not, cannot, and should not, constitute any obligation, contractual or otherwise, on the part of ‘the community’ to exchange your money for a given quantity of goods (effectively, like the good old gold standard). Notwithstanding the form of government, the State’s power of money-creation and taxation, let alone sending us to the battlefields, speaks for itself.

    4. And a word about the banks. Unfortunately, recent events totally obfuscated the basic and indispensable functions of the banking system (already in 1991, Ron Chernow wrote: “At this point [the 60’s], investment banking still functioned according to a textbook model in which capital was tapped for investment, not financial manipulation. The age of financial engineering hadn’t yet dawned”).

    Regulators cannot tell high-tech people how to design their products, or what style the hairdresser should apply, but as for the banks and the ‘product’ they are dealing with, there is nothing regulation cannot fix or control, and in particular, having them return to what is called ‘boring banking’.

    However, by saying that “In the real world, banks issue money by creating it out of nothing and ‘loaning’ it”, I believe that Davies alludes to the core function of banking, not to financial engineering or machinations; meaning thereby that goods production is conditioned upon the creation of money (purchasing power) out of nothing. Now, instead of ruminating on the question as to whether banks really create money out of nothing, let me ask a simple question: if Davies (backed by a most distinguished group of economists) is right, what does the liability section in the banks’ balance sheets stand for? Is it a fiction, a mere book-keeping formality, or does it represent real debt (owed by the banks)?

    My answer is that the liability side is real, at least as the household wage- and non-wage purchasing power created by the assets side is (see Schumpeter above). Davies says that “firms borrow money from banks and use the funds to manufacture goods”. The problem, or rather, his problem, is that wages are paid in cash, and therefore, the wage-earners who are supposed to manufacture Davies’ goods, would, first, demand cash from the bank that created the new money, expecting, as Davies most aptly put it, goods to be waiting for them in the shops. But, goods produced by whom?

    There is a good answer to that, but it is not to be found in the money-creating keyboards of bankers.

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