Austrian School: Crap/Not Crap?

[camouflage]

I suspect we're going wrong if we think of effects as being mostly independent of one another, with effects ending and another beginning. If we look at the complexity wrought by, for example, derivatives (and I don't mean the products themselves, but their effects), then we need to accept that effects, be they from Peak Oil, other scarcity, commodities blips or from banking chickens coming home to roost, interact with each other and sometimes synergise in terms of the number of people they effect. I think it's impossible to blame Peak Oil, QE or any other single factor.

Indeed, it's all a glorious tapestry etcetera.

 

[camouflage]

TBF, UK housing prices are still in a bubble, to all intents and purposes.

I agree, it's scary that so far we have the 'great recession' but not even the benefit of being out of the bubbled-up asset prices to be grateful for. It's like having been knocked over by a bus that then stops and parks itself on you. It's ok for the people on the bus I suppose, but still. Isn't a similar situation responsible for Japans "lost decades"?

 

[ViolentPanda]

I agree, it's scary that so far we have the 'great recession' but not even the benefit of being out of the bubbled-up asset prices to be grateful for. It's like having been knocked over by a bus that then stops and parks itself on you. It's ok for the people on the bus I suppose, but still. Isn't a similar situation responsible for Japans "lost decades"?

The cynic in me says "well, the government and the market have an interest in keeping the bubble inflated, however many people the bus runs over".
I'm not sure that Japan is a good analogy, though. They did/do at least have a productive capacity which could take up some of the slack in their economy, even if it couldn't take them off the plateau. here, we've got nothing similar.

 

[littlebabyjesus]

Japan's economic indicators before their credit crunch in 1990 were remarkably similar to the UK's in 2007 in terms of the debt structure. Both crunches were caused by an excess of private debt - in Japan's case it was more company debt than individual, but as a % of gdp, the figures for private/public debt are near as damn it identical. And the response to both crunches has been the necessary replacement of that private debt by public debt. So far, as in Japan, the private sector remains stubbornly intent, taken as a whole, on paying down its excessive debts, and demand in the economy remains very weak.

This doesn't have to be all doom and gloom. If a way were found to stop the rich from continuing to get richer, zero growth would be perfectly acceptable. After all, the economy today is larger than it was 10 years ago, and 10 years ago, nobody was saying that we were in a crisis. But because of the functioning of capitalism in its current form, zero growth means that capital still takes its returns, and everyone else gets progressively poorer as the size of their slice of the pie is reduced.

 

[littlebabyjesus]

To add a point about the Austrian school, their whole way of thinking is detestable. They are amoral in their outlook, and to look at economics as if it were amoral is itself immoral.

Adam Smith said famously that the baker does not bake his bread out of altruism, but out of self-interest. But he wasn't entirely right about that. There is a real sense among most people that they like to do good. If they can combine doing good with making a living, that is ideal. We are moral beings, after all, and to remove morality from the economy in this way is simply wrong. It leads to a 'Dragon's Den' / The Apprentice style of thinking where the profit is what matters, the means of making that profit largely incidental. To remove the concept of service from work is a horrible thing to do - and we see all around us the faceless chains that are a result of this.

 

[camouflage]

Adam Smith has in my opinion been horribly misunderstood. To my reading what he meant was that there's no 'grand plan', that generally enriching effects can emerge from people just tootling along doing their own thing, talking and walking and transacting and planning in the manner we call the market. For some reason this has been read as some sort of ruthless selfish I'm-alright-so-yooz-can-fuck-right-off type attitude which is not to my mind what he meant at all! It's a bit like what happened to Darwin really ("wow, life seems to evolve and adapt to different environments" becomes transformed in the minds of muppets into "Crush The Weak, The Strong must Dominate!!111!!)

In fact the guy wrote another book too that I'm quite interested in giving a read (if I ever complete my struggle through the one currently on my Kindle where he blathers on a bit too much re bushels of wheat and things called 'shillings') titled

The Theory of Moral Sentiments​

in which he apparently espouses (as the name suggests) the wider context in terms of human relations and wider society.

