← The Peter McCormack Show
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- [00:00]
A
Economists get away with this garbage. And it is garbage in my opinion, because you don't need the economist to have an economy. The economy is something which exists independent of economists. That doesn't apply to engineering. Without engineers, you don't have engineered products. So economists effectively have no skin in the game, to use Taleb's phrase. They can say whatever they like and still be taken seriously if they get inside the mind of a politician. And that's where economics turns into ideology.
- [00:32]
B
This show is brought to you by my lead sponsor, Ayron. The AI Cloud for the Next Big Thing. Iron builds and operates next generation data centers and delivers cutting edge GPU infrastructure, all powered by renewable energy. Now, if you need access to scalable GPU clusters or are simply curious about who is powering the future of AI, check out iren.com to learn more, which is I r e n dot. Steve, hi.
- [00:57]
A
Hi. Good to be back with you. How long ago since we last talked?
- [01:01]
B
I'm gonna say it was very early when I did the podcast. I'm gonna say seven or eight years.
- [01:06]
A
Okay. Okay.
- [01:07]
B
Yeah, a long time ago. And you know what, it's funny enough that show still does really well.
- [01:11]
A
Okay.
- [01:12]
B
You're a good guest to have for Google. It's lived well. But I'm glad we're doing it in person. And you know, the show's very different now.
- [01:23]
I deeply care about two things right now, economics and politics and the cross section of the two, and therefore the future of this country. I think about it a lot and so it's good to talk to you again. I've obviously been entrenched into the Austrian school quite a bit.
- [01:38]
A
Of course. Yeah.
- [01:39]
B
And I'm sure we'll have things we agree or disagree on that. But really I'm just more interested in you and what you talk about. Why does economics matter?
- [01:47]
A
Oh, economics is the description of the way in which our social system functions. So if you want to know how it functions, you've got to know economics. But the question is, does economics actually fulfill its task? In my opinion at the moment, no, it does not.
- [02:02]
We have a whole range of competing schools of thought about how the economy operates, all of which talk past each other. And that's standard for competing paradigms in virtually any discipline. But the reality is most of our decision making about how we should change the economy to make it work better works from what I can fundamentally prove are myths. And therefore, if you kind of. This is the fundamental guiding principle for me is you can't reform what you don't Understand, and that's what I find is the nature of economics.
- [02:30]
B
Would economics work better without politics?
- [02:32]
A
It had worked better without economists, frankly, I think it's. I mean, the extent to which economists have clouded the theory of how the economy actually operates is ludicrous. Politics. We're always going to have political systems. The trouble is, what we've got as a political system basically is inherited from the French Revolution. Even the terms of your left and right, they relate to the structure of the assembly in France after the 1812 revolt.
- [03:06]
And what we get is you get people from ideologies, left ideology and right ideology, competing with each other and, and we vote for them as individuals. And what we basically say is, let's select the most extreme narcissist we can find on the left wing and the right wing and get them to fight each other. And we call that managing the economy, managing society. And what we do is we flip flop from one extreme to the other. And basically one group does what they think is ideologically correct. The right, let's say, then you get the left, comes in and demolishes that and do what they write and you flip between the two because both of them flow fundamentally are wrong. And you don't choose people who actually say, let's try to understand how the system actually operates. And that's why I think the Western economies have been so dysfunctional for the last 40 or 50 years. This everlasting flip between one ideological extreme and the other. Rather than saying, let's just work out how the system works first of all. And then we can debate whether we want to have society going in a left direction or a right direction in social terms, but understand the economy itself. And basically neither side understands it. And the people we select do not have the capacity to understand the system itself as well.
- [04:18]
B
Does politics reward.
- [04:21]
Let me think how to phrase this. Does politics reward bad economics or does good economics get in the way of winning power?
- [04:33]
A
I think it actually comes out of the political system itself.
- [04:37]
I think economics, obviously, given that managing a capitalist economy is the essence of what politics actually does, then.
- [04:48]
If you manage to actually have a correct description of the system, then you will do, and you follow what that description tells you to do, then you'll function better than another economy. But what ends up happening? I saw this particularly looking at how the west won, the progressive west won this World War II. When you take a look at it and what came out of that, we basically learned that the government creates the money that finances the war machine. You had German doing that deliberately from 1932, 33. When Hitler took over the West. Catching up to that, when America got dragged into the war. And of course Britain involved as well. That experience taught the people who managed the economy at that time that government fund things like a war is funded by government money creation, not by borrowing money. And there's a fabulous paper which you may not be aware of, but I'll give you this. Here's the president of the New York fed in the 1940s, goes by the wonderful theatrical name of Beardsley Rummel. Ever heard of him?
- [05:53]
B
No.
- [05:53]
A
Okay, take it down. Cause it's worth reading. Beardsley as in the artist and then Rummel. R U M L. And he wrote a paper in 1946 called Taxes for Taxes.
- [06:06]
I think taxes for spending are obsolete or something of that. Taxes from revision. Taxes for revenue. Tax. Sorry, Taxes for revenue. Taxes. Thank you. Taxes for revenue are obsolete. Great paper. And that was basically recounting the experience of World War II, that the dramatic increase in armor and manufacture in America obviously at the time wasn't financed by borrowing money, it was financed by creating the money. And then that is such an anathema to the Neoclassicals and the Austrians, but mainly the Neoclassicals, they spent the next 30 or 40 years destroying that lesson. So if you look, if you go back and look at the 1940s, what we'd learned from that experience, if that had been transferred to politics in a pragmatic way, we wouldn't be having the crises we've gotten. Most of them. We would have some for sure. We. We wouldn't be having the debates we have now, because that was settled by the experience of World War II. And since then, neoclassical economists have spent their time demolishing that understanding. And now we have these crazy arguments about governments borrowing to spend, et cetera, et cetera, which we learned were wrong during World War II. We've unlearnt that lesson. So in that sense, politics is undermined by economics rather than vice versa.
- [07:14]
B
Does economics require a kind of foundational set of goals, like what you're trying to achieve? And therefore the different schools set.
- [07:21]
A
Now it's more a foundational set of concepts about how the system functions. And when you take a look at the two extremes of visions about how the economy functions, often relate to the question of what determines prices. A price is set by cost of production or a price is set by utility of the buyer. Those are the two extremes. So the Marxian, Post Keynesian schools of thought, classical economics under Smith and Ricardo, all said cost of production sets prices. The Austrian and neoclassical both say it's a combination of the utility of the consumer with the cost of production that sets prices. The classic argument from Marshall being that demand and supply curves are like two blades of a scissor.
- [08:07]
You can't say the top or the bottom blade of a scissor cuts the piece of paper. They both do, and therefore supply and demand both set price and quantity. That's the neoclassical position. The Austrian position is very similar, but it says that we don't always reach equilibrium.
- [08:27]
It's the divergence from equilibrium that gives you the interesting characteristics of capitalism. And then on the post Keynesian and classical side, they say it's the cost of production that sets the price and the utility in that sense determines the quantity. So it says cost determined price and in a sense utility also division of labor, a division of income sets demand since quantity and they separate the two. And that's been a dispute which has been going on for 200 bloody years and it's still unresolved in theoretical terms, but obviously resolved empirically. And that is that the post Keynesians are right and the neoclassicals and Austrians are wrong.
- [09:09]
B
And so help me understand that in real terms, because I would have thought the cost of production sets the base price, but demand can increase the cost of that.
- [09:19]
A
You can have. I mean, Ricardo allowed that. One thing I find very funny is reading neoclassical economic papers and when they try to dress themselves up, they say this is the Ricardian principle. You read Ricardo and he actually trashes neoclassical theory and says it is cost of production that ultimately sets the price. They allow for market high levels of market demand to cause prices to rise at some times and fall a bit at the others. But fundamentally the cost of production sets price. That also comes out of the neoclassical theory. When they reach their point of so called general equilibrium, then you get the bottom of the average cost curve and that sets price. But fundamentally.
- [09:55]
The classical school and the Post Keynesian which follows on from them says it's the cost of production that sets prices for 95% of what we consume.
- [10:06]
Manufacturing goods, you don't go into the local Sainsbury's and if there's a large coup, you don't see the price rises. If there's nobody there, you don't see the prices fall. There are these prices which are set. So the practice of firms is set a price, you either pay the price or you walk out of the shop. That applies to manufactured goods. When it comes to.
- [10:27]
Agricultural products and minerals. Then in that case, because you can't control the output. In the same way you can control the output of a factory, then you've got to move the goods, otherwise they're going to perish. Then you do get demand determined prices in agricultural goods and raw materials. But for manufactured goods, the fundamental prices are set by the manufacturer, but not.
- [10:47]
B
Always or sometimes secondary markets. So during lockdowns, the price of toilet rolls suddenly shot up.
- [10:55]
A
Well.
- [10:57]
You simply can't supply them, you simply run out. The normal situation for factories is to be on average anywhere between 70% and 80% capacity utilization. So there's 30 or 20% of additional output you can produce at the drop of a hat. In effect, you've got to pay for the inputs, but the flexibility for the factories is there to expand that much. When Covid hit, everybody bought toilet paper, I bought toilet paper. And so bang, it was cleaned out. And therefore it became something which was scarce. But the point that Ricardo made, and this is well worth people getting their heads around, Ricardo argued that what economics is about are the things which are easily reproduced in the production systems of a capitalist economy. And that doesn't apply to Picassos, for example, it doesn't apply to fine wines, it doesn't apply to statues that to unique items. So he said scarcity definitely determines the price of those objects. But what we should be looking at in the capitalist economy is how does a section which actually produces goods in a production line for profit, how does that work? And he said, that is not scarcity. We actually have more capacity to consume at any point in time than we have demand for it. And this is another point where I find Austrian and neoclassical basically presume that there's a limit, you're producing past the point of full capacity. When you look at how the neoclassical theory defines diminishing marginal productivity, which is also an Austrian concept, and it then implies you're going to have rising cost, not because you're paying more for your inputs, you assume the inputs are constant quality, but because inputs are crowded. If you read economics textbooks like Mankiew and stuff like that, that describes a typical factory. One of his typical factories is.
- [12:55]
Hungry Helen's Pizza Factory or something like that. Hungry Helen? You've shopped at Hungry Helen?
- [12:59]
B
No, don't know it.
- [13:00]
A
How strange. I mean, there's thousands of outlets all over the planet. So long as you look inside economics textbooks, they're fictional. They make these examples up, okay? So what they have is people are trying to Hungry Helens. I think it was a. May have been a biscuit factory, I think, or something of that nature. And Everybody's, I think it was a coffee machine. You're all lining up to use the grinder. So you've got more workers per cappuccino machine than actually is ideal. And therefore because of that, people queue, they bump into each other, they fall over. It's keystone cops, basically, idea of a factory. And therefore to produce more output, you've got to put more workers, same number of machines, you get less output per machine. That is garbage that might apply to somebody's corner lemonade stand, you know, a kid doing something on a weekend to make extra money. You go inside a factory, they've always got spare capacity. And the reason for the spare capacity is because you're competing with known rivals. You're trying to attract customers away from your rivals with product differentiation, which is completely left out of the neoclassical mindset. They seem homogenous products, which is nonsense. So you're fighting different rival companies. You want to bring customers into your shop rather than theirs. You need to have spare capacity to do that.
- [14:16]
B
Well, does it mean the nuance here is that it's product dependent? There is mass produced goods in factories and then there's items that rely on scarcity.
- [14:27]
A
Yeah. And there's 95% in the former and 5% in the latter. So if you're going to do a simplicity in your analysis, which one do you focus upon? The 95%. What do the textbook focus upon? The 5%. And this is incredibly frustrating to me because I've read pretty much every resurvey paper that's been done on the cost structure of actual firms. And this dates from the 1930s. It's coming up to a century that this has been known. All the economists expected this rising supply, cost, diminishing marginal productivity, et cetera, et cetera. Every time they sat down with manufacturers, they managed to say, what the hell are you talking about? Our costs fall with output, they don't rise.
- [15:07]
B
Okay, that's what I would expect.
- [15:09]
A
I know, and you're wrong. And this is. There's one thing I find amusing about the Austrian perspective is that it's all about introspection. You look inside yourself and you. What's it called?
- [15:21]
B
Praxeology.
- [15:22]
A
Praxeology, okay. How can you look inside yourself and know what a factory does? Okay, okay. That's one of the obvious flaws to me. So you've got to go and ask a factory. Okay, that's one part you simply cannot introspectively work out how a Tesla is made or a Falcon 9, or even a hamburger. So you've Got to go and ask them what's their production system and so on. And you'll find that the competitors competitive process leads to them having excess capacity and differentiated products. So you don't fight your rivals by producing exactly the same thing and making it cheaper. You produce something differentiated and you try to attract customers away from your rivals. You know who your rivals are. You're targeting particular firms to beat them in the marketplace. It's a dynamic evolutionary process. It never reaches equilibrium. It's all evolutionary. So that to me is this frustrating mindset that both Austrians and neoclassicals begin with falls over at the very first hurdle when you ask firms how they actually produce output.
- [16:19]
B
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- [17:16]
A
Well, Rolex, you know the brand. Okay, who does Rolex compete against? Longines, A range of other brands. You try to get something which is differentiated yourself. And people aspire to owning your product. So therefore you can charge a larger margin that if you're putting out a swatch. Okay, so what you have is markets are differentiated. The whole idea, you start with a homogeneous product is just bullshit. It's homogenous. Like, I'm a blueberry addict. I eat blueberries for breakfast. Blueberries are not homogenous. You get the crunchy, the squishy ones. Don't put them in your mouth. You got the solid ones. You're willing to pay a higher price for that. Everything is differentiated. So in watch manufacture, you have a whole range right from this watch at the bottom, which only began. What about 30 or 40 years ago, way up to the Longines and the Rolex, and you've got the Apple Watch in the middle and so on. Everybody's producing a differentiated product and they then target a particular segment of the market. And then if you want to, you know who your rivals are in that segment. Okay, so you fight to try to drag customers away. You might also come up with a new product to target a section that you can't currently hit because you've got some innovations that you think can take sales away from that particular market segment. That's the nature of competition. It's dynamic, it's exciting, it's evolutionary. And it's completely missed by both neoclassical and Austrian economics. Except that Austrians are more aware of diversification than neoclassicals are.
- [18:41]
B
The reason I brought up Rolex, I know there was a long period where they were controlling the supply. There was a huge amount of demand. The secondary, I mean, to buy a new Rolex you had to be on a waiting list and they controlled the supply. And demand was so high, that was very hard to get a new Rolex. And the secondary foundry market became very expensive. So whilst they would have the capacity to increase production, they chose not to. They don't.
- [19:07]
A
And that's partly, again, that's partly the way they differentiate. Rolex is a status symbol. You don't want that status symbol to be on every kid's elbow. So you do have to do De Beers is the same thing with diamonds. They created an artificial scarcity of diamonds, an artificial market for diamonds. Diamonds are a girl's best friend, all this sort of stuff. So what you have is strategies that work in a differentiated marketplace. And that then means that marketing becomes an important part of economics. Now at the moment, you talk to an economist about marketing, they'll say that's a waste of money. Everybody knows everything already. Let's assume infinite. Everybody knows the price of every producer. That's part of the way they teach.
- [19:46]
B
No, you create brand value. You create brand value.
