Condivergence: Why standard finance theory is incomplete — Andrew Sheng

Mainstream finance theory suggests that money is the life blood of the real economy, helping to provide liquidity, means of payment, store of value, market price discovery and risk management, and reinforcing credit and governance discipline.

These basic functions appear as self-evident truths — logical, consistent and convincing. But the 2007 global financial crisis revealed that these four functions can only operate depending on at least five more key interrelated preconditions of stability. Change in any one element would destabilise money and finance. These are: law and institutions, technology, politics, social inequality and climate change.

Mentions MMT skeptically.

The Edge Markets

Condivergence: Why standard finance theory is incomplete

Andrew Sheng

Bill Mitchell — Inverted yield curves signalling a total failure of the dominant mainstream macroeconomics

At different times, the manias spread through the world’s financial and economic commentariat. We have had regular predictions that Japan was about to collapse, with a mix of hyperinflation, government insolvency, Bank of Japan negative capital and more. During the GFC, the mainstream economists were out in force predicting accelerating inflation (because of QE and rising fiscal deficits), rising bond yields and government insolvency issues (because of rising deficits and debt ratios) and more. And policy makers have often acted on these manias and reneged on taking responsible fiscal decisions – for example, they have terminated stimulus initiatives too early because the financial markets screamed blue murder (after they had been adequately bailed out that is). In the last week, we have had the ‘inverted yield curve’ mania spreading and predictions of impending recession. This has allowed all sorts of special interest groups (the anti-Brexit crowd, the anti-fiscal policy crowd, the gold bug crowd, anti-trade sanctions crowd) to jump up and down with various versions of ‘I told you so’. The problem is that the ‘inverted yield curve’ is not signalling a future recession but a total failure of the dominant mainstream macroeconomics. The policy world has shifted, slowly but surely, away from a dependence on monetary policy towards a new era of fiscal dominance. We are on the cusp of that shift and bond yields are reflecting, in part, the sentiment that is driving that shift....

Bill Mitchell – billy blog
Inverted yield curves signalling a total failure of the dominant mainstream macroeconomics
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia

Lars P. Syll — The weird absence of money and finance in economic theory

It is indeed strange since "money" as a unit of account is basic for quantitative measurement in economics and finance. Moreover, economic activity involving production, distribution and consumption of real good is dependent of finance in the creation of "money" in a monetary production economy.

"Money" and finance are hidden assumptions in economics that constitute foundations of the framework for economic activity and therefore economics. They are for the most part unexamined, and where they are examined much of the investigation is either wrong or confused. 

The conventional excuse of ignoring "money and finance is that "money" is neutral in the long run and measurement using the money scale is just a convenience that allows for expressing on one scale the range of real goods using prices denominated in a currency unit. End of story.

Economists treat economics and finance is givens, like the metric scale, for example. However, there is little in common between "money" and other quantitive measurement scales. Money is not a measurement convenience. It drives the system so that economics and finance are joined at the hip.

This failure to consider presumptions is one of the major flaws in the conventional approach to economics, in addition to presuming that economic factors are "natural" rather than largely based on institutional arrangements.

MMT corrects that inadequate and careless approach.

Lars P. Syll’s Blog
The weird absence of money and finance in economic theory
Lars P. Syll | Professor, Malmo University

Lars P. Syll — Econophysics

Quote worth pondering.

Lars P. Syll’s Blog
Econophysics
Lars P. Syll | Professor, Malmo University

Jason Smith — Money is the aether of macroeconomics

So I've never really understood Modern Monetary Theory (MMT). In some sense, I can understand it as a counter to the damaging "household budget" and "hard money" views of government finances. To me, it still cedes the equally damaging "money is all-important" message of monetarism and so-called Austrian school that manifests even today when a "very serious person" tells you it's really the Fed, not Congress or the President that controls the path of the economy and inflation when neither inflation nor recessions are well-understood in academic macroeconomics. People have a hard time giving up talking about money...

Information Transfer Economics
Money is the aether of macroeconomics
Jason Smith

Michael Pettis — Why market liberalisation now may hurt China more

In the end, while standard macroeconomic reforms may work in theory -- albeit under an unrealistic set of assumptions -- they’ve never worked in practice. Rather than eliminating the controls that protect China from a financial crisis, leaders should confront their debt problem head-on and begin deleveraging.

For that to happen, it would help if the decision-making process were more, not less centralised. Only forceful action from the top can overcome the tremendously powerful vested interests that are blocking the redistribution of local-government wealth.

A more liberal China may be desirable in the abstract -- but not until a more controlled China gets a handle on its debt problems.

Today
Why market liberalisation now may hurt China more

Michael Pettis | Professor of Finance at the Guanghua School of Management at Peking University in Beijing

See also

While China's government debt remains contained, at 46.9 percent of GDP as per latest figures from the Bank for International Settlements, top policymakers have recently raised concerns about a sharp build-up in household debt.