 

[littlebabyjesus]

He assumed that everyone shared core values of decency and fair play. However, he did stress this point about self-interest. I agree that he was taken the wrong way by the likes of Thatcher. But imo, his model was still wrong. It did not allow for the complexity of human motivation. As is often the case with models, the process of simplification can introduce lies.

 

[camouflage]

He assumed that everyone shared core values of decency and fair play. However, he did stress this point about self-interest. I agree that he was taken the wrong way by the likes of Thatcher. But imo, his model was still wrong. It did not allow for the complexity of human motivation. As is often the case with models, the process of simplification can introduce lies.

I disagree. If I were to say that a network of paths can be formed through woodland without any grand-design, just by people and animals coming and going about their own individual business, I don't think that equates to saying you need a gaggle of psycopaths to make it possible to navigate the wooldand, it's got nothing to do with selfishness, just describing that aspect of emerging patterns that is not designed in accordance with any overall scheme but can lead to making it easier for all to get around. Not even saying that selfishnes has a virtue really. He did use the term 'self-love', I concede. but that was missleading considering what he was actually saying. As misleading as saying people and animals walking through the undergrowth going about their own 'self-loving business' might imply a bunch of wood-dwelling masturbaters wandering around Hamstead Heath.

 

[littlebabyjesus]

I don't disagree particularly with that aspect of what he said, although it's almost a truism - but yes, order can emerge from the interactions of many individuals, none of whom has that order in their heads, and none of whom necessarily understands the order that they are a part of. I agree with that bit, and it's something that occurs in all kinds of contexts.

What I disagree with is the emphasis Smith laid on self-interest as the motivator, as defined by him. He mistakenly characterised people as rational. We're partially rational beings, but we are also emotional beings, and we are motivated by all kinds of things that cannot easily be reduced to self-interest, even 'enlightened' self-interest. We also do good for the sake of doing good, and any economic model that doesn't include this will be wrong. Smith only told half a story. And while I also agree that Smith was no Austrian-school devil, he got lots of things wrong, including not anticipating at all how capitalism would lead to extremes of wealth distribution. I suspect that if Smith were alive today, he himself would be making these same criticisms of what he said.

 

[camouflage]

I don't disagree particularly with that aspect of what he said, although it's almost a truism - but yes, order can emerge from the interactions of many individuals, none of whom has that order in their heads, and none of whom necessarily understands the order that they are a part of. I agree with that bit, and it's something that occurs in all kinds of contexts.

What I disagree with is the emphasis Smith laid on self-interest as the motivator, as defined by him. He mistakenly characterised people as rational. We're partially rational beings, but we are also emotional beings, and we are motivated by all kinds of things that cannot easily be reduced to self-interest, even 'enlightened' self-interest. We also do good for the sake of doing good, and any economic model that doesn't include this will be wrong. Smith only told half a story. And while I also agree that Smith was no Austrian-school devil, he got lots of things wrong, including not anticipating at all how capitalism would lead to extremes of wealth distribution. I suspect that if Smith were alive today, he himself would be making these same criticisms of what he said.

Well I've been putting forward my disagreement with the way he is generally represented, but frankly I don't think anyone can claim a proper understanding of Smiths ideas on human behavious unless they have first read both of the books I've referred to above. "Smith only told half a story" you said, but have you like most people only read half of what he's said?

(I know I have, only read part of half )

 

[littlebabyjesus]

Alright. Fair point. No I haven't read that book.

 

[love detective]

Have you read wealth of nations?

Do you think if he was alive today he would criticise the parts of Wealth of Nations that talked about the desirability & requirement for things like progressive taxation, redistribution, safety nets, public good provision and pro worker organisation (and anti-employer collusion) - all such things suggest that, despite the very early stage capitalism was at at the time he was writing, he certainly had some insight into how capitalism could lead to 'extremes of wealth distribution' which you claim he did not anticipate.

not to mention his theory of alienation of labour through productivity developments, and his (somewhat muddled) labour theory of value - all of which can be found in WN - and that's before we start to look at WN in the context of the theory of moral sentiments

You seem to be taking your reading of Smith from right wing free market types who also haven't read him

 

[littlebabyjesus]

I've only read some of it, I admit. I'm aware that he spoke a good deal about how employers need to be prevented from exploiting workers/customers. The dangers of the very private monopolies that Thatcher created, for instance. But do you think he anticipated the savage exploitation of the 19th century?