- [19:49]
A
Yeah, you create brand value and then that's what you then enables you to get a segment of the market and then you've got to defend that segment. Okay, so it's a brilliant evolutionary process. If you want to see what is the main advantage of capitalism over previous social systems, it's the evolution of production. Now that's left out of neoclassical theory by the assumption of equilibrium. And not the assumption, the obsession with equilibrium which drives me spare, because equilibrium, if you're in equilibrium, why change now? Capitalism is different, is distinguished from other social Systems by change. There is dramatic change in products over time. Virtually everything inside this room didn't exist 30 years ago.
- [20:33]
And so that's the nature of a capitalist economy. Why do we ignore that? It comes down to a bad starting point for economic theory, which is supply and demand curves.
- [20:43]
B
So how does that extrapolate itself across the broader economy?
- [20:47]
A
Well, it means the broader economy is a non equilibrium system, all as evolving. And the distribution of income matters as much as the price of goods.
- [20:59]
And the market segments interact with each other. And you can describe it to some extent using matrix mathematics and say you've got all these inputs necessary to produce outputs and so on, but that matrix that describes the current production system is always adding new rows, new columns, et cetera, et cetera. And that is, you can't capture all of that in the detail of an equilibrium way of thinking. Equilibrium, to me it's the biggest flaw in economic thinking is the obsession with equilibrium.
- [21:32]
B
Explain equilibrium.
- [21:34]
A
Okay. Equilibrium for neoclassicals means if like in a single market, supply equals demand. If you look at the. You have a. You draw a demand curve and a supply curve. You work at the point of intersection and you imagine everything happens at the point of intersection. Firstly, both the demand curve and the supply curve, either empirically or logically failed. You can't derive either of them. They're both false. Secondly, the idea that everything happens in equilibrium between the two is wrong. You're always out of equilibrium. Now that's one reason that I prefer. At least the Austrians are aware of that.
- [22:09]
B
But are they trying to predict what the. So for example, a supermarket, it's trying to predict how many apples it needs.
- [22:15]
A
And how many supermarkets are too sensible to use neoclassical economics. It's the economist who try to model the system that assume everything happens in equilibrium and then that becomes what the people in politics think. And we ended up distorting how the capitalist system works by bringing in this obsession about equilibrium which comes at the political level. That's what labor versus versus conservative fight over here. And it's an intellectual abstraction which gets in the way of understanding capitalism.
- [22:45]
B
And how does that play out? How is the argument between the left and the right over equilibrium? How would I see it?
- [22:53]
A
I have to read Twitter.
- [22:55]
B
Because I'm not seeing people argue about equilibriums.
- [22:58]
A
What is it there I should see? There's actually a huge. Well, not a huge. But there's a fight in Twitter at the moment between neoclassical economists mainly, but also they're taking sideswipes at my side and every second word in what the neoclassicals were right as equilibrium.
- [23:12]
B
But I'm on about the politicians themselves.
- [23:14]
A
Politicians, yeah, they get a superficial understanding of all this economics. They go to university, they do ppe, what they call it is that philosophy, Politics and economics. They might do one year of economics in the middle of all that and then they apply for the job as chancellor. So they get a superficial understanding of a superficial theory and then that ends up with what we saw on the budget a couple of days ago. So it's people relying upon a theory of economics which if they relied upon a theory of engineering comparable to the theory of economics, bridges would be collapsing every day. Okay, so economists get away with this garbage. And it is garbage in my opinion. Not in my opinion. In fact, it's garbage that they get away with because you don't need the economist to have an economy. The economy is something which exists independent of economists. That doesn't apply to engineering. Without engineers, you don't have engineered products. So economists effectively have no skin in the game, to use Taleb's phrase. They can say whatever they like and still be taken seriously if they get inside the mind of a politician. And that's where economics turns into ideology.
- [24:29]
B
Okay, so is the economy, is it an organic system? Is it a machine?
- [24:36]
A
Organic is the way to go. I mean, I had a great student in my undergraduate class back in Australia when I worked at the University of Western Sydney who said that he made the point that the analogies that people use about the economy, we're going to step on the gas, we've got to put the brakes on to stop inflation getting too high. And it's all this mechanical stuff. And we all use cars so we can understand the analogy. He said, what if we made the evangel being a rainforest, Nick? And the politician said, I think the rainforest would work better if we eliminated that species. All of a sudden. Oh, shit. This is not quite so simple anymore, is it?
- [25:09]
B
So is the role of an economist to understand the economy and explain it to people? It should be so they know how to operate within it. But has it become something which an economist has tried to understand to tell you how you can manipulate it?
- [25:26]
A
It's worse. They've got a mental vision which isn't checked against reality. Okay. And like Austrians are particularly bad on this front because of praxeology, because people say, just introspectively work out how the system works. You don't need to check empirically. As I said, that might work with working out how you decide whether you're going to buy cornflakes or Muesli for breakfast.
- [25:49]
B
But hold on, wouldn't the Austrians prefer just the study of the economy and people to leave it alone?
- [25:56]
A
Well, but they don't because their theory presumes they know how factories work. Diminishing marginal productivity turns up in the Austrian way of thinking, and you look empirically, it doesn't exist.
- [26:08]
Real world firms do not have diminishing marginal productivity. When you actually look at it in what they report, you'd say increasing marginal productivity because the higher volume that they get inside their factory, the lower their per unit costs are in total because fixed costs fall with each additional unit. But they also, they're designed by engineers to work at maximum efficiency. As they approach 100% capacity, you're starting at 70. If you increase your demand, your costs fall per unit. Okay? And then also, as once you've made a factory, you've got a prototype, you've made your first prototype. Once you're actually producing them, you start to realize what parts of your manufacturing process need improvement. So there are changes happening in real world factories all the time. So unless you get something like the COVID thing, when suddenly everybody wants toilet paper, okay. But in the standard functioning, as you increase your capacity and you learn and you produce more over time, your per unit costs fall. So the precondition for that rising supply curve disappears.
- [27:10]
B
Okay, okay, so.
- [27:14]
What is the role of an economist?
- [27:17]
A
Unfortunately, it's to cause political confusion these days. That's what it's turned out to be.
- [27:23]
B
Okay, what should the role of an economist be?
- [27:25]
A
The role should be to understand how the economy functions and to communicate it. And to communicate that. Yeah, and that's like my school of, I mean, I'm largely associated with post Keynesian economics. I might differ from them because I've got more of a mathematical foundation than most of my fellow post Keynesians have. So I'm also cast as being from complexity theory, which is a mathematical approach to modeling systems which are complex as mathematicians define them. But post Keynesian was driven by frustration at watching Marxists versus Austrians back in the end of the 19th century. All this, there's what's called the method on stripe dispute, which is a German dispute between the German historical school and another group. It was just Marxists shouting at Austrians shouting at proto neoclassicals. And post Keynesians go, we just want to understand the system. So there's an extent to which post Keynesian is non ideological. And so we're trying to describe the system, but we have got neoclassicals in the majority who've got a vision of capitalism as a perfect utility maximizing system. And Marxists on the other end who believe socialism is perfect. And we look at both of them and say, we just don't want to know what you argue about. We're trying to tell people how the system functions.
- [28:40]
B
So there's essentially two types of economists. There's those who observe and communicate and those who become political and try and.
- [28:47]
A
Influence, though they can't actually tell the difference themselves. I mean, the neoclassicals, for example, do econometrics all the time. They're fitting data.
- [28:56]
But they're fitting data within a preconceived theory of how the economy operates. Okay, now what post Keynesians actually evolved out of this dispute over the cost of firms. Fundamentally, if you go back to the 1930s, which is where post Keynesian economics began, it's called post Keynesian not because it post dates Keynes, but because they saw how Keynes is being interpreted by mainstream economists, people like John Hicks, and said, that's not at all what Keynes said. We're breaking away. So rather than called Keynesian, which is what people think dominant economics is these days, they call themselves post Keynesian. And the separations began over two things, over how you handle time. So neoclassicals were happy to assume that uncertainty is the same as risk. So an uncertain situation, which uncertain means you don't know, risk means there are probabilities you can calculate. They say, let's use risk as sort of a proxy for uncertainty. Post Keynesian said, you cannot do that. And then when it came to the cost structure of firms, this actually began at Oxford University. In a funny way, the guy who was the government statistician, Henderson, forgotten his first name. He got his position, sort of retired to a position at Oxford, and then was dissatisfied with what he found about the absence of grounding in the empirical reality that academic economists had at Oxford. So he said, let's invite businessmen to come up and join us in Oxford and tell us, and we'll have a conversation both sides can learn from each other. And this was back, this is the 1930s, you can imagine the status of being invited to go and have high tea at Oxford, you know, the whole thing. So they'd go along and have these meetings, they'd sit around. It was a classic cocktail type situation. They'd sit back in armchairs and drink scotches and smoke cigars and talk about what they saw happening. And there was complete incongruence between what the businessman told the economist, what the economists expected. So as a result of that, some of the economists said, we better go and actually survey firms and see what they tell us. Are we getting something strange from that guy in the armchair over there, or is that commonplace? And they found it was commonplace. And so there's this. The first was a pair of researchers called hall and Hitchhiker, and they did this very first survey, and they found that firms did not report rising marginal cost. They had constant or falling was the normal sort of thing they got. They tried to understand that still within a neoclassical framework. But ultimately a whole group of economists found whenever they tried to communicate this to the dominant stream, the neoclassicals, they'd be laughed at, ridiculed, not listened to. And so they broke away. And the combination of empirical understanding of how firms actually operate within the micro level, with a focus on uncertainty about the future, the macro level, that led to what's called post Keynesian economics.
- [32:00]
B
I think one of our first interactions a long time ago on Twitter was because Keynes is a bad word in the world of Bitcoin and the Austrians, because I'll do a really poor summary, but Keynes is government economics, which allows money creation. And they believe that we should be on a kind of gold standard of fixed money. And so I think I put somebody out there, blah, blah, blah, Keynes this. And I think you came at me and you tried to make me debate an answer, and I didn't have a solid answer. I think that's why we ended up doing the original interview. And so.
- [32:42]
Make the argument against Keynes from the Austrian point of view and then defend it, because it's like, help me understand both sides of this.
- [32:49]
A
Well, the Austrian argument is fundamentally that money should be a commodity. Money should be gold. Okay? And what Keynes is arguing is for government intervention, and that's seen as being catastrophic. Changing the actual price system because the government gets in there and changes the price, distorts things.
- [33:06]
And that is misunderstanding what money actually is. Okay. And that's actually, this might be a point to bring up the Ravel files instead, because.
- [33:16]
There'S a strong belief amongst Austrians and neoclassicals to some extent that money.
- [33:23]
Is or should be a commodity like gold. Now, if money is gold, you and I can both go and get more gold. You can go to one mine, I can go to another. We can both increase the stock of gold at the same time. When you look at how money actually functions, money is a promise. Money is entries at a bank. And what the entries at a bank are, the bank saying, I've got a liability towards you as a depositor and I've got a liability with this other person as a Depositor. And if you want to buy something, use, transfer your liability from your account to his account and they transfer good back to you. So the understanding of money that Post Keynesians have is that money is a promise of a third party that the two parties to the transaction accept in full settlement of a purchase. Whereas the Austrian and neoclassical vision is that we're bartering. You've got a phone, I've got a mouse. We want to work at how many phones per mouse? Or vice versa. And we work at a relative price between the two of us, and there's no third party involved. And that's historically in terms of how money evolved. And practically today it's a fiction.
- [34:39]
B
Is that a change in money? Is that a change in money? Because no. If we went back hundreds of years and you and I met and I was buying a chicken from you, and I had some gold, that would be.
- [34:51]
A
How we know gold. This is. Have you read David Graeber's debt the first 5,000 years? I have.
- [34:55]
B
A long time ago.
- [34:57]
A
What he made. And this turns up in the historic record as well. Gold and silver, which became money during periods of massive military conflict in Europe, the Thirty Years War and the Hundred Years War. Why? Because if you're fighting as a mercenary for one side or the other, if your king got killed, his coins were worthless, so you demanded payment in gold and silver at that time, so that whether your side won or lost, you still got paid for fighting. So fundamentally, when you've got a period of social breakdown, that's when gold and silver turned up as a form of commerce and transactions. But fundamentally, when you had politically stable periods, money was a creation of the state in each country. Each country had its own type of its own currency, and the banking system evolved in that situation. So again, this is something you can only resolve by looking at history and saying, was there any period where barter or commodity exchange mediated by a particular commodity like gold or silver, was the dominant form of transactions? When you look between countries, yes, you can find periods where if you want to buy something from China, you've got to ship gold to China. But within each of those countries, they use national currencies. So it's a fiction to regard money at the moment or in the past as a commodity.
- [36:23]
B
Is the commodity a kind of the existence of the commodity, a forcing function on the state to have at least some responsible economic policy? But how would you argue in the rise in the price of gold now? Isn't it the same instability around wartime and money losing its value that a Time now people are buying more gold because money's losing its value.
- [36:46]
A
Periods of political instability, people are more likely to try to grab hold of something that's not part of the monetary system. So when you've got periods of political instability, speculative commodities do.
- [36:58]
B
Well, is economic instability and political instability the same thing?
- [37:04]
A
Normally one causes the other. Yeah, yeah, for sure. They go together. I mean we get political instability in the States and the current war mongering towards China, that's going to cause economic instability, starting with political instability. Other times economic instability leads to political, but they tend to go together.
- [37:24]
B
So if money's not a commodity, is it just a utility?
- [37:27]
A
It's a promise. There's actually the best paper that I've ever read on the nature of money is by Italian economist called, it's got a wonderful name, Augusto Agraziani. And he's a wonderful character too. He died about 10, 15 years ago. But he was the most elegant short.
- [37:46]
What's the term for just a small human being? Homan. I've forgotten the term. But he was only about 4 foot 10.
- [37:53]
B
Okay.
- [37:54]
A
He dressed immaculately and he spoke in perfectly formed English paragraphs.
- [37:59]
B
Okay.
- [37:59]
A
Never anybody like him. And he said that to understand what money is you have to go back to first principles. And he said, how can you distinguish a barter economy from a monetary economy? So he said a barter economy is one where we use, we exchange commodities. If you then say that your money is also a commodity.
- [38:21]
You'Re just touching one commodity and saying we're going to use that to avoid the double coincidence of wants. But it's still basically a barter system. So a monetary economy cannot be using a commodity as money. Secondly, if you're not using a commodity, then it's got to be something which is valueless in its own right. So you can't use money to, you know, you can't hop on a dollar note and get taken to another suburb in England. You've got to, it has no use apart from transactions.
- [38:50]
B
So then what gives money its value?
- [38:53]
A
The fact that it's accepted in transactions. So if I, if I, you know, if you, if I was going to go buy your phone off you and I said I'm going to transfer £300 to your bank account, you'd say, okay.
- [39:03]
B
But what makes that worth £300 a day and £200 the next day?
- [39:08]
A
Well, because this is produced in a production system and that's the cost. You know, the costs are related to the production system, which is fairly stable. But fundamentally money is a Promise by a third party that both parties to a transaction, except in full settlement of an exchange of goods.
- [39:25]
B
Sure.
- [39:26]
A
And then Graziani's argument was the only way that can happen is that rather than exchange being two people with two commodities trying to work out a relative price, which is the neoclassical and Austrian framing, it's three people. You have a seller who's got a commodity they want to market, a buyer who wants that commodity, and a bank. And the bank. Then you transfer the promise from one bank account to another bank account and then when that transfer is done, the goods are exchanged.
