Something is seriously wrong

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1. Bill,
   Can you please go into politics!
   It’s clear that none of this is going to change and for a very long time as well.

2. Hello Professor Mitchell,

   I have some questions about MMT.
   Do you consider MMT to be a sub-branch or part of Post Keynesian economics?
   Or do you think it is an independent theory in its own right? (even though it seems to have strongly Keynesian policy implications through fiscal policy, perhaps made more radical by Abba Lerner’s functional finance thesis).
   What do you think of the work and macro theories of Paul Davidson, Geoff Harcourt etc and the other Post Keynesians? Do they also fail to properly understand MMT?

   Regards

3. Also did you ever write your post on manufacturing?

4. Dear Andrew

   You asked:

   did you ever write your post on manufacturing?

   Not yet – but one day.

   best wishes
   bill

5. I think more effort is needed in explaining why ongoing fiscal stimulus won’t lead to the problems that beset countries in the 60s and 70s. Whenever I try to explain the virtues of ongoing govt spending to others, I often get the response that it was tried before and failed back then, and this view seems ingrained in the general public mindset.

   I think one needs to look back far before the effects of the oil shocks of the early 70s. In the UK, unions were making and getting vastly inflationary pay demands well before 1973. I would like to see commentators on the left being honest about the problems of that time and why it won’t happen again this time if that road is followed. The neoliberal mindset would never have taken hold if things had been working well in the 60s and 70s. In the 70s we had the greedy unions. Now we have the greedy bankers. Same story, different actors. What is constant? Human nature.

   What will make it different this time?

6. Dear Andrew

   You asked:

   Do you consider MMT to be a sub-branch or part of Post Keynesian economics?

   I really don’t like to categorise things in that way. It also depends on what you mean by Post Keynesian economics. There is some analysis calling itself that which I can relate to and other analysis also calling itself PK which I reject outright.

   MMT has a long tradition and for me goes back to Marx. For others, it goes back to Keynes. It clearly has been influenced by both as well as Kalecki, Lerner (functional finance), Minsky etc.

   What do you think of the work and macro theories of Paul Davidson, Geoff Harcourt etc and the other Post Keynesians? Do they also fail to properly understand MMT?

   The people you mention are known to me and I would call friends (in the professional sense). I don’t care to comment on such a broad question other than to say I agree with many aspects of their work but I also have serious disagreements with them on matters pertaining to budgets and money. I would consider them to be deficit doves, in the main.

   best wishes
   bill

7. Bill, for the past 2 months (when I found out about you) I’ve done nothing but just reading your blog (try to read all the archives) and reading many papers from Levy Institute, and UKMC.

   I’m from Malaysia an currently doing Phd Economics in the UK, you are very much true when you said that none of the conventional economic models could provide clear answer or even satisfying description of what caused and why this crisis is happening. Thank God that I found your blog and now I feel very much relieve, contrary to what been taught to us that this crisis could not be solved by a ‘pro people comprehensive policy’ since everything are subjected to the ‘market dynamic’, you could provide the only workable alternative that I’ve been seeking for.

   I would love to bring your idea (MMT) to be included as a subject at economic faculty in Malaysia, since I been lied for most of my Undergraduate and Graduate life I feel very much compel to teach the truth for our future generation.

   By the way, my younger brother is going to ANU early July for Bsc in Economics, I advise him to play along with the system for a while and at the same time to constantly read your blog. . .

   To be honest, I could make sense of economics and its dynamic more by reading your blog than using other models

8. “Keynes argued, are of a domineering and even psychopathic nature … Far better to have them absorbed on Wall Street or in the City of London than in organised crime.”

   Keynes was right and wrong at the same time. The psychopaths landed in finance and also built a very successful organized crime ring.