Things like this:

As soon as government management begins it upsets the natural equilibrium of industrial relations, and each interference only requires further bureaucratic control until the end is the tyranny of the totalitarian state.

And many other quotes like it, show the idea that those right wing types picked up on - the idea that there is a 'natural equilibrium' that the invisible hand will bring. That this equilibrium is good is a given to him, is it not?

My criticism of this kind of thinking is that it doesn't account for the fact that essential resources are limited. It also takes as a given the idea that private property is somehow 'natural'. Combine those two, and you have a problem, imo.

And this quote was famously said by Thatcher:

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages.

This most definitely only tells half the story for me. There is a certain kind of (imo, mistaken) philosophy that insists that there is no such thing as altruism, that everything we do can be put down to self-interest of some kind or other. But I find this way of thinking barren, since it provides no explanation at all as to why people act as they do. Appealing to the idea of self-love really is only half a story. What about love for others?

 

[ItWillNeverWork]

And many other quotes like it, show the idea that those right wing types picked up on - the idea that there is a 'natural equilibrium' that the invisible hand will bring. That this equilibrium is good is a given to him, is it not?

My criticism of this kind of thinking is that it doesn't account for the fact that essential resources are limited. It also takes as a given the idea that private property is somehow 'natural'. Combine those two, and you have a problem, imo.

Another criticism of equilibrium theory is that it is grounded in an immature understanding of dynamic systems. All systems have circular causation, feedback loops, and variables that interact in other complex ways. Systems can have multiple equilibria, or be completely unstable around a number of equilibrium points that are never reached.

Anyone who has studied even a small bit of engineering or physics can tell you this, but all these advances in science/maths have completely bypassed most economists despite having been around for the best part of a century. It beggars belief that economists are so out of touch, tbf.

 

[littlebabyjesus]

Yes, good point. tbf there are economists who take this seriously. Not the Austrian school, though. You do still hear extraordinary things, such as the 'natural rate of unemployment', which are not just wrong, but bear no resemblance at all to the society they are trying to describe. It's like they've just arrived from Mars.

 

[Blagsta]

Another criticism of equilibrium theory is that it is grounded in an immature understanding of dynamic systems. All systems have circular causation, feedback loops, and variables that interact in other complex ways. Systems can have multiple equilibria, or be completely unstable around a number of equilibrium points that are never reached.

Anyone who has studied even a small bit of engineering or physics can tell you this, but all these advances in science/maths have completely bypassed most economists despite having been around for the best part of a century. It beggars belief that economists are so out of touch, tbf.

This is kinda what Marx was getting at with his dialectics.

 

[love detective]

But do you think he anticipated the savage exploitation of the 19th century?

why would someone push for the desirability & requirement for things like progressive taxation, redistribution, safety nets, public good provision, the benefits of worker organisation and the dangers of employer collusion if they didn't recognise that capitalism, left to itself, was capable of such degradation of humanity?

If, as you assert, he didn't anticipate that capitalism would lead to the extremes of wealth distribution, what logical explanation could there be for him focussing on, and being supportive of, the kind of things i mention above?

Smith also got to a couple of things nearly a 100 years before Marx did - namely a labour theory of value and the revolutionary potential for society of the division of labour/automation, while at the same time foreseeing the alienating aspects of it for labour. Given how rudimentary & nascent industrialised capitalism was at the time of Smith's writing, I don't think there is much scope to criticise him for his lack of anticipation of a whole load of problems that the ongoing development of capitalism could and would bring with it. Politically and economically he was effectively a social democrat who believed capitalism could be tamed and made to work for the benefit of all (so if he should be criticised it should be for this) - and just as much cause could be made for him being a pre-marx marxist as could be made for him being a full on market liberal (i.e. a little, but not much either way)

Things like this:

And many other quotes like it, show the idea that those right wing types picked up on - the idea that there is a 'natural equilibrium' that the invisible hand will bring. That this equilibrium is good is a given to him, is it not?