- [39:55]
B
Hold on. But you and I can do transactions without a bank.
- [39:58]
A
We can with money. And then there's a third party there, which is the central bank or the treasury. Because if I gave you pieces of paper, you know, pound notes, those pound notes were a liability of the central bank. If I gave you coins, as it happens, they're a liability of the treasury. So we're still exchanging liabilities as a third party to make a transaction. And that vision that a monetary system is a triangular one.
- [40:24]
B
But hold on, didn't that liability come from the fact that you could take that and swap it at the bank for gold originally when we're on a gold standard?
- [40:32]
A
No, not necessarily.
- [40:35]
Gold standard tended to apply between countries, not inside countries, except during periods like the Thirty Years War and the Hundred Years War. So you didn't go shopping with gold?
- [40:45]
B
No, but there was a promise that you could take the money to the bank in exchange for gold.
- [40:51]
A
If you go back to the Venetian period, when Venice is the place that double invented double entry bookkeeping about the 1200s, and you had the benches equally that applied back in the time of Christ, when Christ goes inside, allegedly goes inside the temple and knocks over the tables. There was a way in which the religious systems were the way in which money first evolved in a form of credit. And it's credit rather than a commodity that backs that acceptance. And this, again, this is something which people have a hard time getting their heads around. But if you take ourselves way, way back, before we had sedentary civilizations, when we had small tribes.
- [41:38]
A normal village in a tribe would be about 150 people max. A tribe might be 7 or 10,000 people. And you would be peeking your own personal record of who owes you and who you owe, because they were mutual exchange societies. We didn't trade inside that community. We did things for each other. But if you had some asshole who accepted stuff and never did anything back, you'd realize not going to deal with that person. So you start excluding them, but you have to keep track of it yourself. And in Those small communities, 150 people, you can do it. Have you heard of what's called the Dunbar number? Okay, that's.
- [42:17]
B
That's 150 people.
- [42:18]
A
150 people. And the reason is because there's like, there's a. It's a combinatorial issue. You have to know how 150 people are each going to react on two person pairs. You get an enormous factorial number of combinations to think about then so that you can do it up to 150. And then beyond that becomes, how the hell do I keep track of this?
- [42:38]
B
But what were they keeping track of? I owned you two chickens, you owed me eight apples.
- [42:42]
A
No, you do something. Somebody is a great.
- [42:47]
Stone tools maker. Somebody else is a great beer maker, okay? Somebody else is a good fisherman, et cetera, et cetera. You do what you're good at. That specialization occurs, okay? But you. Then you don't do it and expect payment. You do it, you gift it and you get gifts back.
- [43:03]
B
But that was barter. But that is barter, right?
- [43:07]
A
No, no, it's gifting. The first time that Europeans accounted this was in the early explorations of America when they found things like the Iroquois tribe, for example. And the way the Iroquois tribe distributed commodities was through a women's council. The women would all the goods which were hunting was done and everything else be collected. The women's council would then distribute. So there were political structures inside that they weren't barter at all. The whole idea that barter is how we relate to each other imagines we don't form personal relationships.
- [43:40]
B
No, I understand. And look, it happens in our house, right? We do it in a house like I might make dinner and Connor might wash the car. Right? We do things.
- [43:47]
A
Yeah, that's right.
- [43:48]
B
Yeah, yeah, but he never makes dinner. Yeah, and he's never washed my car.
- [43:53]
But similar things like that.
- [43:56]
But sorry, I'm just trying to go through my understanding because my understanding say in America, banknotes ended up replacing gold because it became easier to deal with banknotes. But banknotes were a promise for gold. But it feels like we've evolved beyond that promise to gold now. But the gold was what always backed the banknotes.
- [44:16]
A
I mean, there's weird periods of experimentation with money in America as well. There was a period where there were individual banks that produce their own banknotes and you had to know whether you trusted the bank, et cetera, et cetera. And they were called wildcat banks. If you know that expression?
- [44:30]
B
Yeah. It was like it was a free market for money, really.
- [44:33]
A
I wouldn't call was a free for all free banking.
- [44:37]
B
It was like a free banking era.
- [44:38]
A
Yeah, yeah. And it was disastrous because people would be doing con jobs. I mean there was classic. I've got quite a few papers on this front where people, inspectors would go and check and see and here's our gold stash. And then they'd open up the gold stash and there's a layer of gold on top and then there's all this lead and shots and stuff beneath the box.
- [44:59]
B
They inflated the money. They inflated the money.
- [45:02]
A
They inflated the money beyond their gold because it's a con job. You're trying to, you know, America is great for con artists. So.
- [45:08]
B
But the belief was that you could exchange the money.
- [45:11]
A
I still think that's a myth.
- [45:14]
The importance of the gold conversion would make that case at different times. And this is also something about American culture that leads to scam artists becoming dominant. And it's not just Donald Trump. That's a manifestation of that. It's been going on for centuries. But.
- [45:35]
I think we've made an association with the role of gold and with barter. And when you look historically at both, you can only find the gold issue applying when you've got periods of serious social breakdown. And I think you can actually define America as a process of serious social breakdown for the last 200 years. Guns. And that dominates that culture rather than collaboration and peaceful discussions.
- [46:00]
B
But if you talk about the three parties, if we do it in person, you say the notes and the coins.
- [46:08]
A
Are a liability of the government.
- [46:09]
B
Of the government. In return for what?
- [46:14]
A
In return for being a citizen.
- [46:17]
B
But what is the guarantee of the money?
- [46:20]
A
The guarantee is you live in a. You expect this to continue. I mean, we've been using an English pound for, you know, 200 years.
- [46:27]
B
So it's kind of a faith based system. It's confidence.
- [46:30]
A
It's a case of trust. There's a confidence actually comes to the whole way that bitcoin came about. In many ways, it's a system which relies upon trust.
- [46:37]
B
So it's a confidence system based on a political structure that provides safety, security, rule of law and good economic policy.
- [46:48]
A
Well, that's, that's getting a bit.
- [46:51]
B
But the faith in that currency can be eroded.
- [46:57]
A
It can and it can collapse when the country overextends itself militarily and loses a battle. And that's why the currencies collapse, because the country that created the fiat's currency gets defeated. Et cetera, et cetera. But it is fundamentally trust based. And this, I mean if you come back to the early CRO Magnon societies, we're all based on trust. If somebody didn't trust, you exclude. That's how we got people leaving one community and different communities forming and so on. So trust is an essential element of being a human being and trust is the basis of money, not gold.
- [47:32]
B
Well, I mean.
- [47:35]
I would have a preference in every scenario to have the gold than the piece of paper or the coins. But it's so inconvenient. I don't.
- [47:44]
A
But then that's partly. It's obviously inconvenient, but secondly it's the preference. Okay, where does the preference come from? Is that from ideology or is that from.
- [47:53]
B
No, it's just an understanding of the value of gold in the market and that.
- [47:58]
A
But why does. I mean, you actually should read scarcity.
- [48:01]
B
I think it comes down to scarcity.
- [48:02]
A
Yeah. Again this is trying to focus. And that's actually a very important point because a lot of the thinking of Austrian and neoclassical circles faces upon scarcity as the determinant of value. And therefore you want your money to be scarce as well. Yes, it's a very good point. Okay, but the reality of a capitalist economy is that there's. In terms of what we can produce using our manufacturing system, it's not scarcity, it's abundance. Not completely obviously, but there's a capacity because of the competitive nature of a capitalist economy.
- [48:36]
Factories are built with excess capacity because capitalism is being a growing system over time. That alone is a reason why we don't have 100% capacity utilization because we're building new factories all the time. If the day you opened your factory was 100%, you made it too small. So this is a reason that a potential for abundance lies in capitalism, not scarcity.
- [48:59]
B
So having a scar, there's a value to having a scarce money. But also that becomes a limiting factor for creating abundance. If you have a faith based currency, which isn't because say based on a gold standard you can produce more of it and create abundance because you have more flexibility. But you can't go too fast and you have to create value off the back of it, otherwise you get inflation.
- [49:27]
A
Exactly. So.
- [49:30]
The reason you're a capitalist is to make money. Not usually want to assemble. I mean you get a huge number of commodities as a result of that if you're successful. But the driving motivation is accumulation of money in that sense. So then that has to be tied up with production of commodities to make it viable. So we have this monetary system we have to understand which we get wrong. And a production system we have to understand which we also get wrong in mainstream thinking.
- [49:58]
B
So is one of the differences, therefore, between say, the Austrians and say, the Post Keynesians is a view for how the economy should grow?
- [50:10]
A
Yes.
- [50:11]
B
And so I would say the Austrians think it will grow naturally and have natural booms and busts.
- [50:20]
Whereas the Post Keynesian would say, well, because you control the money supply, you can actually accelerate growth.
- [50:27]
A
Not so much that. I mean.
- [50:31]
In terms of like the vision of money as a commodity versus money as a promise. Okay. The vision that money is a commodity if you enforce it at all effectively, if the gold standard is somehow imposed, and if you don't have money creation occurring by the banking system, then you can get.
- [50:52]
Constricted demand.
- [50:55]
You can't. Like again, another great book on how to think about capitalism is Schumpeter's book, the Theory of Economic Development. And he makes the case that the neoclassical vision can't explain profit. He said, if you actually have a neoclassical equilibrium and say you're an entrepreneur and you're hiring labor and you're hiring machinery as well, then you've got to pay the marginal cost of each of those units, and overall the price system will come up with no profit. You get accounting profit, you don't get economic profit. So Sean Peter said, to get economic profit, you've got to disturb the production system. And how do you disturb it? You come up with some new process to make existing goods, or you come up with some new good and you then need to make it. But to make his model as real, well, not realistic, but as hard to prove as possible, he assumed that there was full employment, so you didn't have spare labor and spare machinery lying around, and that entrepreneurs are people with good ideas and no money, so they can't buy anything. So he said, therefore to buy something, they've got to go and borrow money. And then the borrowed money, they can then use that money to hire labor and machinery away from other industries. So they cause a bit of a boom when they do that, then when the products are produced, they cause a slump because those products now compete with existing products, neither undercut them in cost of production or take demand away from them. So that saw the elasticity of the money system as an essential part of the capacity of capitalism to grow. Now, when you have the focus upon making sure money maintains its value, which I think is a huge part of the Bitcoin argument, and also Austrian and neoclassical that actually goes against money as a form of transactions.
- [52:47]
B
Okay, so is there a difference? Therefore, is it. The Austrians would believe we actually, a lot of them would believe we don't actually need government and government is actually a distortion and interferes with the economy. Whereas the more kind of. It's Minsky, isn't it?
- [53:06]
A
Minsky, yeah.
- [53:07]
B
Minsky accepts the reality that there is government and government does control the money. Therefore this is how we should use the money to create abundance and drive the economy.
- [53:20]
Is it almost like.
- [53:23]
I don't know, a theory of the role of government within money?
- [53:28]
A
I mean that's one of the main dividing points between post Keynesian and Austrian and neoclassical. Fundamentally, the neoclassical vision of the economy is the system works best with no government. Yeah, same thing for Austrian. If you draw your intersecting supply and demand curves, then as long as you hit that point, everything's hunky dory. The government comes in, you're going to be above or below. That's disequilibrium. That's bad. So there's an anti government at the core of both Austrian and neoclassical thought. Okay, now, has there been a society without a government?
- [54:02]
B
Well, historically, yes. Well, I mean you just go, well, it depends what you define as government. But if you go back far enough, you will have a time of no government. But then you might.
- [54:11]
A
Well, you still have, you still have people obeying social rules. Well, so that you have tribes. You don't have.
- [54:21]
B
Again, you still have order.
- [54:22]
A
You have order and you have conventions and accepted beliefs. This is, See, it's partly in some ways Austrians and neoclassicals think they're getting to the essence of humans. What they've got as a vision is isolated creatures who come together for a transaction and then don't interact with each other ever again. The reality, we interact with each other all the time and so social structures build up and then those social structures become government.
- [54:50]
B
Well, this is the. So this morning, we did an interview this morning with Carl Israel. Frederick or Frederick Israel. He was on a panel with you once. Yeah, he knew you.
- [55:01]
A
Carl Friedrich Israel.
- [55:02]
B
Carl Friedrich Israel.
- [55:05]
A
Can't say that.
- [55:06]
B
German economist. So he's an Austrian. And I said to him, because one of the, like I am, I every book I've read on economics, I like it, I kind of agree with their analysis. But where I struggle with the libertarians is if you get rid of government, you will still end up recreating government.
- [55:23]
A
Absolutely.
- [55:24]
B
And you might end up recreating it worse. And, and some sometimes like people believe, some people rightly believe government is infringement of liberty, but also some governments defend liberty. And so what I kind of, when I was trying to prepare for this and I was trying to understand the Austrians versus the post Keynesian, the Minsky, it was that the Austrians view the world as we would rather not have government and they get in the way. And the Minsky.
- [55:50]
A
Is it Minskians, Minsky, Minsky and Wolsey.
- [55:53]
B
Yeah. Minskians.
- [55:55]
Accept the reality of government and adjust for that.
- [55:57]
A
Yeah, yeah. And then also says, and this is actually a very important point, but much of this is very important because there are some things the government does better than the private sector. Because the private sector. Yes. Tax.
- [56:10]
B
Tax collection, sewerage.
- [56:13]
A
Have you been for a swim in a British river recently? Would you go for a swim in a British river?
- [56:18]
B
So this.
- [56:19]
A
Come on. No, no, no, that's my point.
- [56:21]
B
This is. As a, as a, as a fan of Thatcher.
- [56:27]
I always compromise on the.
- [56:32]
Privatization of the utilities because I think they are a public utility and a public good.
- [56:37]
A
There are some things which are better done by the public sector. Because you don't want them done for a profit.
- [56:41]
B
Exactly.
- [56:41]
A
Because they won't be done well enough or there won't be enough of them. So there's a dividing line between what you want to have done provided by a state system with whatever financing it has, and buy a capitalist system, whatever the financing it has. And that dividing line tends to be how long it takes to make a profit.
- [56:58]
B
Yeah. And a privatized air traffic control does make me nervous as well.
- [57:02]
A
Oh, yeah.
- [57:04]
There is something. You just want it done. You don't want it done for a profit because it's done for a profit. They'll leave out little things like checking to see whether there's enough tire air in the tire of the planes. I mean, it's an example.
- [57:16]
B
Do you know what you can, you know, we don't need two guys looking at that radar and you know, you can actually do an overtime shift and.
- [57:22]
A
That's. Right. You can work longer. It won't matter. Oh, dear, the titty about those two planes crashing into each other. So, yeah, you want some things you want, you don't want. Like forget electric power, for example. You don't want cheap power. You want reliable power all the time.
- [57:35]
B
Well, I think, I think you want both.
- [57:37]
A
You want a bit of both, but you don't sacrifice one for the other.
- [57:40]
B
I think you can make a solid argument that in the UK the government has interfered too much in the energy sector and have made our energy too expensive. I think you make a Solid argument for that, but we're jumping forward. Okay, so therefore, is there a place in economics for morality?
- [57:58]
A
Absolutely.
- [57:59]
B
Okay, Yeah.
- [58:00]
A
I mean, and this, the reason we worry about it is because we are trying to achieve what is the best outcome, not just for humanity, but for the whole planet.
- [58:10]
B
But how do you define the moral obligation within economics? Because morality is always subjective.
- [58:19]
A
Some parts of morality are objective. Wiping out a species is not a moral activity. And this is like this, this is jumping into a completely different realm.