9. I think MMT counter-terrorism with respect to the bond market is misguided or at least fuzzily focused.

   The bond market exists as an instrument of active monetary policy. If the central bank takes an active approach to adjusting the short term rate, the market will take an active approach to incorporating expected monetary policy into interest rates, where it can. Moreover, to the degree that the central bank adopts active policy rate management, this will affect interest rate risk directly in terms of the short rate. That interest rate risk spills over into the cost of paying interest on the deficit. If the deficit mechanism is no bonds and reserves only, and interest on reserves is paid only the short rate, that interest rate risk poses a concentration of interest rate risk that is unacceptable by any prudent standard. On the other hand, if policy is actively managed, and interest on reserves is paid throughout a term structure of reserve deposits, the risk profile and the pricing of it is equivalent to having bonds. So the real reason for issuing bonds when the central bank actively manages the policy rate is to diversify interest rate risk. Bonds are only an issue for MMT because the central bank actively manages the policy rate.

   The counter-terrorism campaign shouldn’t be focused so much on bonds. Bonds are only the symptom. The problem (from an MMT perspective) is active management of a short term policy rate for monetary policy purposes. MMT’s true terrorism threat in that sense is not from bonds, but from central interest rate management. The only counter-terrorism response that makes true sense in this regard is the zero natural interest rate, with no bonds as the sweetener.

10. There will be no attempt to balance the budget…MMT has won, but no one in Washington will admit it yet. The lack of a budget resolution says it all, I think.

11. The psychopaths landed in finance and also built a very successful organized crime ring

    Professor William K. Black (University of Missouri at Kansas City) has been especially articulate about this.
    http://neweconomicperspectives.blogspot.com/search/label/William%20K.%20Black

    Black on the reform bill that just passed:

    The fundamental problem with the financial reform bill is that it would not have prevented the current crisis and it will not prevent future crises because it does not address the reason the world is suffering recurrent, intensifying crises. A witches’ brew of deregulation, desupervision, regulatory black holes and perverse executive and professional compensation has created an intensely criminogenic environment that produces epidemics of accounting control fraud that hyper-inflate financial bubbles and cause economic crises. The bill continues unlawful, unprincipled, and dangerous policy of allowing systemically dangerous institutions (SDIs) to play by special rules even when they are insolvent. Indeed, the bill makes a variety of accounting control fraud lawful. The financial industry, with Bernanke’s support, already got Congress to extort FASB to gimmick the accounting rules so that insolvent banks could hide their losses and continue to pay the executives (already made rich by destroying “their” firms – that’s the meaning of Akerlof & Romer’s classic article: “Looting: Bankruptcy for Profit”) massive bonuses. All of this is made possible by huge, off budget subsidies to the SDIs via the Fed and Fannie and Freddie.

    The idea that consumer protection should rest on the Fed’s tender mercies is a particularly sick joke. The Fed, institutionally, has never made “safety and soundness” regulation more than a tertiary concern. The Fed’s historic approach to consumer protection regulation is malign neglect.

    Source

12. The counter-terrorism campaign shouldn’t be focused so much on bonds. Bonds are only the symptom. The problem (from an MMT perspective) is active management of a short term policy rate for monetary policy purposes. MMT’s true terrorism threat in that sense is not from bonds, but from central interest rate management. The only counter-terrorism response that makes true sense in this regard is the zero natural interest rate, with no bonds as the sweetener.

    I would agree with this politically. The point is to change policy and reduce suffering globally in the process of globalization that will occupy this century. This will require both education and political action. People need to understand how the financial system operates relative to the economy, and the economy relative to society, in terms of both theoretical possibilities and practical options. Then we can start talking about the option based on reality, instead of on myth, confusion, obfuscation, and fallacious argumentation based on erroneous assumptions.

    I do think that the no bonds proposal is a useful tool, however. I suspect that it is in this spirit that some MMT’ers have proposed it. It introduces the shock factor. Once people realize that bonds are unnecessary, the whole universe of discourse shifts, since it is now presumed that “the bond market” has the last word on policy. I think that it is important to establish that no bonds is a viable option and that there are good reasons for considering it. But I don’t think it is something to lobby for with great effort first.