Smith generally had the view that government intervention could not make things better unless there was a market failure in that particular area - this is the view that led him to believe in the necessity for public good provision etc (as the market would never provide it safely/properly) - so from a wider perspective and reading of him, there is a case for invoking his 'market failure' qualification to negate the specifics of some of the more commonly used market liberal love in type quotes. Clearly he felt the market had a role to play and supported its extension into various aspects of life, but not in the unlimited & unrestrained way that he is used by market liberals.

My criticism of this kind of thinking....

I'm not sure you have the necessary holistic grasp on what his 'kind of thinking' was to be honest (as evidenced by your various comments above) - your criticisms of him are responses to selectively mined quotes by pro market liberals, devoid not only of the wider context of his theory of moral sentiments but also of the context of wealth of nations itself from which they come. This kind of passive 'engagement' with Smith just feeds into and supports the false appropriation of Smith by nakedly pro market liberals - much better to deprive them of their hero by using his work against them

There is a certain kind of (imo, mistaken) philosophy that insists that there is no such thing as altruism, that everything we do can be put down to self-interest of some kind or other. But I find this way of thinking barren, since it provides no explanation at all as to why people act as they do. Appealing to the idea of self-love really is only half a story. What about love for others?

I agree with you about there perhaps being a certain kind of philosophy that insists there is no such thing as altruism, but to lump Adam Smith into the type of thing you talk about above says more about your lack of understanding/knowledge of his writings than it does about anything else. If you'd even been aware of the existence of what Smith probably considered his most important work (The Theory Of Moral Sentiments) then there is no way you would have written the above - for example does the quote below from TMS fit in with your portrayal of Smith as only being concerned with self love and not love for others?

to restrain our selfish, and to indulge our benevolent affections, constitutes the perfection of human nature; and can alone produce among mankind that harmony of sentiments and passions in which consists their whole grace and propriety. As to love our neighbour as we love ourselves is the great law of Christianity, so it is the great precept of nature to love ourselves only as we love our neighbour, or what comes to the same thing, as our neighbour is capable of loving us.

 

[camouflage]

Yes, good point. tbf there are economists who take this seriously. Not the Austrian school, though. You do still hear extraordinary things, such as the 'natural rate of unemployment', which are not just wrong, but bear no resemblance at all to the society they are trying to describe. It's like they've just arrived from Mars.

What would you say the 'natural rate of unemployment' means?

 

[ymu]

Adam Smith proposed a land tax, on the grounds that rentiers produce nothing useful and land cannot be hidden or expatriated. Fell over backwards when I read that. There's plenty the right don't like to mention about their intellectual forebears.

Thanks for those posts ld, really useful.

 

[ItWillNeverWork]

This is what nature thinks of equilibrium.

A chemical clock is a complex mixture of reacting chemical compounds in which the concentration of one or more components exhibits periodic changes.[1] They are a class of reactions that serve as an example of non-equilibrium thermodynamics, resulting in the establishment of a nonlinear oscillator. The reactions are theoretically important in that they show that chemical reactions do not have to be dominated by equilibrium thermodynamic behavior.

In cases where one of the reagents has a visible color, crossing a concentration threshold can lead to an abrupt color change in a reproducible time lapse. Examples of clock reactions are the Belousov-Zhabotinsky reaction, the Briggs-Rauscher reaction, the Bray-Liebhafsky reaction and the iodine clock reaction. The concentration of products and reactants of oscillatory chemical systems can be approximated in terms of damped oscillations.

http://en.wikipedia.org/wiki/Chemical_clock

 

[camouflage]

This is what nature thinks of equilibrium.

A couple of things here... first I don't see what your point is with the video, the solution seemed to switch fairly evenly between blue and clear. I imagine that on a graph it would be a fairly regular sine-wave, a steady heartbeat. Over the long term the liquid will be about fifty percent blue and fifty percent clear. How does this contradict the idea that equilibriums can exist in nature? Secondly, who is asserting that equilibrium is real, economists generally or Adam Smith? Hayek or Mises?
I don't think anyone in the thread has said that including those named.

I'm interested in reading up on Minsky, he's an economist whos ideas you might find interesting.