- [58:27]
B
This is fun, though.
- [58:28]
A
Okay, But I, if I had to say what I saw as being the ultimate objective of humanity, it should be to maintain life on Earth for all creatures. For all creatures. Because we, we happen to have evolved in the last 300,000 years.
- [58:47]
We didn't exist back at the time of the dinosaurs. They're not our responsibility. We do exist at the same time as all the mammals and all the other life forms that we depend upon. And for our own self interest, if we ignore them, we wipe ourselves out ultimately. And so if I had to say what my religion is, I'm a Saganist, I'm a Sagan.
- [59:09]
B
Okay, What's a Sagan?
- [59:10]
A
You heard of Carl Sagan?
- [59:11]
B
Yeah.
- [59:11]
A
Okay. I think the religion we need is Saganism because he said, you know that classic blue dot statement that when we took the photograph of Earth from Voyager and this tiny blue dot, everything is happening there. And so we still don't know whether there's any other point in the universe that supports life. We know it's here. Now, if we have a social system which destroys the capacity of the planet to support life, we're not an intelligent species, we're a dumb species. And I think in that front, we are being dumb. So my ultimate morality is the maintenance of life on this planet.
- [59:47]
B
Okay. I mean, I can agree and argue and support that.
- [59:52]
Moral objective, but there's a lot more nuance and small moral objectives.
- [59:58]
A
Oh, yeah, I mean, like, you know, fair exchange. Okay. And there's actually, if you read Aristotle, Aristotle talks about a fair exchange. Quite a fascinating. This is in the Nicomachean Ethics, and he says a fair exchange is somewhere between a form of loss and a form of gain. So he said a fair exchange is where they feel whether you've neither lost nor gained. And then that's the nature of exchange. So if you would have seen the classic experiment, I think capuchin monkeys were being fed grapes, and then they gave one of the capuchin monkeys a piece of cucumber instead of a grape. He looked at it and Threw the cucumber back at the experimenter. You feel like you're offended, you've been treated badly. So this is not just a human thing, a feeling that you haven't been exploited is a major part of having relationships. And that again, that's, in a sense, that's a commonality of all attempts to understand the economy. What is a fair exchange?
- [60:52]
B
Can you have a fair exchange when the government can distort the money supply?
- [60:57]
A
And now hang on straight away, how do you say it distorts it? You don't even know how it creates money.
- [61:03]
B
Well, I know ways in which it creates money or allows money.
- [61:07]
A
Do you? Okay, tell me what they are.
- [61:09]
B
Well, so my understanding there's three primary sources of money creation. There is bank credit, which is fractional reserve, which allows.
- [61:19]
A
Which is a false model.
- [61:21]
B
Okay, we'll come back to that.
- [61:22]
A
Banks do create money. Not by fractional reserve banking.
- [61:26]
B
Well, they, they, okay, they create, okay, they create money by allowing loans, which is the creation money out of thin air.
- [61:34]
A
Yeah, that's what they do.
- [61:35]
B
They credit your account and they hold that.
- [61:37]
A
They're nothing to do with reserves, as it happens.
- [61:39]
B
The reserves are the rules by which.
- [61:41]
A
Well, let's, let's get the regulation. So that's, that's one.
- [61:43]
B
Okay.
- [61:43]
A
Private banks create money. That much we agree on.
- [61:45]
B
Yes, there is the, the, the printing of money, which is essentially the same thing. Governments, central bank creating money.
- [61:53]
A
The central banks very rarely do. In fact, it's the treasury that creates the money, not the central bank. This is where you've got to do the accounting. And that's why I brought my Ravel.
- [62:03]
B
Okay, we'll get to that. But there is the creation of. So there is an amount of supply money in the economy and then there is the creation of more money out of thin air. That can create distortions, but it's.
- [62:19]
A
Is it a distortion? And again, this is, it's a loaded term. Is it distortion or is it part of the system? Look, the private banks create money, okay? Yeah, that's part of how capitalism functions. Governments create money. What was your third way of creating money, by the way? I was trying to remember trade deficit, trade surplus?
- [62:38]
B
No, I had. It was private money creation by the banks. There was the.
- [62:46]
There was the central banks buying.
- [62:50]
Government debt.
- [62:51]
A
They buy bonds off private banks.
- [62:54]
B
But that is a money creation.
- [62:58]
A
This is why I built my Ravel software so I could actually analyze this stuff properly. So the central bank, when it's doing that, it can only do that if the bonds have been created by the treasury in the first instance.
- [63:09]
B
So there's a match.
- [63:11]
A
There's a match.
- [63:12]
B
But the government seems to never just.
- [63:13]
A
Pay everything off, it never does.
- [63:15]
B
So acts like a Ponzi. So the debt pile grows and grows like the 38 trillion in the US.
- [63:22]
A
Yeah, so does the economy.
- [63:24]
B
So the point I want to get to is that I know, so I benefited from this as an asset holder. And so if there's moral obligation within the economy, if we allow money creation to benefit the richer more than the.
- [63:41]
A
Poor.
- [63:43]
B
Does that create moral hazard?
- [63:44]
A
Yes, it does. I mean this is what you can see in the system, misunderstood as it is by the people who manage it. And the managing people are definitely neoclassical economists. Post Keynesians don't get a look in. Austrians sort of get a look in at the political stage, but they never get asked to run a central bank. So the management of the economy is done by neoclassical economists and they stuff up all the time.
- [64:08]
B
Okay, so what are we doing wrong here?
- [64:11]
A
Well, first of all, not understanding how money is created.
- [64:14]
B
Help me understand how money is created.
- [64:15]
A
Well, that's why I'll drag in my Ravel software at some point in that conversation. But money fundamentally comes down to two things. It's cash or it's bank accounts. Yes. Okay, now cash obviously is created by the central bank printing notes or the treasury printing coins. So that's again tied up on the government money creation system. When you look at how the government actually creates money, how do you think it creates money?
- [64:42]
B
Well, so there is the.
- [64:46]
Let me just think this through. So.
- [64:52]
Every piece of physical money is. Money is printed and every, every bit of credit that exists in account is essentially money because you can access, you can either send it to somebody else or you can withdraw it.
- [65:06]
A
Yeah, yeah, yeah.
- [65:08]
B
And I guess that also includes the government has its own accounts. Yes, which has money in. So I guess the creation of money from government comes from if they are the liability, if they have possess the liability, they allow people to create their version of the money which allows banks, the private sector to do it because they honor that debt. They print the money that goes into the system and then they also create their own money to inject into the system.
- [65:37]
A
Yeah, but you've got to see. And again, I've only worked this out by building Ravel.
- [65:41]
B
By the way, I'm at the limits of my understanding. How am I doing Con?
- [65:46]
A
Pretty good. Pretty good for a normal. But it's intriguing. The only way I truly understand this was by building a software package that lets me look at an integrated double entry Bookkeeping view of the whole economy. And when you do that, you find that the post Keynesians are correct about how money is created. Loans create deposits. Okay, okay. The neoclassicals are wrong about government. They think government has to issue debt in order to create money. Okay, that's false. Now, it's believed by most people that it's false. And I can prove it. Okay, we have a go at that.
- [66:24]
B
Yeah, let's have a go. Show me it.
- [66:25]
A
Okay, let's get this rolling. Hang on.
- [66:31]
So that's something else I want to come back to if we need to in a moment. But I'll start with this one here, which is just looking at a blank system of banks, private sector central banks and the Treasury. And I'll bring up the little define window here. First of all, make it easier to see the dynamics. So what Ravel does, it's got a lot of powers to it. But one of the fundamental unique features, it uses double entry bookkeeping to show the financial system. So banks, of course have assets we call reserves, which are fundamentally. That's their accounts at the central bank and they have loans which they make to the private sector. And they have bonds which they buy off the central bank. And I'm going to use the subscript B that indicated bonds owned by the banks. Then you have deposits which. Where you and I put our bank accounts. And then you look at the network of the banks. And the thing which is unique about Ravel is that it applies the rules of accounting. So if you work out your financial assets, your financial assets are claims on other people, your financial liabilities, they're claims other people have on you. The gap between the two is your equity. So the rule applies that assets minus liabilities equals equity. Therefore assets minus liabilities minus equity is equals zero. And that's the little logical check that Ravel applies here. So if we look at what.
- [68:01]
B
Let's go a little bit slower so people understand the double entry bookkeeping is assets should equal liabilities.
- [68:08]
A
Yeah, sorry.
- [68:08]
B
Double entry bookkeeping, explain. So people understand.
- [68:12]
A
Yeah, okay. Double entry bookkeeping is really a way that merchants invented the 1200s to make sure they recorded transactions properly.
- [68:20]
B
There's an asset and a liability.
- [68:21]
A
The idea is record it from the point of view of the buyer and the seller fundamentally. So there's a buyer's perspective and a seller's perspective. In every transaction, you must record them both. You actually got quadruple entry out of that. But when you do it, you record each as a debit and a credit on individual lines. And then so there's very specific rules. Accountants learn that. What do you call a debit and what do you call a credit? And that's what makes accounting complicated. I've worked out a simpler way to go, which is I'll just type some numbers inside here.
- [68:51]
B
So it's just. So people are just listening. You've put 100 into the reserves, 1,000.
- [68:54]
A
Into the loans, and I'll put 1,000 of the bonds.
- [69:00]
I'll put 900 into the bonds as well, just for the heck of it. So I got a total of 2,000. Now, what the program makes sure is that each line balances. So if I type 1800 here, I've got to type 200 for the banks, and that's guaranteeing the line sums to zero, which is. And that rules applied to every set of transactions. So if I look like bank lending, for example, what you use now is. Use words now. So if you have a bank lends money to you, then it puts money in your bank account. And the change in loans every year is called credit. So if I say the loans go by credit dollars per year. For example, if I type credit here, then the program tells me my assets minus liabilities.
- [69:43]
Minus equity equation is equal to credit. Right now it's got to be equal to zero. So I need a matching entry on that line.
- [69:50]
Okay, so loans go up and deposits go up. That's how loans create deposits. That's bank lending. If you look at what the government does, a government deficit.
- [70:00]
Some people are going to rile at this. But a deficit actually involves putting more money in people's bank accounts. That's obvious. People get shocked by it. But if a deficit occurs, what it means is the government is taking spending on you and taxing you, and it's actually doing more spending than taxing. So the deficit increases your bank balance. Okay, now what's the balancing item there? Where do I put the balancing item, deficit into?
- [70:27]
B
Hold on. So you've created a deficit on the liabilities from the government, so it goes into the bonds. No, no, Mike, Mike. Oh, sorry, sorry. Hold on. They've created a liability.
- [70:42]
Oh, into loans. Was it into reserves?
- [70:45]
A
Yes. Okay.
- [70:48]
And I mistyped that a bit, typed the capital D there. Okay, so that's how you balance.
- [70:53]
B
Oh, because apologies. Because they've given.
- [70:55]
A
Yeah, so that's your starting point. Now that's given you a vision of what happens at the banking sector. So I've got that worked out. Now let's look at the private sector here. What's the follow through of that effect? So I can bring up the table for the private sector.
- [71:12]
And then we now say whatever is an asset.
- [71:17]
In somewhere else is a liability for somebody else here. So if I click on the down arrow key, it goes looking for a liability that hasn't yet been allocated to somebody's asset. So this is now deposits and it brings across the operations. We've shown at the banking level. The liabilities are going to be. There's three there. It's going to be loans that are a liability of the private sector. Now you want to see the private equity?
- [71:45]
Then I put this here and now I can tell the program, just balance the equity for me and notice what happens because when you get a loan from a bank, your deposits rise, but your loans rise at the same time. There's no change in your net worth. You need the money for transactions. That's why you'll take out a loan. You can't buy that house unless you've got the money. But with it comes necessarily the loan as well. Whereas the government does it. You get the deficit. There is no offsetting cost to you for the deficit. So the deficit actually increases your net worth. Yeah, okay, take that one on board. Yeah, okay.
- [72:19]
B
I'm doing my best.
- [72:21]
A
Now we take a look at what happens at the central bank because we've got the reserves there which are an asset of the banks. They're going to be a liability of somebody else and they're a liability of the central bank. So I bring off reserves here, okay? And now I've got the central bank equity.
- [72:42]
So how do I balance this line? And the question who creates the deficit? It's the Treasury.
- [72:52]
And the treasury has all sorts of accounts at the central bank. They tend to be called the Consolidated Revenue Fund and things like that. Okay? So the deficit is financed by the treasury going to negative. So there's a transfer of funds from the treasury to the reserve account. Okay, now I come to the what does that look at the Treasury? So I bring up the table for the treasury here.
- [73:19]
And what are the remaining assets? There's the Treasury's Consolidated Revenue fund. What are the liabilities? That's bonds which haven't yet turned up on the whole system. So bonds aren't part. Bonds don't balance deficit. So how do you balance that line?
- [73:40]
And the answer is you balance it by the treasury going into negative equity. So what creates money? Notice here we've got a deficit here, okay? And that's a negative over. You have the private sector. That's a positive.
- [73:53]
B
So that's the treasury. That's the treasury injecting liquidity into the private sector?
- [73:57]
A
Yeah, yeah. So it's creating money for the private sector.
- [74:01]
B
Okay.
- [74:01]
A
Okay. And that actually means that the treasury getting a negative net worth creates identical positive net worth for the private sector.
- [74:10]
B
So this is the treasury providing liquidity.
- [74:14]
A
Into the private sector in the form of money.
- [74:16]
B
In the form of money to drive economic activity. This is how the government can drive economic activity.
- [74:21]
A
Okay.
- [74:23]
B
You following this, Conor?
- [74:26]
A
Now there's one intriguing thing that comes out of this, and this is. Oh, no, I haven't actually balanced the column here. I better go back and balance the equity there. I'll just get the program to do that for me. Hang on a second. So I just want to balance the equity there. Okay. So that's now a balanced, integrated look at the absolute bare bones of creating money. So banks create money by lending out more than they get back in repayments. The government creates money by spending more than it gets back in taxation. Those are your two forms of money creation. Now, one, and this is one thing, I've only worked this out recently in terms of how to intellectually communicate it. Banks have to be in positive equity. Banks must have short term assets that exceed their short term liabilities. That means, Therefore I've got 200 being shown there as the equity of the banking sector.
- [75:17]
B
Is that maturity matching?
- [75:19]
A
No, it's not maturity matching. They do maturity matching. Obviously that's part of the whole process they're involved in. But at a fundamental level, if a bank has short term liabilities which exceed its short term assets, it is bankrupt. Okay? So the banks are different to you and me.
- [75:36]
B
Why can't they just create money for themselves?
- [75:38]
A
Huh? Now.
- [75:41]
Let'S just get the basics working before we talk about fraud. Okay? It is possible for fraud. That does happen. And I've heard plenty of reports from people inside the banking sector. But if they do, they've got to have a balancing entry there. They can't, you know, they've got to have a loan and a deposit they create at the same time. But fundamentally, banks must be individually and in the aggregate in positive net financial worth.
- [76:05]
B
What you've modeled here is like a simple version of the economy.
- [76:07]
A
Yeah. Starting at the very beginnings of it. Yeah.
- [76:10]
B
And so if I had an Austrian here, they would say, take away the central bank, take away the treasury, we just need banks in the private sector. And the banks would have to create their own loans.
- [76:21]
A
And that would mean the private sector is necessarily in negative financial equity.