    The immediate challenge is reversing the present political course that is captive to neoliberal ideology. The latest Gallup poll in the US puts 42% of respondents identifying as conservative or very conservative, and only 20% liberal. This is a huge problem heading into the elections of ’10 and ’12.

13. Speaking of profits and looting.

    How does MMT treat the paradox of profits ?

    [In a closed system without external exchange, with money created by banks through loans, the private sector financed by such loans can hope to recover only the original loans by selling the totality of their products. When the principal was repaid, there is nothing left for either profits or even interest (see the circuitist theory, e.g. Graziani)].

    Steve Keene approached the problem with some unorthodox accounting, but some mmt’er (I do not recall who exactly) commented that (s)he was puzzled by the paradox without elaborating much.

    Since the private sector consolidated sheet balances to zero, how do mmt’ers ‘monetize’ profits in the accounting sense ? Where does money come from (my hunch is that the CB has to be involved to generate new money)? Could an mmt’er in the know describe a more or less detailed sequence of money flow through balance sheets that leads monetizing profits ?

    I am familiar with various circuitist attempts to solve the paradox, however, I could not find any SFC MMT treatment of the problem.

    Thanks.

14. This is another word for the value realization problem – how to account for redistribution of real surplus via value representations (e.g., money forms).

    Clearly, there must be an “injection” of representation forms in order to account for surplus (as well as a destruction of forms in some cases, but let’s be optimistic). It isn’t quite that simple, as real surplus tends to lose unit value and demand patterns shift. Also, timing and relationships are important – government spending (for example) might put more savings into households, whereas government bailouts apparently put more money into executive paychecks.

    So you get our Rube Goldberg, jerry-rigged, contingent existing system that neo-classical economists think can be modeled with fairly simple math. Go figure.

    Keen is far from neo-classical – he is applying what looks (to me) like very sophisticated models to understand system stability and cycles, with a focus on private debt effects. He still has a neo-classical view of value, however – seeing it as a consequence of machine productivity + technology. His early post graduate work included attempts to disprove Marx’s labor theory of value – Keen highlights Steedman’s critique of the “Transformation Problem” in his introduction history of econ lectures. Unfortunately, that critique has been shown to be false (just iterate the transformation of input/outputs 5 times and you get the same answer as the simultaneous equations). Having said all that, I like Keen and his work – he just needs to figure out how to include government spending in his model and not get freaked out over government debt levels.

    Without an discussion of what value is, the realization problem can’t be addressed – I don’t believe this is an area that MMT addresses anyway – but I think it helps one understand the political structures built into the monetary system.

15. There’s no need to get into dynamic models or a philosophical discourse about value in order to explain profits.

    As long as people can create and sell IOUs, you have the possibility of profits, in the form of being a net accumulator of the IOUs.

    Here profit needs to be taken in some context — you are not earning stockpiling bags of currency in your basement. All income is spent. Some on IOUs and the rest on non-IOUs (i.e. goods, labor, capital investments, etc.).

    So even though all cash-flows net to zero, that does not mean that no one can accumulate financial assets.

    In a growing economy, everyone can accumulate a growing stock of IOUs in a non-ponzi fashion. And the “sustainable” rate of IOU growth is growth rate of production, assuming stable prices.

    But even if the economy does not grow, you can still time shift, by spending less on non-IOU’s when you are young and then selling the IOUs for goods when you retire.

    This is in addition to the possibility of ballooning profits due to excess IOU issuance, or the deflation of profits due to too insufficient IOUs being issued.

    And once you introduce governments, the government can supply profits by deficit spending, funding that spending by any combination of new IOUs or new currency, depending on its taste for one over the other.

    But you don’t need government deficit spending to explain profits. You don’t even need banks. All you need is a market for IOUs.

16. ooh, just to interupt everyone,
    Obama has called for co-ordinated action, whilst showing concern about early cuts in deficits.

    DECODE:
    It’s okay to defict spend, as we (the US) are going to do the same, in order to get growth. Therefore, by co-ordinating our spending, the relative values of our currencies should stay the same – it’s clear as day!!! Yipeee!!!