 

[ItWillNeverWork]

A couple of things here... first I don't see what your point is with the video, the solution seemed to switch fairly evenly between blue and clear. I imagine that on a graph it would be a fairly regular sine-wave, a steady heartbeat. Over the long term the liquid will be about fifty percent blue and fifty percent clear. How does this contradict the idea that equilibriums can exist in nature? .

The point is not that equilibrium's don't exist. The point is that systems do not necessarily converge on a single one. The concept of equilibrium as used by economists assumes that these convergences occur in order to clear markets. For example, the Austrian theory of business cycles rests on an assumption that the economy will coordinate present investment with future consumption via an equilibrium interest rate - if this rate is distorted by government, then the economy is thrown out of equilibrium. Their opposition to minimum wage laws and unions are a consequence of believing that there is a unique price that clears labour markets and spontaneously leads to full employment.

My suspicion is that the economy contains internal dynamics that produce cycles spontaneously, and that boom/bust will therefore not be ameliorated by simply getting government out of the way. Cycling might be as natural to economies as it is to certain chemical reactions.

Secondly, who is asserting that equilibrium is real, economists generally or Adam Smith? Hayek or Mises?
I don't think anyone in the thread has said that including those named.

I don't think Smith talked of equilibriums in the same way as economists do today. He wrote about an invisible hand of course, and this is a verbal description of a similar process, but the idea of a formal mathematical equilibrium came later on. Hayek and Mises (or at least followers of them that I have spoken to) would reject the claim that they utilise equilibrium concepts (and Austrians in general tend to make a big fuss about how their theories are truly dynamic, and unlike the mainstream). However, they just sneak equilibrium in through the back door as an assumption in their business cycle and labour theories.

I'm interested in reading up on Minsky, he's an economist whos ideas you might find interesting

Yeah, I've read a little bit about him just recently. Intuitively there seems to be a lot that makes sense in what he says.

 

[littlebabyjesus]

Their opposition to minimum wage laws and unions are a consequence of believing that there is a unique price that clears labour markets and spontaneously leads to full employment.

Thing is, even if this is true - which I dispute - that doesn't necessarily mean that the condition of full employment in this hypothetical situation of a free market will produce wages at the bottom that are liveable. Amartya Sen has done a lot of work showing how famines are not necessarily caused by bad harvests so much as the collapse in the value of the wages of the poorest workers to the point where they can no longer afford to feed themselves. He specifically looked at the Bengal famine of the 1940s, during which he and his family and loads of other middle class families experienced no shortage or hardship at all, while just down the road people were starving. The harvest wasn't particularly bad - it was the means of distributing it equitably through pricing that had gone wrong.

There is no reason in a world of limited resources for any kind of unregulated market to provide for everyone. I wish I had the skills to do it, but I think it should be possible to model this in, for instance, a housing market. Where there is a limited resource - land, primarily in this case, but also building materials and workers - that is owned privately, the most profitable situation for those who already own is one of permanent shortage. What I'd like to be able to show is how this situation can be produced without any kind of controlling mind, simply through individuals and firms acting to maximise their own wealth.

That's the stupidity in my mind of Austrian school thinking - resources are limited and distributed unequally: in such a situation, there is not, and can never be, a free market. They model something that bears little resemblance to reality.


I've also been reading up on Minsky. He hypothesises that it is stability itself that sows the seeds for instability - there is no equilibrium in other words - as long periods of stability lead to riskier and riskier investments until investments in fact become Ponzi investments. The power of his argument, to my mind, comes from the way that he very precisely predicted the rise in sub-prime mortgages after a long period of stability, and described how these would eventually lead to collapse. This paper sums up briefly his idea. And this table shows how what he predicted would happen happened - the 'sub-prime' are the Ponzi investments in Minsky's way of thinking. The 'Minsky moment', when wile coyote realises that he's run off the cliff, asset values collapse and Ponzi investments show their real (lack of) value, is pretty clear too:



Minsky talks a lot about the way that banks are not merely facilitators of profit, but active profit-seekers themselves - and as such, are constantly looking to innovate. What I'm not clear about is whether or not he thinks that the finance for the Ponzi investments is always properly backed by a liability - a deposit of some kind - or whether he thinks that the complexity of innovative financial instruments is in fact a cover for financing that is not backed by a corresponding deposit. It would explain a lot to my mind if the latter were true.