- [76:25]
B
But they would say the reserves would be.
- [76:27]
A
Reserves. Reserves Disappear.
- [76:29]
B
Well, they would want the reserves to be the commodity.
- [76:32]
A
How?
- [76:32]
B
Because they wouldn't want, they wouldn't want the reserves of gold to match the loads.
- [76:37]
A
I'll bring that up as another issue. I'll do that quickly. But I want to stick to this level to begin with, first of all. But see, what is gold in that sense? Is gold a financial or a non financial asset?
- [76:49]
B
Well, I would say it's a financial asset.
- [76:51]
A
It's not? No. Okay. A financial asset is a claim you have on somebody else.
- [76:57]
B
Well, the claim is on the gold.
- [76:58]
A
No. How can you.
- [77:02]
Gold's got no say in the matter. If you've got it in your pocket, it can't say I demand part of your net worth. Gold is a non financial asset.
- [77:09]
B
No, what I'm saying is I could go to the bank and I could deposit gold into their reserves and they could issue me.
- [77:18]
Banknotes.
- [77:21]
In the Austrian model.
- [77:22]
A
In the Austrian model. Okay. Okay. But what gold is. When you want to see what gold actually is. Let's put gold inside here. This is not what I intended doing, but I'll give it a try. Okay. Gold.
- [77:35]
Gold is a non financial asset, okay? Because think about like this is a non financial asset, okay? The microphone is a non financial asset. The things you own, okay? That your asset and nobody else's liability, okay? So think about commodities in general. Once they're produced, they're non financial assets. We use the financial system to enable us to create non financial objects, okay? Now when you do it that way, you've got to show gold.
- [78:11]
As.
- [78:13]
Both an asset and equity. Whatever you put into gold. If I put say 300 here in gold, then that turns up on both sides, okay? It's your asset and your source of your equity. It's not a financial claim. So when I look at what Austrians and neoclassical societies.
- [78:32]
B
Hold on. But if we put the gold in there, wouldn't we have to create the liability? Because the liability would be the banknote.
- [78:39]
A
Well, I'm saying it's independent gold.
- [78:43]
Gold itself is not. You don't have to have banknotes with gold. Okay? If you think about.
- [78:51]
Have you ever.
- [78:51]
B
Been gold panning on a gold standard?
- [78:53]
A
You would though. Well, you're now imposing a. Yeah, yeah.
- [78:57]
B
That'S what I'm saying.
- [78:57]
A
You're imposing a system here. I'm saying what you start with is a non financial asset. And so a huge part of the Bitcoin and the gold bug enthusiasm is a belief that money should be a commodity.
- [79:09]
B
Yes.
- [79:09]
A
And it turns up here because when you put it in say, what is gold? Is gold a financial asset, strictly speaking? No, it's not. It's something which has value in its own right. So the value of a bank check is the fact the bank will back it. I'm relying upon that relationship. The value of gold, which is what people wish to change the system over to, or Bitcoin, is that it's my asset and it's not a liability for anybody. It's an asset in my hands. You can use it as a form of financial transactions. What you get out of that is a very different dynamic indeed. Okay, so, but anyway, let's go back.
- [79:48]
B
So you've modeled the whole financial system to show how money can be created and injected into the system.
- [79:58]
Where does leverage play a role?
- [80:00]
A
Well, leverage turns up in the amount of debt you, you take on to buy other financial assets. But.
- [80:08]
We can get to that at some point. I want to focus on here is that if you don't have the government in the system, which is the neoclassical and Austrian fantasy. Well, yeah, but I think the desired fantasy.
- [80:21]
B
Yeah, but I think, but they also, if you know, if we had one of them here, they would accept the reality of the government and just say this is how we want the government to behave.
- [80:29]
A
Yeah, well also they'd say it'd be better if we didn't have the government at all.
- [80:32]
B
Of course, central bank.
- [80:34]
A
But if you don't, if you take the government out of this system, what you do is you push the non bank private sector into negative financial equity. Because take a look at here, you've got, I've got, I'll take, I'll leave, I'll leave gold inside there. I think I can do it anyway. You've got 200 as the net worth of the banking sector. Okay. I've got the private sector having equity of 800. Okay. They're both positive. Why are they positive? Because I've got a negative here. Okay. So if I just look at the, if I look at the banking sector, the banking sector is in positive 200. What's the sum of the others? You've got 800 minus 900, minus 100, that's minus 200. So for the banking sector to be in positive equity of 200, which it must be in positive equity. The rest of the system, including the government is in negative equity. If I take the government out of there, I remove the bonds and the reserves. So I take 1,000 out of the system. I'm left with loans of 1,000 and I've still got 200 net worth. For the banks, I've got deposits of 800, liabilities of 1,000, assets of 100 of 800. The private system is a negative financial equity of minus of 200.
- [81:50]
B
So when the private sector creates money, does that instantly become a negative for the government because of the lending last resort?
- [81:59]
A
No. Has no effect on the government at all at that stage. Ramifications flow from it, but the government's not involved. This is the beauty of double entry. There's only two parties to every transaction.
- [82:09]
B
So at the point the government, the treasury wants to create money, why are they creating it and where are they putting it?
- [82:17]
A
Okay, they're creating it to fund their activities, their own activities. They're also partially creating money. So capitalism can work. Because if you. There's a great Harvard Law professor, Christine Desant, who's done fabulous work on the historical origins of money in uk. Because one of the advantages of the UK as a historical case study is there were the Roman period and the post Roman period. So you had a period when the Roman Empire collapsed here, I think The Romans lost you 176 AD and then it was about 430 AD before it was a complete collapse. You had a period where you basically had the uk, what we call the UK these days, becoming a subsistence economy using Roman coins as part of it. But then there was a particular king, I think of Northumbria. No, hang on, Essex, called King Offa and he introduced a coin. And if you think about how the feudal system.
- [83:17]
Provisioned itself was basically take a bunch of thugs with swords, go down to the village and say, we're taking those animals, okay? And then what you really had was the vision that people have of government today was literally what happened in that period. The thugs come along and say, we're taking the possessions away from you. Then Odoffer invented as a coin and he said, we're going to buy those off you and we're going to tax you as well, okay? So that you had to earn the coins. And the side effect of that was that suddenly there was commerce, money intermediated commerce. So that in kingdom grew much more rapidly than its others that are still relying upon the sword as a way of provisioning the state. And you had to have the government spending more than it took back in taxation to put coins in circulation in the first place.
- [84:09]
B
Okay? So therefore it's the choice of either a private free banking system or a government banking system. Someone has to supply.
- [84:18]
A
Yeah. The money. To make a monetary system you've got to have the money. You've Got a money creator.
- [84:23]
B
And so the Austrians believe we don't need a central money creator. They want decentralized. And the post Keynesian believe you should centralize it.
- [84:31]
A
Well it's what happens if you don't centralize it. And this is where I've come up with a great analogy which I haven't got loaded here but I could show it if you want. Can I find this? It's a seesaw because everybody thinks about these bloody supply and demand curves and I'm sick of that bloody useless mental meme of got to eliminate it. It's exactly the same as toll make epicycles and equants and deference. It's a useless way of understanding the system we're in. But a seesaw makes sense because when you look in terms of financial assets, the sum of all financial assets and liabilities is zero. Non financial is positive. Add up the value of all these things, you get a positive number. But for the financial add them all up to get zero. Now if the banks must be in positive equity to function as banks, that means the non bank sector is in negative financial equity. So if the banks are going to be able to function as banks, they have to have assets that exceed their liabilities. The rest of society necessarily has liabilities that exceed their assets. Now if the arrested society is just the private non bank sector, then that means you look at your bank accounts every day and you see you owe more than you've got worth. What does that make you do? Oh shit, I better go buy some non financial assets and hope their price rises. And because of the non financial assets increase, my net worth is going to be positive. So it encourages to go and dig up some gold somewhere, speculate on a stock market, et cetera, et cetera. If we do the speculating on a stock market or speculating on a property market, we borrow money from a bank and go and gamble that the price is going to rise. But that gives you a feedback between the level of debt and the rate of growth of asset prices. We got caught up in booms and busts and that's what we had in the 19th century, particularly because we had the government.
- [86:21]
How much of GDP roughly speaking do you think the federal government represents in America today?
- [86:26]
B
I don't know the federal government. I know we're approach. Is it 38% in the UK?
- [86:31]
A
Yeah, something of that. Or the America's 20%?
- [86:33]
B
No, sorry, taxation is 38%. I think the government is over 40%.
- [86:39]
A
Yeah. The American federal cause American's got this weird Mixture of federal and state and local. But the numbers from the White House so that the federal government spending is about of the order of 20% of GDP, 25%. Taxation's of the order of 20%. They've got all sorts of other taxes, they leave it there. If you go back to the 19th century, what do you think? Like so 20% of GDP, roughly speaking, spending, what do you think it was in the 19th century?
- [87:04]
B
No idea.
- [87:05]
A
Two percent.
- [87:07]
B
Okay.
- [87:07]
A
A factor of ten smaller than now.
- [87:10]
B
Is that a good or a bad thing?
- [87:11]
A
It's a bad thing because what it meant was when you look at the overall equity situation, the equity component of the government, the negative equity of the government was trivial back in those days. So if you look at the, the overall financial equity situation is that assets and liabilities financial come to zero. So if the banking sector is in positive, which it has to be, then the rest of society is in negative necessarily.
- [87:37]
B
So 25% is better than 2%. Sorry, I'm just so unclear. The government being 25% is better than 2%.
- [87:45]
A
Yeah. Because that means the non bank private sector can be in positive financial equity if the government's sufficiently in negative equity itself.
- [87:54]
B
So wouldn't we with that thesis, shouldn't the goal therefore be the government be 100% of GDP?
- [88:00]
A
No, no, no, no.
- [88:02]
B
If it gets better as it gets higher.
- [88:03]
A
No, no, no, Hang on, hang on. I'm not talking and I'm not a cardboard cutout socialist on that.
- [88:08]
B
No, no, no. But I'm wondering what is the sweet spot?
- [88:11]
A
It's something which is sufficient to enable the private non financial sector to be in positive net worth.
- [88:17]
B
How do you even measure or know what that is?
- [88:19]
A
You can do it with the accounting. I've done it here, that's a very simple example. So in this situation I've got the private sector having positive equity of 800 even though it must be a negative equity with respect to the banks because the government's got 1,000 in total here of negative equity. So the thousand of negative equity for the government counterbalances the 200 of equity for the banking sector to enable the private non bank sector to be in 800. In this example of positive equity, so long as you've got positive equity, this is a bit like the old macorber.
- [88:54]
If you're slightly ahead, you don't panic. If you're positive financial equity, you're not going to be panicking and trying to buy other assets to see your value rise so long as you get it sufficient to balance this ok, hold on.
- [89:07]
B
So to be so for a young person watching this.
- [89:10]
A
Yeah.
- [89:12]
B
With no assets, just come out of school wanting to have a good life, create wealth, have a future.
- [89:21]
This implies the closer they are to the treasury or where the private sector issues and creates money, the more successful they will be.
- [89:31]
A
Not the latter. Okay, but it's implying that they actually would want the government to create enough positive financial net worth for them by spending more than it gets back in taxation to mean that their financial assets can exceed their financial liabilities. And the example I've chosen here, that's well and truly happening.
- [89:51]
B
When you say their financial assets, what are you referring to?
- [89:54]
A
The thing is their claims and other their claims on the rest of the system, all of which sum to zero. But if the government spends more than it takes back in taxation, it creates negative equity for itself, which is what you're seeing over here. Okay. And positive net worth for the bank, for the non bank public.
- [90:11]
B
But doesn't this naturally create poor incentives and inequality?
- [90:18]
A
Well no, not doesn't naturally, but it can. Okay. It's not.
- [90:22]
B
It seems to have.
- [90:23]
A
Well the thing is if you leave the government out of this and I take out reserves and I take out the treasury, et cetera, et cetera, if I just have a private sector, you're in hock to the banks.
- [90:37]
You owe the banks more than the banks owe you, period. Without the government being in there, you're in negative net worth. And that when we look back in the 19th century, why necessarily it's accounting.
- [90:53]
If.
- [90:54]
B
Hold on, but if I go so say I get my first job, I earn a certain amount of money and I go and borrow money off the bank and I buy a house.
- [91:04]
And I start paying off my house and I have more equity in my house.
- [91:10]
A
I'd bill ting, I'm building now you're talking about a non financial asset. And the value of that non financial asset is caused by the amount of financial debt you took on to buy it in the first place. The valuation gets tied up with the amount of money you borrowed to buy it and you get booms and busts coming out of that.
- [91:29]
B
Sure. But when I get to the point where I retire and my house has paid off, my position is as I have whatever money I have in the bank and I have whatever I hold in terms of assets and I should be in a positive position.
- [91:42]
A
You would be when you include your non financial assets inside there. But the value of a non financial assets reflects what you can sell that house for sure.
- [91:50]
B
But the market would dictate that.
- [91:52]
A
Yeah, but the market is driven by the dynamics of private debt.
- [91:58]
And this is getting to another area altogether from this fundamental point. But the valuation of houses and shares fundamentally reflects the level of leverage we take out on those. And you get booms and busts like we saw in the 1920s.
- [92:14]
This is one of the craziest stats that I have learned when analyzing the economy over time. Level of margin debt at the moment is about 3 or 4% of GDP.
- [92:28]
And of course, with a margin loan, you can get, if you put down $500,000, you can buy a million dollars worth of shares. So your leverage is 2 to 1. Guess what it reached in 1929.
- [92:38]
B
Have no idea.
- [92:39]
A
9% of GDP and the leverage was 10 to 1. Okay, so it meant this huge valuation of shares made everybody feel prosperous in the 1920s.
- [92:48]
B
Is that same with the housing crisis?
- [92:50]
A
Same with the housing crisis. All driven by the level of leverage.
- [92:52]
B
Are we heading towards another crisis?
- [92:55]
A
No, I don't think we are in terms of the actual dynamics of the financial system. Because to have a crisis, you've got to have a high level of credit in the first instance. And because we crashed into the global financial crisis with no warning, neoclassicals had no bloody idea it was going to happen. Some Austrians figured that it was going to happen, and lots of post Keynesians. But the people running the bloody system had no idea the crisis was coming. And we then have a financial collapse coming out of it.
- [93:23]
B
So, on this podcast, you are definitely hearing me talk about bitcoin a lot. Well, why? We live in a really strange time with governments driving inflation with their reckless spending and endless money printing. There is a way out of this. There is a way to protect your money, and that is by stacking bitcoin. I've made loads of shows about bitcoin. You can go and research this, you can go and read the books, but the truth is, it is the hardest money ever created. If you are interested in protecting your financial future, it's time for you to get on the bitcoin train. I have. I've been stacking bitcoin personally and through my businesses since 2017. It's protected me, it's secured my family's future, and it also strengthens all of my businesses. So if you want to start stacking bitcoin, where do you do it? Well, for me, it's with Gemini. They're a fully licensed, full reserve exchange and custodian. So they give you a secure way for you to buy and own your bitcoin. There's no risks and no funny business. So if you're serious about stacking Bitcoin the right way, head over to gemini.com, which is g e m I n I dot com. Okay, what is the role of interest rates in this and how should they be set? Because we have had the central bank say set very low interest rates, which has made it's created incentives to borrow money and take risk, which creates leverage in the system and also does significantly benefit people who can get those loans because they can buy the assets.