17. Michael Hudson, Europe’s Fiscal Dystopia: The “New Austerity” Road to Serfdom

    Hudson’s analysis applies to the US as well. He covers a lot of ground and lays out the plan the bankers have in store to recoup and are now implementing through the G20 and the central banks. It’s pretty devastating.

18. On the issue of deficit terrorists, do people notice how often the idea that government debt is a Ponzi scheme gets tossed about?
    I have tried to refute it here, with some use of MMT:

    http://socialdemocracy21stcentury.blogspot.com/2010/06/rolling-over-government-debt-and-debt.html

    I have probably made a mistake by referring to “debt monetizing”, but maybe people here are interested in reading it.

19. Ormerod (1994, pp.203) suggests that Japan, Austria, Norway, and Switzerland, among others have (in their own ways):

    … exhibited a high degree of shared social values,, of what may be termed social cohesion, a characteristic of almost all societies in which unemployment has remained low for long periods of time …

    This is very interesting – shared social values, social cohesion. I know in japan’s case I read about latin based japanese that were allowed to work in the country for a time, but some were being pressured to leave japan and return to latin america so they don’t hurt the “real” japanese people and employment. It seems USA is the “melting pot” of social values and cohesions and probably does not have the cohesions as tight as the nations listed above.

20. Tom Hickey: “I do think that the no bonds proposal is a useful tool, however. I suspect that it is in this spirit that some MMT’ers have proposed it. It introduces the shock factor. Once people realize that bonds are unnecessary, the whole universe of discourse shifts, since it is now presumed that “the bond market” has the last word on policy. I think that it is important to establish that no bonds is a viable option and that there are good reasons for considering it. But I don’t think it is something to lobby for with great effort first.”

    Well, I think that it would be interesting to try it in a public debate with a debt/deficit hawk. “The debt is too big, it is out of control, it is a burden to our children and grandchildren. We should pay it off.”

    “OK. Let’s do that. Let’s just print the money. {sic}”

    Deficit hawk has apoplectic fit. 😉

    (Yeah, yeah. Technically it’s not printing money. But printing money is a metaphor ordinary people can quickly understand. A lot of them think that’s how we get our money, anyway. 😉 )

21. Anon,

    Interest rate risk of central bank itself ?

22. Andrew: “On the issue of deficit terrorists, do people notice how often the idea that government debt is a Ponzi scheme gets tossed about?”

    Yes, indeed, I have. Here is how I have thought of dealing with it, but I am not sure.

    A. Bank debt is like a Ponzi scheme. Banks create money by making loans. However, they require the loans to be paid back plus interest. In a world with only bank money, the borrower either has to roll over the debt or default, or somebody else has to borrow money and spend it. Without defaults and bankruptcies the system has to grow like a Ponzi scheme. And like a Ponzi scheme, there will eventually come a day of reckoning, when there are not enough new borrowers, and the system collapses in a financial crisis.

    B. On the surface, gov’t debt looks the same. However, with gov’t debt there is no day of reckoning, because even if nobody is able and willing to lend to the gov’t, the gov’t can simply create money. (If such a day came, there would surely be other problems in the economy, but the gov’t need not default or go bankrupt.)

    Recently I have heard that A is not accurate, because the banks are also able to create the interest in time for it to be paid back without rollover or other borrowing. Is that so? If so, how does it work?

23. Central banks in many countries except the ones whose liabilities are in demand (“foreign reserves”) try to keep the interest rates sufficiently high to put a deflationary bias on the aggregate demand. This is done so that the current account is in surplus and they don’t want the scars from the past to happen again. They also have to manipulate rates to attract foreign demand for their currencies and want to keep their currencies acceptable in global markets. What keeps them awake at night? The fear of a currency fall. Of course, weaker currency is good in some sense but the worry is about a plunge in exchange rates. When their currencies get weak faster, the level of imports doesn’t adjust so fast – people still have to go to work and use oil. Fall in currency also indicates that there could be a further fall and it is scary. High volatility is bad for the acceptability of their IOUs which a country wants if she wants to have strong international trade.