Outstanding household consumer loans have surged close to 30 percent since the middle of last year and reached 30.2 trillion yuan as of October.

Outstanding yuan-denominated property loans amount to 31.1 trillion yuan and individual mortgage loans totals to 21.1 trillion yuan as of the third quarter of 2017, data from the People's Bank of China showed.

Yet, at the same time, China's economy is said to be held back by the traditionally high level of household saving, which is supposedly holding back restructuring from an investment-based economy to a consumption-based one.

CNBC
China's debt is growing at a faster pace despite years of efforts to contain it

Reuters

Two reviews of Steve Keen's Can we avoid another financial crisis?

I just read the new book by Steve Keen, which is … a little red book. It is very readable and brings the reader up to the economic theory and reality of 2017. The focus is on private debt, and that is very important....

Dirk says to read it.

econoblog 101
[book review] Steve Keen – Can we avoid another financial crisis?
Dirk Ehnts | Lecturer at Bard College Berlin

See also

Surprisingly good review from Reuters.

I would beg to disagree with Keen's analysis of private debt in China as comparable with private debt in a Western capitalist system. The systems are different, first owing to different and economic infrastructure, and secondly owing to economic conditions in China, where private sector incomes are increasing correspondingly, for example, and the household saving rate is high. We'll see.

Reuters
Review: Can we avoid another financial crisis?
Edward Chancellor

r

Brian Romanchuk — Released: Abolish Money (From Economics)!

My latest report - Abolish Money (From Economics)! - has been released in ebook format. (The paperback edition will be published within a few weeks.) The ebook is available at the same online booksellers as my previous books.

• Amazon.com link.
• Universal book link (books2read.com)

A big problem with conventional economics lies in integrating economics, which is concerned with the real or actual, that is, production, distribution and consumption of real goods, with finance, which is concerned with the nominal — money, cost, price, accounting, and financial assets.

The problem arises in economics as result of aggregation based on nominal value (costs, prices, etc.) without adequate consideration of the relationship of the nominal and the actual. The assumption is that this can be disaggregated by going back to journal entries to determine the prices of specific units and the number of units of various goods involved.

This is to treat money simply as a veil over barter, as conventional economists do, and to miss the role that money itself plays in the integrated economic-financial system owing to the specific dynamics of finance and the creation and use of financial assets along with real assets.

This approach is simplistic, as Keynes observed, and it leads to modeling that is not realistic enough to be very useless. In fact, the modeling can mislead, especially at junctures that are financially and economically crucial to a society.

It should be obvious that Brian is not calling for abolishing money but rather rethinking how conventional economists use the term as a key concept in economic modeling, in particular with respect to monetarisms in which interest rates are assumed to be determinative and monetary policy by the central bank rules. This is a failed approach.

Bond Economics
Released: Abolish Money (From Economics)!
Brian Romanchuk

Merijn Knibbe — Cecchetti and Kharroubi on the non-neutrality of money

Is money ‘neutral’? Is it just a veil over ‘real’ transactions? Or does it affect the level and composition of ‘real’ expenditure? Stephen Cecchetti and Enisse Kharroubi recently published an article which in a very net way shows that money is non-neutral (as it is closely related to credit). It’s not a veil. It’s part of the essence of our economy. The abstract:….

Real-World Economics Review Blog
Cecchetti and Kharroubi on the non-neutrality of money

Merijn Knibbe

Noah Smith — The Folk Theory of business cycle

Hmm.

1. NS doesn't seem to know that Minksy's financial instability hypothesis is based on quality as well as quantity of debt.

2. NS doesn't seem to realize either the difference between a currency issuer and currency users, nor does he realize how the currency issuer's debt is the inverse of currency users' debt.

Funny things. People subscribing to the "folk theory" of the business cycle, actually financial cycle, warned about financial fragility prior to the financial crisis while conventional experts in finance and economics missed it.

Dirk J Bezemer, “No One Saw This Coming”: Understanding Financial Crisis Through Accounting Models (2009)

James K. Galbraith, Who Are These Economists, Anyway?  (2009)

Noahpinion
The Folk Theory of business cycle
Noah Smith | Assistant Professor of Finance, Stony Brook University

Mark Thoma — Macroeconomics: The Roads Not Yet Taken

How can we fix modern models? There are many avenues that need to be explored, from the need for micro foundations to how expectations are modeled. One of the biggest problems is the failure of these models to connect the real and financial sectors in a way that gives insight into why financial panics occur, how financial meltdowns impact the rest of the economy, and how policymakers can limit the subsequent damage.

To gain insight into these important questions, modern models must overcome their reliance on the representative agent approach. This modeling technique misses the strategic interaction among agents within the financial sector, something I believe is important to fully understand financial panics. Let me explain.…

However, the search for better macroeconomic models eventually turns out, we need to get beyond the tribalism and in fighting that limits inquiry and impedes the search for the truth. What macroeconomics needs most of all right now are open minds and a willingness to consider new approaches to macroeconomic problems.