- [94:49]
What's going on there?
- [94:51]
A
Interest rates? I'll give you a funny little story. One of my favorite books on stats is a book called Data Reduction by a guy called Ehrenberg. I made the mistake of lending to a student. I lost the damn thing. But it was brilliant. And he used as an example of a constant, this is written in the 1920s, I think. Guess what he used as an example of a constant? The interest rate.
- [95:15]
The varying of interest rates as a control mechanism is a peculiar outcome of neoclassical economists being in charge of the economy because they have assumed away uncertainty. They think the future is just risky. And therefore the value that you put on a capital asset reflects the interest rate that you've got to pay to buy that capital asset. So if you put the interest rate up, we reduce the future value of those cash streams and therefore we can use the interest rate as a control mechanism to when the economy is getting overheated, we're going to make it more expensive to finance a loan. So therefore you'll do less investing. And it's a fine tuning control mechanism. The point that Keynes made was that interest rates are at best a secondary consideration for anybody doing investing. It's your expectations of the future that set your willingness to borrow money. And if you think you're going to make 100% gain in two years, interest rates aren't going to stop you because you're never going to get interest rates of 50% when the inflation rate's close to zero. It's just not a control mechanism against what pain is called. Animal spirits.
- [96:27]
B
I thought the interest rate was a control mechanism on the economy for controlling inflation. When inflation's running hot, the central bank raises interest rates.
- [96:34]
A
That's what they think it does.
- [96:35]
B
Yeah, but it kind of does happen because we had interest rates running. We had inflation running quite hot post Covid and then we saw a massive spike in. Sorry, we had inflation running hot post Covid. We had interest rates starting to go up pre the trust mini budget carried on through it. People's mortgages went up, their rent went up.
- [96:58]
A
You've got less money to spend.
- [96:59]
B
Yeah, they've got less money to spend.
- [97:00]
A
And that's the real impact of it. What they think it's adjusting future expectations. I mean, if you read a neoclassical paper about what interest rates do, they think it makes you buy less cornflakes because of the higher interest rate. Because you are actually, when you go shopping, you're maximizing the lifetime utility of your family.
- [97:19]
B
Well, I think it's maybe less holidays or less cars or.
- [97:24]
A
Well, no, that's actually about you thinking about your great, his 30th, the 13th generation after your son. You're thinking of them when you go shopping. You gotta read this stuff to believe it in terms of what the neoclassicals actually believe. But they see it as fine tuning. Now this actually comes out of Hicks misinterpreting Keynes because what's called, have you heard what's called the ISLM model?
- [97:48]
B
No.
- [97:48]
A
Okay. That's the original model of macroeconomics from the 1930s was called ISLM and it stands for investment, savings, liquidity money. And this was a neoclassical economist called John Hicks attempt to under. He called it his attempt to understand Keynes. In fact it wasn't. He admitted later it was a con job. He conned himself because he'd actually developed this model before he read Keynes. So he had a model of an economy where you knew the future fundamentally. So the only thing which could affect your decision to invest was the interest rate. And therefore you put the interest rate up, you're going to invest less. And therefore interest rate is a control mechanism. But Hicks himself realized in the 70s that that was wrong. He misunderstood Keynes and he was assuming that you could know the future. Hicks was assuming effectively and that worked in his model because the time factor he was working on was a week. He said, whereas Keynes expectations are what's going to happen over a year or five years. And he said there's no way you can know that. You can imagine expectations are constant for a week. That's a reasonable assumption when you're working with a period of time that brief. But you're working in terms of year. No, it's ridiculous to say that expectations aren't going to change. It's ridiculous to say they're going to be accurate. So Hicks realized, he trashed Keynes focus upon uncertainty. And that is what led to the whole neoclassical approach to economics. And it's based on the mistake of believing that the interest rate is the only thing which affects your decisions about the future. In Fact, it's your uncertainty about the future that determines your behavior. And therefore, what do you do when you have. You don't go in the future. You extrapolate current trends. You think current trends are going to be sustained. You accept that current asset prices are realistic, though you'd know if you look back at history, that wasn't true. And one of my favorite lines in Keynes said, you rely upon the judgment of others who are perhaps better informed. In other words, we herd. Okay. We have herding. So that was the stuff that Keynes wanted to bring in as the approach to macroeconomics. And we said we got this complete distortion by Hicks, which led to neoclassical economics. We've gone really deep here. Yeah.
- [100:13]
B
So look, this stuff's hard to follow. I'm sure there's people listening going, pete, ask this question and ask that question. Yeah, I'm just, honestly, I'm just a moron trying to survive in the economy, ensure I can pay my mortgage and create a future where I can retire and look after my kids. But the thing I really struggle with is inflation. It really bothers me because inflation does turn up in the economy and it has a real pernicious effect on people. It appears to make the rich richer and the poor poorer. I'm considered fairly successful. I know inflation is pretty good for.
- [100:50]
A
Me on the main, so.
- [100:51]
B
Pretty good for me.
- [100:52]
A
Yeah.
- [100:53]
B
In that, you know, in terms of the kind of assets I hold, they do very well under inflation. And, and the kind of slightly rise, the rise in kind of shopping. Going to Tesco's, buy my shopping. I, I can. It just doesn't make a difference to me.
- [101:07]
A
Yeah.
- [101:07]
B
But I watch other people, the change in price to fuel. Oh, yeah, Housing, you know, it. It has a disastrous effect to them. And so my understanding of, say, the MMT crowd at the moment, their belief is that you can keep creating money as long as you can control inflation, and that is good for the economy. Are they right.
- [101:28]
A
The best people on that front? I'll give you two good names. Blair Fix, who's a Canadian independent researcher, and Isabella Weber, who's a professor at the University of Amherst.
- [101:40]
B
Not Stephanie Kelton?
- [101:42]
A
No, not Stephanie. Stephanie's good, but she's not an expert in this area. Definitely. It's Isabella and Blair. And they talk about the income distributional effect of inflation, as you're saying right now, which is true. And they say we break it down to one single index. It's a consumer price index. But in fact, prices of some goods are rising all the time. If you're Poor, that really matters. If you're rich, it doesn't matter to you because the goods you actually buy are getting cheaper. So there is an income distributional element to it.
- [102:09]
B
Yeah. And CPI might not be, you know, an issue for some people, but somebody want to get on the housing ladder.
- [102:15]
A
Property inflation's amazing and that's been huge. And that's been caused by banks. That's some work I've done over the last 15 years.
- [102:21]
B
Banks and regulation planning.
- [102:23]
A
Yeah, well, but we didn't have house price inflation in the UK until Thatcher. Okay. You take a look at the rate of change of prices of houses over time and I've done a recent block.
- [102:39]
YouTube video on this front. If you take house house prices from about 1800 to 1930 in the change in real house prices over that time. So house prices relative to consumer prices was virtually zero until about 1920. Okay. It's pretty much constant. Then you had a period where house prices rose.
- [103:05]
About doubled over 60 years. But over the whole period before Thatcher deregulated lending, there was house prices doubled over like 120 years. Then after Thatcher, they doubled in 40 years or trebled in 40 years. So the real inflation was when we let banks start lending for housing.
- [103:23]
B
And that's been continued since that short period.
- [103:25]
A
That's been continued. We've reached a ceiling in some ways because like house prices in the UK compared to consumer prices are about. They've reached a peak of five times as expensive as they were in the 1970s. Now they're about four and a half times. So house prices have risen far faster than consumer prices. But what I wanted to focus on. Yeah, that's.
- [103:46]
B
Let's see, so Thatcher came in what, 78, was it?
- [103:50]
A
Yeah, it's 80. See, there's a. So it was happening 82. That's when she deregulated lending.
- [103:57]
B
So it was happening, but you can see it was happening before there. But it's really shot up, up until 88 and then it's got insane since.
- [104:04]
A
Yeah, yeah, okay. And of course it sets. Compared to prices, prices are different to income. So you don't get quite the same gap for incomes. But the act of Thatcher and deregulating lending for banking in the early 1980s, 82 was, I think, the crucial decision. Before that, building societies dominated lending. So for a building society, a building society, something you pay money into the account, you don't have access to it.
- [104:31]
It's not a demand deposit with a building society. So you're putting your money in there, you're trying to Build up your capital over time. And then you can go to them and say, I've got 30% of the price for a house where you lend me the money. They give you the other 70%. Their bank account goes down, yours goes up. There's no creation of money. So in that sense, the.
- [104:49]
B
So that is full reserve.
- [104:52]
A
It worked at a full reserve system once we allowed banks inside there. Banks increase the loans and increase their liabilities at the same time. They're creating money. And that drives up house prices because.
- [105:04]
B
It'S easy access to capital.
- [105:05]
A
Yeah, yeah. And it's also because the amount of money you've got is increased. So there's a positive feedback, an amplifying feedback between bank lending and house prices.
- [105:16]
B
But should our goal be to end inflation? And can we.
- [105:19]
A
Huh?
- [105:21]
B
Should we have an economic goal of ending inflation?
- [105:24]
A
No, we shouldn't. No.
- [105:25]
B
So we should have inflation, a small.
- [105:27]
A
Amount of inflation, because you don't want deflation. That's what I show the graph on my. Thank you. That's great. If you look at that like the immediate sort of eyeballing of that is it all went hell in a handbasket after the Fed. Not particularly the Fed. It's after World War II. Look at the inflation. It's awful.
- [105:46]
B
Where does he. Up sticks, really? Upsticks. What year can you go down? Keep going down the years. What's that? 64.
- [105:55]
Keep going back here? No, no, no, the other way. So we showed me 1961. So there was a jump there in the 30s.
- [106:03]
A
Okay. Now that looks like there's been inflation after World War II and no inflation beforehand, doesn't it?
- [106:10]
B
I mean, it looks like there's been periods of inflation and deflation from 18.
- [106:14]
A
Now you've got the right point. It's that when you look at the difference, this is the annual change in prices. So there are periods in the 1890s when prices rose by a bunch of plus 20% in one year and they fell by 10 and 15% another year. But since World War II, there've been virtually no periods of deflation.
- [106:33]
B
This is like one little tiny period there. What was that?
- [106:36]
A
That's the global financial crisis.
- [106:38]
B
But if you go back up to the other one, the chart above go to around like, there's a lot of talk usually about 1971 and coming off the gold standard. Obviously there was inflation afterwards, but a huge uptick is pretty much around when the gold standard ended.
- [106:56]
A
Yeah, conversion. Yeah. I mean, this is when American peculiarities come in because they made the mistake of insisting on the Dollar being the currency for international exchange. When Keynes wanted to be a neutral thing, he called the Bancorp.
- [107:13]
But the inflation was actually what really matters here. Let's go to the takeoff of it. Okay, 1973. What's the main thing that happened in 1972? 73.
- [107:24]
B
Vietnam War.
- [107:24]
A
No, the Yom Kippur War. Was that when Nixon took about the Six Day War? Okay, okay. So what happened after the Six Day War? When the Israelis destroyed the Arab armies that were trying to invade? The OPEC had been formed of maybe 10 or 15 years before that. They then decided to put an embargo on any country that supported Israel. So the oil price went from $2.50 a barrel to 10 in one year. And then, of course, that feeds through to other prices. And then in 1979, it went from $10 to 40. Okay. So that was what broke the gold standard to a large extent. That's what caused the inflation.
- [108:02]
B
I thought the gold standard was broken because Nixon wanted to pay for the Vietnam War, so he had to take them off the gold standard to pay for it.
- [108:09]
A
Was actually Charles de Gaulle, who's the key factor there, and America.
- [108:13]
B
He went and asked for his gold back.
- [108:14]
A
He wanted his gold back because America's running a huge trade deficit. Europe is running a huge trade surplus. France accumulated enormous claims in American dollars, which was effectively. That's numbers in the Federal Reserve account in New York is what that turned up as. And because they had the convertibility of gold into dollars at that time, $35 an ounce for gold. At that point, de Gaulle threatened to turn up at Fort Knox and insist that he got the trade surplus of France converted into Gaulle. And that had two things. First of all, Nixon, De Gaulle was going to do it.
- [108:52]
B
What year was that?
- [108:53]
A
Not in 72, 73. Okay. Now de Gaulle would literally have done it. Okay. He was. De Gaulle didn't. Well, he wasn't a bluffer. He would have actually done it. So that would have meant they would have emptied Fort Knox. So at that point, Nixon broke it into two gold standards. 35 still for the official. 42 for private purchases of gold.
- [109:16]
B
Sounds like Argentina.
- [109:19]
A
Okay. But the driving force there was America running a trade deficit.
- [109:24]
B
Sure. But you could see the argument that at least the Austrians have to say, look, what happened since we've come off the gold standard is a hockey stick upwards.
- [109:33]
A
Yeah. But what the hockey stick is eliminating. And this is why we want you to be careful what you wish for. The instability of the night. People think it was stable prices. You look at that and you were right when you were first reaction.
- [109:48]
It's the absence of deflation that characterizes the post war period, not inflation. Now those periods of deflation, they called them panics, okay, Financial panics. So what the period of sustained inflation has done since here is get rid of the panics that happened every 10 to 15 years.
- [110:07]
B
It's a trade off.
- [110:11]
We use inflation to ensure we don't have periods of inflation.
- [110:14]
A
Effectively, the system we have now largely eliminates deflation. And with deflation, what you have is financial panics and collapses. So you'd have a period of growth and then bang, a collapse in the 19th century. And if you want to bust, Berman bust, huge Berman bust cycle, far more severe than we've experienced since the great, since World War II.
- [110:34]
B
But are we not just backing up massive busts? Are we not kicking the can down the road like the global financial crisis that was essentially.
- [110:47]
Trying to avoid the boom and bust and we end up just having a massive length.
- [110:52]
A
Look, I was warning about that crisis long before it happened and Win Godley beat me by almost 10 years saying it's inevitably going to happen. So post Keynesian analysis said this was an inevitability for quite some time. And it's neoclassicals not realizing this bloody stuff is happening and letting private debt get out of control. They obsess about government debt, they don't look at private debt at all. And that's just another one. If I can bring that up for a moment, since we're onto this topic, that is looking at private debt versus government debt over time, with all the obsessing about government debt, you'd think it was bigger, wouldn't you?
- [111:26]
B
Oh no, I know, I know.
- [111:28]
A
The general audience, you know this. So the private debt was always bigger than government debt, except during periods like the Civil war, World War II, and then post the global financial crisis, which these neoclassical morons who'd ignore private debt completely didn't see coming. They don't think private debt has any role in the economy. So when you look at it properly, private debt drives the system. And that's again why I want to stick on just getting us to understand how the system functions, get away from ideology, look at the accounting, look at the consequences of financial assets and liabilities. And then when you do that you think, well, you want the government to have a certain amount of debt because that debt represents the positive equity of the private sector, which means both banks and non bank private institutions can be in positive net worth, which means you don't panic about.
- [112:22]
Not having Necessary net worth. So you don't get in there and go and borrow money from banks and get screwed by the banks.
- [112:30]
B
So back to the inflation point.
- [112:34]
How would we maintain it? So we do only have minimal manageable inflation and hopefully an economy that grows more than the inflation rather than these kind of like. Because even, even when they quote 3.6% UK CPI, I know it's higher. We all know it's higher.
- [112:54]
A
Well, let's see. Thing is, it's distributed. This is the point you made earlier, okay? The prices of ordinary commodities rise a lot. The price of exotic commodities falls. If you're buying Lamborghinis or, you know, cars from China and so on, your prices are falling. If food's trivial for you, you're doing okay. If food's essential for you and you're poor, you're being screwed.