 

[littlebabyjesus]

Coming back very briefly to Adam Smith, I'm not sure what bearing his moral philosophy has on his political ideas, tbh. His ideas about morality seem to be a fairly conventional expression of Christianity - where 'love thy neighbour' is held to be the most important commandment of all. Thatcher always claimed to be motivated by Christian morality. Cameron's Big Society guff could be taken to be the same thing.

 

[camouflage]

Thing is, even if this is true - which I dispute - that doesn't necessarily mean that the condition of full employment in this hypothetical situation of a free market will produce wages at the bottom that are liveable. Amartya Sen has done a lot of work showing how famines are not necessarily caused by bad harvests so much as the collapse in the value of the wages of the poorest workers to the point where they can no longer afford to feed themselves. He specifically looked at the Bengal famine of the 1940s, during which he and his family and loads of other middle class families experienced no shortage or hardship at all, while just down the road people were starving. The harvest wasn't particularly bad - it was the means of distributing it equitably through pricing that had gone wrong.

There is no reason in a world of limited resources for any kind of unregulated market to provide for everyone. I wish I had the skills to do it, but I think it should be possible to model this in, for instance, a housing market. Where there is a limited resource - land, primarily in this case, but also building materials and workers - that is owned privately, the most profitable situation for those who already own is one of permanent shortage. What I'd like to be able to show is how this situation can be produced without any kind of controlling mind, simply through individuals and firms acting to maximise their own wealth.

That's the stupidity in my mind of Austrian school thinking - resources are limited and distributed unequally: in such a situation, there is not, and can never be, a free market. They model something that bears little resemblance to reality.


I've also been reading up on Minsky. He hypothesises that it is stability itself that sows the seeds for instability - there is no equilibrium in other words - as long periods of stability lead to riskier and riskier investments until investments in fact become Ponzi investments. The power of his argument, to my mind, comes from the way that he very precisely predicted the rise in sub-prime mortgages after a long period of stability, and described how these would eventually lead to collapse. This paper sums up briefly his idea. And this table shows how what he predicted would happen happened - the 'sub-prime' are the Ponzi investments in Minsky's way of thinking. The 'Minsky moment', when wile coyote realises that he's run off the cliff, asset values collapse and Ponzi investments show their real (lack of) value, is pretty clear too:

View attachment 17474

Minsky talks a lot about the way that banks are not merely facilitators of profit, but active profit-seekers themselves - and as such, are constantly looking to innovate. What I'm not clear about is whether or not he thinks that the finance for the Ponzi investments is always properly backed by a liability - a deposit of some kind - or whether he thinks that the complexity of innovative financial instruments is in fact a cover for financing that is not backed by a corresponding deposit. It would explain a lot to my mind if the latter were true.

Hedge Finance: can pay interest and principal.
Speculative Finance: can pay interest, but not principal.
Ponzi Finance: can pay niether interest nor principal.

To my understanding this would indicate that Ponzi finance is not backed by anything, thus being named after this guy...

 

[JimW]

Coming back very briefly to Adam Smith, I'm not sure what bearing his moral philosophy has on his political ideas, tbh. His ideas about morality seem to be a fairly conventional expression of Christianity - where 'love thy neighbour' is held to be the most important commandment of all. Thatcher always claimed to be motivated by Christian morality. Cameron's Big Society guff could be taken to be the same thing.

Wasn't one of the main points Polanyi made in The Great Transformation that it was precisely this divorcing of some supposed rational economics from a moral framework for human interactions that was one of capital's ideological achievements?

 

[littlebabyjesus]

Here I'm a little unclear about what Minsky means. He says that loans can only be paid back if there are also future loans, and indeed loans are made in expectation of future loans.

But fractional reserve lending is supposed to work in such a way that less than 100 percent of any deposit is loaned out - so no matter how stupid your investment was, or how unwise the loan, it is not money that's come out of nowhere. You have a problem if the loan isn't paid back, of course, as you can't honour your liabilities, but the money doesn't just come out of nowhere - every loan is backed by a deposit.