The Fiscal Times
Macroeconomics: The Roads Not Yet Taken
Mark Thoma | Professor of Economics, University of Oregon 

Noah Smith — Finance Stumps World's Best Minds

If the financial crisis and the Great Recession changed one thing in the minds of macroeconomic policy makers, it was to make them care about finance. It seems almost unimaginable, seven years later, to think that anyone could have ignored the connection between the financial system and the rest of the economy. It’s an almost dreamlike experience to look at the macroeconomic models made before 2009 -- many of which are still in use today -- and search in vain for any reference to leverage, asset prices or the financial industry.

Today’s macroeconomic policy mavens are determined not to repeat the mistakes of the past. At the International Monetary Fund’s April conference on “Rethinking Macro Policy,” much of the focus was on the interaction between government policy and finance. IMF Chief Economist Olivier Blanchard summarizes the conference here and here.

The biggest basic question is what the government can do to limit financial risk. There are three basic approaches...

So basically, the IMF conference confirms that top macro policy thinkers are not certain about how to approach the thorny problem of the financial system. But the other takeaway from the conference is that these doubts are not limited to financial policy. Macro thinkers are very confused about what monetary policy should be doing to fight recessions and inflation, as well....

So the IMF conference demonstrates that even at the very top of the economics profession, there is massive confusion and uncertainty. The macroeconomics world is in a great state of flux, with all of the old verities having been called into question, and new bedrock principles as yet undiscovered.

These people should resign in disgrace and make room for new blood.

Bloomberg View
Finance Stumps World's Best Minds

Noah Smith | Assistant Professor of Finance, Stony Brook University

Lars P. Syll — The loanable funds fallacy

Keynes and Minksy answer Krugman and Mankiw.

Lars P. Syll’s Blog
The loanable funds fallacy
Lars P. Syll | Professor, Malmo University

Noah Smith — Thinking out loud: Do government deficits equal private surpluses?

(Shaking head) Noah Smith is a professor of finance and he doesn't know the answer to this — although granted it is not very clearly stated as "government deficits equal private surpluses," as Jan Hatzius does, whom Noah quotes.

It is clearer to say that the government fiscal deficit equals the consolidated nongovernment fiscal surplus in aggregate, since the government balance plus the consolidated domestic private sector balance plus the external balance must sum to zero as an accounting identity. Transposing, the government balance will be the inverse of the consolidated nongovernment balance in aggregate.

If the external balance is zero, then the government balance and the domestic private sector balance must sum to zero, therefore, must be in inverse relationship. In this case, if government net spends by running a deficit, then the domestic private sector saves the same amount in aggregate wrt net financial assets. And vice versa.

If the both the external sector and the government sector are in balance, then the domestic private sector must also as an identity. There can be net savers but not net savers in aggregate, since accounts within the sector must balance, i.e., net to zero.

Hint to Noah: Read Godley and Lavoie, Monetary Economics for an explication of stock-flow consistency in sectoral balance accounting. Jan Haztius learned this from Wynne Godley, and it is the basis of MMT SFC macro modeling. This is really simple when you do the accounting properly.

While accounting identities don't say anything about the causality, they do reveal what is necessary and what is impossible in terms of stock flow consistency. Mixing up stocks and flows is a novice error.

Noahpinion
Thinking out loud: Do government deficits equal private surpluses?

Noah Smith | Assistant Professor of Finance, Stony Brook University

Timothy Taylor — Size of Global Capital Markets

How economics met finance, and how Milton Friedman almost called off the wedding.

The Conversable Economist

Size of Global Capital Markets
Timothy Taylor | Managing editor of the Journal of Economic Perspectives, based at Macalester College in St. Paul, Minnesota, which can be read free on-line courtesy of the American Economic Association

David Graeber — Can Debt Spark a Revolution?

The idea of the "99 percent" managed to do something that no one has done in the United States since the Great Depression: revive the concept of social class as a political issue. What made this possible was a subtle change in the very nature of class power in this country, which, I have come to realize, has everything to do with debt.

As a member of the team that came up with the slogan "We Are the 99 Percent," I can attest that we weren't thinking of inequality or even simply class but specifically of class power. It's now clear that the 1 percent are the creditors: those who are able to turn their wealth into political influence and their political influence back into wealth again. The overriding imperative of government policy is to do whatever it takes, using all available tools—fiscal, monetary, political, even military—to keep stock prices from falling. The most powerful empire on earth seems to exist first and foremost to guarantee the stream of wealth flowing into the hands of that tiny proportion of its population who hold financial assets. This allows an ever-increasing amount of wealth to flow back into the system of legalized bribery that American politics has effectively become.

When we were organizing the Wall Street occupation in August of 2011, we really didn't have any clear idea who, if anyone, would actually show up. But almost immediately we noticed a pattern. The overwhelming majority of Occupiers were, in one way or another, refugees of the American debt system.

The Nation
Can Debt Spark a Revolution?
David Graeber | Reader in Social Anthropology, Goldsmiths, University of London