- [113:15]
B
But even the basket they pick for the food, they always tend to pick what favors them to tell the best story.
- [113:22]
A
Oh, and there's been like redefinitions of unemployment as well to reduce the rate of unemployment. There's a lot of fudging of numbers that goes on because politicians don't want to see bad numbers.
- [113:35]
B
They don't want to tell a bad story.
- [113:36]
A
They don't want to tell bad stories. The old mate of mine is. He's. I don't know what, he might still be alive. I have totally lost touch with him. A guy called Peter Brain, he used to refuse to have his name put on a. He couldn't have initial at a conference because then he was P. Brain, okay? But Peter went through and looked at all the redefinitions the OECD had done of the unemployment rate over time. There were 17, I think he looked at between 1990 and 1970 and 2000. Every last definition reduced the recorded rate of unemployment. So that is distorting the numbers to make it look better. And even the basket of commodities they put together to work out the cpi, you have to do that. You have to say, here's a set of commodities whose prices we think reflect the average cost, but that's adjusted very, very slowly and it tends to dominate on. Well, then they use what they call hedonic pricing as well. So the pricing, they reckon, they say this is really, really cheap because it can do so much more than an old phone. So there's all sorts of distortions in how we record these figures.
- [114:46]
B
But okay, so I'm just trying to keep it simple. What is the primary driver of inflation?
- [114:53]
A
Primary driver is social conflict, conflict over the distribution of Income workers, if they have bargaining power, they want money wage rises to give them more of income. Firms want to put up markups to compensate for increased wage costs and material costs.
- [115:12]
B
So you think wages drive inflation?
- [115:13]
A
Wages and markups, this is the. You can actually do a disaggregation of prices this way and say take the price level, a bit of algebra comes out and you say the price level reflects a markup on the wage costs of output per unit.
- [115:30]
B
Then how do we get inflation in periods where there's no, or little to.
- [115:34]
A
No wage rises, stagnant wage growth margins, firms can put up markups at the same time productivity, I mean the amount of units you can produce per unit of input, if that's rising over time, that reduces the rate of inflation. If you didn't have conflict over the distribution of income, the tendency would be for prices to fall.
- [115:59]
So what gives you a tendency for prices to rise? It's workers and capitalists and bankers in that matter, fighting over who gets the spoils of capitalism. So workers can do it by getting money wage rises. And if you go back to the early 1970s, it was a boom economy, real economy was really booming in 1971. I know this, that's one of the year I went to university.
- [116:22]
B
But hold on a second. But if we're not expanding the money supply.
- [116:27]
A
Money supply is accommodative. This is the mistake that Austrians make, and neoclassical as well. They think money is a constraint on the system.
- [116:36]
B
It's not that. Sorry, I'm not even trying to argue as an Austrian, I'm trying to argue as a semi economically illiterate.
- [116:46]
Business owner. But if wages drive inflation and.
- [116:53]
The conflict is over the distribution, if the supply of money hasn't changed, same amount of money is in the system, then they're just arguing about redistribution.
- [117:04]
A
You've used a word there called if.
- [117:06]
B
Well, when.
- [117:07]
A
No, no. Okay. What causes this is one essence of the post Keynesian analysis of money, which is based on being empirically realistic, is that it isn't money growth that causes inflation, it's inflation that causes money growth. Because we think about money as if the government supplies it and it's all the government's fault. This is the typical. The neoclassicals have never really understood private money creation. They think the government is. They think the money multiplier determines how much money is created. And that's a combination of the government's creation of reserves and the government's.
- [117:49]
Reserve requirements. And that's what they. It's all wrong. It's all a myth. And the first person to look through this really carefully was a guy called Basil Moore, who wrote a brilliant paper called the Endogenous Money Stock. And what he argued in this is back in the 1970s, looking mainly at corporate loans, because at that stage corporate lending dominated household lending, which is the way it should be. And he said that corporations negotiate lines of credit with their major banks. So a big company like General Motors or General Electric or Ford would have billions of dollars, hundreds of billions of dollars as a line of credit, which is like a credit card for us personally. So if they have a sudden increase in oil costs, which of course occurred in 1972, 73, because of the OPEC embargo, they have got the capacity to say we're going to pay the higher price.
- [118:47]
This is like a credit card. If you have a 10,000 quid credit card limit and you've got 1,000 accessed, you can literally go and spend £9,000. Today. If you wanted to buy something and you create £9,000 of money. When you do that, you also create £9,000 worth of debt for you. The £9,000 turns up and the person you buy whatever you've swiped the credit card to buy, but you've created money and the banks can't stop you doing it. The government can't stop you doing it. That's what you've signed a contract with the bank. So the money supply is elastic and it responds to price changes. And so rather than money growth causing inflation, it's the opposite. Inflation causes money growth.
- [119:31]
B
I find that really hard to get my head around because the deregulation of the financial sector by Thatcher led to inflation of house prices.
- [119:41]
A
Well, that was due to the banks creating much more money.
- [119:44]
B
Yeah.
- [119:45]
A
Okay. Financial, this I'm talking about, we're talking goods and services birth as assets here. Now assets, goods and services, you can like, you know, these get pumped out about one, one every tenth of a second comes out of a factory somewhere in China. Houses, you might as well treat them as constant supply. Okay. And you houses how asset prices are different to consumer prices.
- [120:07]
B
Okay, so are you saying that house prices, house price inflation is the result of an increase in money supply, but iPhone inflation isn't?
- [120:21]
A
No, that's right. Fundamentally, three basic areas. You have to look at price changes, consumer goods, and they tend to be, they're driven by the cost of production is driving them. You have agricultural goods and raw materials. That depends upon supply. And also if there's high demand, that's a market where you can say demand and supply. Play a Role because you can't control the output of a farm the way you can the output of a factory. And equally, if you want to produce more oil.
- [120:53]
In the old days, you just would open the spigot a bit more because it's literally coming out of the ground. Now you've got to pump more gas in to make what's left come out of the ground. So there are costs involved there and then asset prices. Assets. You can basically treat the asset supply of assets as fixed and then your willingness to buy.
- [121:12]
B
Or scarce.
- [121:13]
A
Or scarce. Yeah. And you're depending upon, you know, the price is really driven by the demand side and the demand side is borrowed money.
- [121:21]
B
Okay, so just so I'm clear, so monetary inflation does drive up asset prices. So.
- [121:32]
Houses, shares, shares, equities.
- [121:35]
A
Yep.
- [121:36]
B
Bitcoin, gold maybe.
- [121:37]
A
Yeah, absolutely. Yeah.
- [121:39]
B
But that inflation is.
- [121:44]
That benefit that makes the rich richer and the poor poor.
- [121:46]
A
Yeah, yeah.
- [121:47]
B
And so that's the inflation which I.
- [121:49]
A
Think some fair in society and I agree entirely. It's one trying to stop it. Yeah, but it. But we.
- [121:55]
B
But therefore to stop it, do we then not need to stop monetary inflation?
- [122:00]
A
Yeah, and that's. You control the banks, not the government, because the banks are the ones that are doing that money creation. This again is the hole in particularly neoclassical.
- [122:10]
B
But the government do it sometimes they want to inject liquidity in.
- [122:13]
A
Yeah, but in fact there's a way the government actually cancels that by allowing bond sales. If I carry on further with that table, I can show you the details there. But the government, when it creates money, is required by law, not by practicality, but by law to issue bonds equivalent to the deficit plus interest on existing bonds required to do that, that is in the first instance, those bonds are sold to banks and what they call primary dealers in an auction, which you can only take part in if either you have or you have access to an account at the central bank. Okay.
- [122:50]
B
And if they can't sell them all, the central bank then sometimes buys them.
- [122:53]
A
Well, the central bank can buy all of them. Central bank can buy the whole lot tomorrow. There's no limit on the central bank's capacity to do that.
- [123:00]
B
But that would create new money.
- [123:02]
A
Well, they're not. No, the ones have no role in money creation, but they do have a role in money destruction.
- [123:09]
B
But if they buy the bonds issued.
- [123:13]
If the bank of England buys the bonds, that money gets transferred to the Treasury.
- [123:19]
A
It will happen. The treasury creates money by going into negative equity, not by borrowing money.
- [123:23]
B
Who creates the bonds?
- [123:25]
A
The treasury does.
- [123:26]
B
Yeah, but when the treasury creates the bonds and they do an auction and people buy them. The money goes to them.
- [123:33]
A
Not money.
- [123:34]
B
What goes to them?
- [123:35]
A
Reserves. Okay, but what are reserves? They're funds, they're not money.
- [123:39]
B
Well, what are funds then?
- [123:40]
A
Well, funds are things you can use for specific purposes and you're not allowed to use them for others.
- [123:45]
B
But what is it though?
- [123:46]
A
Like this is we go back to the Great Depression and the Glass Steagall act and so on. Before Glass Steagall banks were allowed to buy shares. Okay. After Glass Steagall banks were only allowed to buy fundamentally government bonds with reserves. So reserves are something you can only use to buy bonds with.
- [124:07]
B
Sorry, I'm just getting confused here. Sorry, Stuart. Just trying to understand it.
- [124:10]
A
So.
- [124:12]
B
The government say they have 50 billion of bonds of which say China buys 25 billion and the bank of England buys the other 25 billion. Because they can't sell them out, what are they getting? Well, it is still money though, isn't it?
- [124:28]
A
Look at this table again. This is why I want to bring this in here because the deficit itself creates the deposits. One thing I've again learned from Devilding Revelle is that to create money you need an operation that occurs on both the asset and the liabilities or equity side of the banking systems ledger with double entry bookkeeping. Let's say you got paying interest.
- [124:53]
B
Why don't we do the bonds?
- [124:56]
A
I'll just do interest first of all, just so on debt. Okay, so what do you do there? Well, that's going to be, you're going to transfer money out of your account here and you're going to pay it to the bank.
- [125:14]
Okay. And then the banks are going to have bank spending.
- [125:21]
So that's going to be money comes out of the bank, short term equity, okay.
- [125:28]
And that goes into the accounts, the deposit accounts of individuals. So both those operations are on the liabilities and equity side and they don't change the amount of money. Something which is only once on liabilities has to be once on assets as well. And that's how you create money. So credit creates money, loans go up, deposits go up, deficits create money, reserves go up, deposits go up. So those are the money creation activities. Now if you want to look at bond purchases.
- [126:01]
I'll call this bond auction because that's actually what goes on. Okay? Then bond auctions means that auction dollars per year worth of reserves, hang on a second.
- [126:16]
Go down and then the monetary value of the bonds that the banks have goes up.
- [126:24]
B
I'm going to be honest, I don't Know about you, Conor. This is quite hard to follow. Right, Yeah. I just want to keep it simple.
- [126:31]
The treasury has a bond auction, say it's 50 billion pound of things and half is bought by China.
- [126:40]
A
No, they're not. Not yet. Because you see, this is. We've got to distinguish primary auctions, primary bond sales from secondary market. And this is a mistake which I see being made all the time because people, again, this is why I designed this software so I can actually analyze these things when the primary auctions. China is. I don't think China's there in the primary auctions. I could be wrong.
- [127:03]
B
Whoever. I just said somebody buys those bonds. Somebody buys those bonds, which is. And they expect a yield to be paid on that, but they have to transfer something to the treasury and they.
- [127:19]
A
Transfer from reserves in the auction itself, the initial auction.
- [127:25]
But when you have bond interest being paid to banks.
- [127:31]
Then you have interest turning up over here.
- [127:35]
On bonds to banks.
- [127:37]
B
Yeah.
- [127:37]
A
And that increases reserves. But the initial auction is just a. You can only take part in it if you either have an account at the central bank and you approve purchases.
- [127:49]
B
Yeah, no, I understand all that, but the point is, at some point after the auction sale, an amount of money which the treasury can use appears in one of their accounts.
- [128:00]
A
Yeah, but the months I was actually made a mistake fixing up a mistake I made here. Pardon me.
- [128:08]
That money is a transfer of funds from reserves to bonds and the funds are being created by the deficit.
- [128:18]
It's getting too complicated.
- [128:19]
B
Yeah, yeah. What I'm just saying is when they create the bonds, it is so they can have new money to go and spend and do things in the economy.
- [128:26]
A
No, it isn't.
- [128:28]
B
So why do they sell bonds?
- [128:29]
A
Because they're required to by law. And the impact of the bond sales is to avoid the Treasury's account at the central bank going into overdraft. That's the actual impact of bond sales. They don't create money. So.
- [128:46]
B
They create the deficit in their account.
- [128:48]
A
By running negative equity and they sell.
- [128:51]
B
The bonds to keep that. So the money creation is prior to the bond sale.
- [128:56]
A
Yes, that's right.
- [128:57]
B
Okay, but so there's still a money created.
- [128:59]
A
There's money created by negative equity for the Treasury.
- [129:02]
B
Okay, so that new amount of money created goes into the system and when that goes into the system, when it goes into system, that creates. Like if you're closer to that, where they issue that money or they distribute.
- [129:16]
A
Oh, yeah, that's. I mean, you being a bank is a license to print money. And another great book I could Recommend to you by Bill Black titled the Best Way to Rob a Bank is to Own One.
- [129:27]
B
So what I'm saying is it is an inflationary system.
- [129:32]
A
By nature, it is a money. It's a system which creates money and enables inflation to occur. But it only could create it directly in terms of asset prices. And there you're going to get. It's far more the credit side of things is going to create that money than the government.
- [129:46]
B
But in a system which is inflationary, which benefits those who hold the assets, isn't that ultimately unfair for the people who don't have assets?
- [129:58]
A
Run it past me again.
- [129:59]
B
So in a system which is inflationary, which benefits the asset holders because their assets inflate, isn't that also then unfair to the people who don't have the assets?
- [130:08]
A
Oh, yeah. And that's like. That's one of the many reasons to reform this system and not enable the level of inequality that comes out of it to occur.
- [130:19]
B
But won't money creation always create more inequality then?
- [130:23]
A
Well, money create. Let's get down. A capitalist economy needs money. Capitalists aren't in it for the goods so much as they're in it for the money. Okay, so you've got to. If you're going to have a growing physical production system over time, you're going to need a growing money supply as well. And if you look historically, you don't get periods of rapid physical economic growth when the money supply is falling. When the money supply is falling, the physical economy's collapsing as well. So if you want to have a growing capitalist economy, you need a growing supply of money. Now the question is, does it grow faster or slower than. It's the relative rate of growth that matters, not the fact that money is created. One thing that really pisses me off, and you're not doing it, by the way. You're not doing it. As soon as you say money creation, they say Zimbabwe. Okay, Money creation can enable inflation, but.
- [131:17]
You'D have to have money growth if you're going to have a growing capitalist economy.
- [131:22]
B
But isn't the scale we've got to grow an economy? And then you can get Argentina and you can get Venezuela in Zimbabwe.
- [131:29]
A
Yeah. The way to get Argentina or Venezuela is to destroy your physical economy and then pretend nothing has happened. And that's. The Zimbabwe thing was kicking all the white farmers.
- [131:39]
B
Zimbabwe, yeah. Is a unique situation. I think Venezuela is a better example because they massively increase the money supply and you have different levels, different countries. Some have. I mean, Argentina still 30% inflation.