Now on the borrower's side, Minsky's terms make sense - the asset/expected income and its relation to their ability to pay: so the finance isn't backed by collateral/earnings on the borrower's side, but should be on the lender's. If it's standard fractional reserve lending, the lender's finance is always backed by a deposit of greater value than the loan.

Minsky elsewhere talks about money being created by loans, then destroyed again when the loan is paid back. This makes a lot of sense - and if you could construct a system so opaque that the origin of the finance is not clear, you could just create the money out of nowhere with no deposit to back it up, and the system would work fine as long as the borrower pays it back: the money is created then destroyed again, and everyone's happy. But that's not allowed under fractional reserve lending. My question is: 1. is an explosion in credit such as was seen in the last 20 years even possible in a fractional reserve lending system where all loans must be backed by deposits, and 2. if not, are the new complex financial instruments in fact hiding the truth - which is that the money for the loans was created out of thin air in a way that isn't supposed to happen - on the back of notional asset prices, in other words, and on the back of the expectation of rising asset prices in the case of Ponzi investments: which would be a true Ponzi scheme.

 

[camouflage]

are the new complex financial instruments in fact hiding the truth - which is that the money for the loans was created out of thin air in a way that isn't supposed to happen - on the back of notional asset prices, in other words, and on the back of the expectation of rising asset prices in the case of Ponzi investments: which would be a true Ponzi scheme.

Yes. Except the not supposed to happen bit, it just does happen because Confidence itself can be Credit. Exuberance as well I imagine.

 

[littlebabyjesus]

Steve Keen (a Minskyite economist) talks about this - basically, he says that banks don't first build up deposits then loan - but the reverse: they make loans then look for the deposits. After all, banks don't make money by taking deposits - they make money by making loans, and it is the demand for loans that determines how much money they need, and can afford, to take in deposits.

The model of money creation that Obama’s economic advisers have sold him was shown to be empirically false over three decades ago.
The first economist to establish this was the American Post Keynesian economist Basil Moore, but similar results were found by two of the staunchest neoclassical economists, Nobel Prize winners Kydland and Prescott in a 1990 paper Real Facts and a Monetary Myth.
Looking at the timing of economic variables, they found that credit money was created about 4 periods before government money. However, the “money multiplier” model argues that government money is created first to bolster bank reserves, and then credit money is created afterwards by the process of banks lending out their increased reserves.

This is the endogenous creation of money idea - that loans create deposits, not vice versa. And it appears that there is empirical evidence for this. Expansion of credit comes first, reserves come later. This also fits well with the way that quantitative easing seems to make such a small impact - it is the creation of money before there is any demand for it, so it doesn't do anything.

There is a good wiki page on this:

'Loans create deposits': for the banking system as a whole, drawing down a bank loan by a non-bank borrower creates new deposits (and the repayment of a bank loan destroys deposits). So while the quantity of bank loans may not equal deposits in an economy, a deposit is the logical concomitant of a loan – banks do not need to increase deposits prior to extending a loan.

This makes sense to me - person A borrows from the Bank, pays person B to do something, then person B deposits the money in the Bank.

 

[ymu]

Useful posts there, lbj.

I think Minsky's fundamental point is that neoclassical economics has no proper way of dealing with debt. This is a good paper by Keen on this:

Like a Dog Walking on its Hind Legs”: Krugman’s Minsky Model

Krugman's response to this is more or less "you're right, but I'm too old to reskill - young guns go for it. Please."

On relending deposits, the problem was banks counting non-cash assets as the same thing as cash. This meant that instead of lending out, say, 90% of a new deposit, they could lend out more than 100%, creating an inevitable downward spiral. Read a really good article about this recently, but I can't find it now. Will keep looking. It goes summat like this:

Someone deposits £1. Lend out 90% of the £1 deposited, put 10p in the reserves. Get the 90p on deposit from the borrower, lend out 90%, put 9p in the reserves. You eventually end up with the original £1 in the reserves. Count things that shouldn't be counted as cash as a cash deposit, and you can lend out more than 100% of cash deposits and the amount of liability compared to assets spirals out of control.