- [131:51]
A
Oh, yeah, yeah. I mean, it tends to a country that's got itself into serious international financial difficulties, that tends to be where you see hyperinflation, including Weimar. So these like hyperinflation. What do you define as a rate of hyperinflation?
- [132:07]
B
Well, isn't the definition. Isn't it? Is it. I'm trying to remember what it was. It's something like 50% every quarter or something.
- [132:16]
A
I found when I looked at the data. I haven't got the analysis handy right now, but I found that a 40% rate of inflation was the sort of dividing line. Right. 40% or more, you're in hyperinflation territory. Below that, you're in sort of.
- [132:29]
B
Still, it's shitty.
- [132:30]
A
Oh, it's shitty. I agree. That's too much. Okay. But like.
- [132:35]
A rate of inflation of 2 or 3%, what that means is your money is depreciating by 2 or 3% per year, which is a minor encouragement to spend it. Now, one of the dangers of getting.
- [132:48]
Something which is where the money's. Whatever you're using for money is rising in value, is you're not going to spend it, because if you spend it now, you can buy more tomorrow. So a certain amount of deflation, a certain amount of inflation is a vector, like depreciation for money. And there's an obsession in monetary theory and obsession in Austrian and Post Keynesian, in Austrian and neoclassical circles as well. And partially, it's natural you want your money to maintain its value, but nothing else does. Everything else depreciates. So that's why there's a great chemist called. I've still got to read his book. I've got to confess, I've read bits, but not the whole thing. A Nobel Prize winning chemist, Frederick Soddy, argued that everything on the planet, everything in the universe, observes the second law of thermodynamics, except money. He said, this is a mistake. Money should also depreciate. So he argued for depreciating currency. You also had Silvio Gazelle, who was a Argentinian businessman, as it happened, who proposed that money should be made to depreciate because that would encourage its expenditure. So have you ever heard of the town called Wargal in. Okay, a town called Wargal in Austria. The mayor was a fan of Silvio Gazelle. And this is in the 1930s. Unemployment's 25%. And the reason why the credit system collapsed, the government money system wasn't adequate to counteract it. You had 25% unemployment in Germany. There's also a decision by the German government to repay its bonds with the Americans, which meant Germany had a worse depression than America. About the only country that did. So Germany and Austria were absolutely in a slump. And he decided to bring in a Silvio Gazelle script, which was money he created, that could be used to pay local government fees in the town of Wargold. And that was designed so the longer you held onto it, you had to put a little stamp on it every week, which depreciated its value. So the way to maintain its value was to spend it. And what happened was Wargall's unemployment rate fell from 25% to zero. Huge amount of development was done in the town, and then they were shut down by the central bank and Walga went back to 25% unemployment and they voted for Hitler like everybody else did.
- [135:10]
B
Do you think there's value in that idea? When people talk about rich people hoarding wealth?
- [135:15]
A
Yeah. Depreciating that wealth would make that not impossible, but much, much more difficult. So a currency that depreciates, and this is Gazelle's idea, would be a more sensible form of money than one that maintained its value over time.
- [135:31]
B
Okay. And so, as a post Keynesian.
- [135:36]
In a world where we do have inflation, which benefits the rich richer and the poor poorer, how do they rebalance that with the poorest? What is the allowance for wealth?
- [135:47]
A
Largely, that is where government spending comes in. Because it isn't Rupert Murdoch who uses public health to get his knee fixed up as an old man, it's the poor that get the welfare, that get the education they couldn't otherwise afford to pay for the state.
- [136:00]
B
So that should be provided by the state.
- [136:01]
A
That should be provided by the state. That's a good reason for state provision.
- [136:05]
B
Steve, are you a socialist?
- [136:09]
A
I believe we need a more complicated society than capitalism. Okay. I want free market stuff.
- [136:16]
B
You want free market.
- [136:17]
A
I want free market, but I also want state provision of goods that are too expensive for the poor. Okay. And things which benefit everybody so nobody benefits out of a stupid population. We get sort of effects we're seeing on the states right now in that way. We all benefit from education, we all benefit from public health. That's what brought the NHS into existence in the very first instance. So there are public goods.
- [136:42]
B
Yeah, sure. But the NHS is massively inefficient and become a bureaucratic system.
- [136:49]
A
And guess why that's happened? Because we had 50 years of bloody Thatcherite administration of them that's run them down.
- [136:55]
B
Yeah, I'm not sure that's exactly true.
- [136:57]
A
Well, I mean, I've had my own personal recent experience with the nhs. I'd be blind in the left eye were it not for the nhs.
- [137:04]
B
Yeah, look, I mean, I have private healthcare and I have used the nhs. The NHS saved my sister's life, my mum worked in the nhs. But there is a whole managerial consciousness.
- [137:13]
A
Oh, look, it's awful. And like, this is a bureaucratization which has happened in.
- [137:20]
Many, many societies, and we fight over this bloody stuff rather than just settling it and letting it sit.
- [137:27]
And there's ranges of ways you can bring in public health as well. Like, I love the original system brought in in Australia, which is called Medicare, and that basically said, we're going to provide, everything is going to be covered and any medical appointment you make, we pay 85%, you pay 15.
- [137:45]
B
See, this is why I go back to that very early question. I said, does economics have a moral obligation? Because I wonder if we bend our. We bend to the economic school we like because it supports our own morals.
- [138:01]
A
We have.
- [138:02]
B
Yeah, morals we have. So, like, I'm. I believe a fairer society is one where there's as little government interference as possible. And the market.
- [138:12]
A
But see, that's you loaded terms straight away. Government interference. Is providing public health and sewerage and water and education interference, or is it providing something the public private sector won't do sufficiently itself?
- [138:27]
B
Well, it depends where the cronyism plays, because I don't believe the NHS is the best answer to public health. I think there should be a mixed model of private.
- [138:38]
A
And that's what Australia had at the time. And that's.
- [138:41]
B
Yeah, it's a bit like, I don't think we should provide in welfare. I like Milton Friedman's idea regarding negative income tax. Income tax, because it's less. It preserves dignity and it creates that incentive to work. So I think of incentives and my problem with more socialist economics is, again, the incentives.
- [139:03]
Interesting.
- [139:04]
A
But see, there's a great book by a good friend of mine, Avner Offer, called the Public Private Divide. And Avner makes. I don't think he makes it sophisticated enough case, but he makes the basic point, and that is that there are some things where the return takes so long to come through that the private sector will look at the costs and say, we're not going to do it, or we're going to do it, we're going to skimp on maintenance and sewerage systems are an obvious case of that.
- [139:31]
B
Yeah, you know, I'm open to that. This is where I clash with the free market.
- [139:38]
A
Yeah, the market people, because, can I just say, it's the light to talk to you.
- [139:42]
B
Yeah. Well, no, no, because it's like I'm not ideological in any way.
- [139:45]
A
Yeah.
- [139:46]
B
You know, I just want the best. I want the best outcome for the most people.
- [139:49]
A
Yeah.
- [139:49]
B
And I, I am a big proponent of Austrian economics, which I'm hoping to correct. I'm a big proponent Astron economics, but I don't believe the free market for the water works because it's a public good. And I'll give you a great example, is that.
- [140:12]
The sovereign wealth fund for Norway has been very good for that country. A lot of people who defend, maybe uae, remember they have a public good which is their oil reserves. I think the water of our country is a public good. I don't want it owned by some faceless capitalists or a private equity company in Turkey or the USA who care only about profit and not us swimming in ships.
- [140:38]
A
And one of the fun things is most of the so called privatized railways in England are owned by public institutions in Europe.
- [140:45]
B
Yeah. But I also think we privatize badly in some ways in that we semi privatize and we've given protection for these companies that haven't actually exposed them to the full free market. And I think it's. Where is that balance between free market and for me, minimal state. But it's interesting. So are you sympathetic to say Zach Polanski?
- [141:07]
A
Who?
- [141:08]
B
Zach Polanski. He's the.
- [141:09]
A
Oh yes, I am. Yeah. I mean Zach. I want to talk within more detail. Me too.
- [141:14]
B
I don't think he'll talk to me.
- [141:15]
A
Well, that's good. I mean, I'll put a recommendation.
- [141:18]
B
Do you know me?
- [141:18]
A
We've talked in Twitter. We DM'd on Twitter. Unlike. You're not.
- [141:25]
B
I've been mean to him before.
- [141:25]
A
You're a humanist.
- [141:26]
B
Yeah.
- [141:27]
A
If I had to say what your ideology is picking up in this concept. You're a humanist? First and foremost.
- [141:31]
B
Yes.
- [141:31]
A
Okay. And that I think would be comparable to what Zach's is. Just different interpretations of how you manifest that. But yeah, I'll see.
- [141:39]
B
Well, I've been a bit mean to him on Twitter, but the truth is if I did an interview with him, it'd be like this. It'll be a good back and forth.
- [141:44]
A
Yeah.
- [141:45]
B
And I think he and I could have a good conversation. I would love to talk to him. Steve, We've been going on for ages. I could talk to you for hours and hours more, but you gotta run out. Comet, got a question.
- [141:55]
A
Sorry, just one question.
- [141:57]
B
He always comes in with the big One, how do we get back to.
- [142:01]
A
The so called, and I know we're in England, but the so called American Dream, you've got to reduce house prices. Or was it. Sorry, let me just add to that. Was it a myth in the first place? It's a myth in the first place. I love that somebody sent me a George Carlin comment saying they call it the American Dream because you have to be asleep to believe it, which I rather liked. But fundamentally what would. The American Dream in this sense is that.
- [142:27]
Average human can live a comfortable life. If you want to live exceptional life, you've got to do exceptional things. But the average person can support a family and live out their life without financial stress. That's the definition of the American Dream, I think, in that sense. And for that dream to be possible, it can't be costing you an arm and a leg and your life's.
- [142:54]
Comfort to buy somewhere to sleep. Well, that's what's happened with the increase in house prices. And when you see where the increase in house prices come, it's from letting banks lend as much as they like for buying a house. And that's what's caused this. I think a huge part of the nightmare that the American Dream is now a nightmare. And the reason is because it's become so expensive to buy a fundamental asset which is somewhere to sleep.
- [143:19]
B
So would you say that you are more open to socialist ideas because we need a rebalancing?
- [143:25]
A
Yeah, I think we've gone far too far in saying the private sector can do everything. And this is an ideology which has been pushed on us ever Since World War II, predominantly by neoclassical and Austrian economists or people who accept that argument about how capitalism actually functions. But because they're wrong, the side effect has been this nightmare.
- [143:43]
B
I think Austrians argue this isn't capitalism, this is cronyism.
- [143:46]
A
Oh, here we go. I mean, I have the same thing. People say Russian wasn't really socialist. Yes, it fucking was. Let's be serious about this. It's a particular manifestation of a socialist system which was a failure. Now we're seeing another manifestation of a socialist system which is China. And you know, you can have all sorts of little reservations, you make it, but Jesus Christ. In terms of increasing people's standard of living rapidly over time, China has creamed it compared to any country on the planet.
- [144:15]
B
Would you say it's socialist?
- [144:17]
A
Yes, I would.
- [144:18]
B
It seems like their success came from opening up their economy. But they have strong controls over the deployment of capital.
- [144:26]
A
And what they did was they read people like Janos Cornu. Another recommendation, a guy called Janos Corni, you probably have not heard his name.
- [144:34]
B
I got a lot of recommendations.
- [144:36]
A
One of my great regrets is I never met Korney face to face. I should have done that, my mistake. He said I was the person who was most his successor over time and I should have gone to visit him in Hungary and I didn't. So it's a big mistake by me. But he tried to understand why did the Soviet socialist economies grow more slowly than the capitalist up to the 70s and 80s, you know, the collapse of the Soviet Union. And he worked out this concept, what he called demand constrained versus resource constrained economies. And he said a socialist economies were resource constrained fundamentally because the Russian Revolution was still a feudal society at the time it took over. You wanted to develop all industry at one time. You made a five year plan and every sector deserved more resources than you could afford to give them. So everybody's resource constrained. So how do you cope with the resource constraint? You produce last year's product again. And I had a hilarious cameo experience for this. When my first girlfriend's brother wanted to buy a 650cc motorbike back in the mid-70s and he couldn't afford a Kawasaki or a Honda, but he found he could buy a Cossack for 650 Australian dollars. So a dollar per cc and the thing turned up in a wooden crate and I helped him pull the thing apart, took off the wooden crate. We found these oil soaked rags, took the oil sides ragged off and there on a wooden pallet tied down by rope was a 1942 BMW.
- [146:10]
Okay, so you just made the same machine every year. Okay. Whereas that's resource constraint.
- [146:17]
Corny said that a capitalist economy is the opposite in the sense that rather than like workers have got all the, there's plenty of money being paid but no goods coming out. So they used to, the Soviet saying used to be they pretend to pass, we pretend to work. You didn't get innovation, you didn't get growth over time. Whereas the capitalist economy got booms and slumps. But the way a capitalist gets consumers in their door rather than their rivals is they innovate. So you get pressure for innovation in a capitalist economy. Now Corney, I don't know his actual personal involvement, but I know that Corney's ideas were accepted by a lot of the Chinese communists when the Deng Xiaoping takeover took over. Deng Xiaoping also went to Japan and saw the innovation taking place there that was affected by the just in time production system. And that was out of Deming, who was an American who was rejected by the Americans and went to meeting and work with them. So he saw the potential for competition and innovation. And so the way that they set up the system was to enable strong state provision of infrastructure. We're seeing that dramatically now with the rail system and energy and so on. But at the same time, massive competition at the individual level. And it's also got a regional manifestation each. Each state in China competes with other states for different industries. So we've got the best of both worlds. The state provision of the infrastructure and long term provision, overall stability. Plus innovate like crazy. And if you fail, you fail. But like, I saw a chart. I think it was one of the good people on Twitter puts out a lot of informative charts. It's 100 plus companies in China making cars.
- [148:00]
B
I saw that the other day.
- [148:01]
A
Yeah. And then they just had the divisions that they sell into as well, which is. So they realized how the good part of capitalism is embedded in a socialist system.
- [148:13]
B
And the combination of. Have you seen the other chart that shows the growth in.
- [148:20]
Car sales from China compared to all other markets?
- [148:22]
A
Oh, yeah. Off scale.
- [148:24]
B
Yeah. It's a hockey stick.
- [148:25]
A
And equally, that's the same thing with solar implementation. And now apparently carbon dioxide output in China is falling, so they're doing a faster transition in that sense again, so they blend the two. And it's not saying there's a tendency in Western thinking in particular to go for one extreme versus the other. Free market versus socialist.
- [148:49]
One part of Asian philosophy is the idea of yin and yang, a balance of the two. And I think in that sense, the Asian societies are better at managing that combination than the west has been because we get this obsessive left versus right focus and we fuck ourselves up.
- [149:06]
B
There's a lot to think about, a lot to go and read. Yeah, We. We have gone on nearly two and a half hours.
- [149:13]
A
Okay. Yeah.
- [149:14]
B
Steve, I'm glad we finally got to do this in person. Thanks for coming in. I'm glad we got to do it in person.
- [149:19]
A
Yeah, absolutely.
- [149:20]
B
And I think we're. I think we're definitely going to do this again. I need to go and think about this.
- [149:24]
A
Happy to come over and join you, mate. It's been a thorough pleasure.
- [149:27]
B
I appreciate that. And safe travels.
- [149:29]
A
Thank you. Yeah. All right.
- [149:30]
B
Thank you, everyone, for listening.