24. Min,

    That story about banks (“A.” in your example) is Steve Keen’s story. Unfortunately his story about banks doesn’t work because of his own rules of accounting which are not self-consistent.

    Banks have build positive net worth and also build capital over time. They can make profit consistent with the rules of accounting. The fact that they take huge bets and end up closing down is a different matter. It has to do with how the regulators are doing their jobs and how incentives are structured etc.

25. Ramanan,

    Interest rate risk for the central bank is a secondary institutional issue.

    I’m thinking primarily of interest rate risk on the interest cost of government debt, where the central bank retains active management of the policy rate as the core mechanism of monetary policy.

    (PLEEEEESE don’t come back and say it’s irrelevant because governments aren’t financially constrained.)

    🙂

26. pebird@at 11:18:

    Thanks, but I was hoping that someone could describe an SFC matrix or give a verbal explanation showing how new money/tokens are created, in the accounting sense, to monetize profits.

    RSJ@12:31 :

    I am not interested in the philosophical part of the new value creation, just in proper accounting.

    Imagine the following:

    A capitalist/”firm” takes a loan of 1000 tokens. Then, the firm spends the loan on production factors, for simplicity only on wages. The workers make products and consume all the output paying 1000 tokens. The “firm”pays back 1000 tokens worth of principal, but cannot pay interest or realize monetary profits — there is no tokens to do that.

    If, hypothetically, the “firm” tries to charge more than 1000 (to realize a profit), there is no one to pay as there is no additional money on hands in the form of wages.

    How does the new money gets into the system ? What is the MMT solution of the conundrum (or logical denialt that such a conundrum exists).

    Thanks.

27. Ok Anon I won’t and wouldn’t have 🙂

    So you are saying that its some kind of strategy where they try to minimize the interest payments ? So you are distinguishing “natural rate is zero” and “no bonds” and analyzing the latter for the moment ?

    Going back to the issues of financial constraints and sustainability, I think its closely tied up with international trade and acceptability of currency in international markets. Of course, one way to beat it is through concerted action by simultaneous fiscal expansion but then it starts resembling the Euro Zone issues – some countries will complain that they will not “take” the debt/gdp ratio to x% etc. Just telling you about the new ideas in my head (picked up from places) and why I wouldn’t have come back saying it is irrelevant.

28. Ramanan,

    Under “zero natural rate”, there is no interest rate risk.

    That’s because the short rate is permanently zero.

    It doesn’t matter whether this is done with bonds or reserves because the market isn’t going to pay a risk premium for term structure when there is no interest rate risk (or at least a lot less of a risk premium than when the central bank actively manages the policy rate into non-zero territory.)

    Given the objectives of a “zero natural rate policy”, there’s no rationale for the government providing a term structure, either through bonds or reserves. The intention is that the rate always be zero. The only consistent implementation of a zero natural rate policy is to eliminate bonds and just dump reserves into the banks as a result of spending, while paying no interest on those reserves.

29. i mean no interest rate risk with respect to government liabilities

    there is interest rate risk with respect to credit spreads over the zero risk free rate (you can call this credit risk as well, but it manifests as an interest rate change)

30. the one exception on government liabilities is that if the government did offer a term structure that was tradeable (bonds or reserves), there might be a premium for the “regime risk” of the possibility that the government could back off its zero rate policy at some future point – which to me is why the zero natural rate as a policy choice actually resembles a fixed rate regime, ironically (and to the horror of MMT advocates)

31. sorry, I’m really not addressing your open economy issues, am i

32. anon, which to me is why the zero natural rate as a policy choice actually resembles a fixed rate regime

    I don’t see it that way. It seems to me that in natural rate = zero the CB is allowing a constant by an operational choice, although the CB retains the ability to choose differently. Under a fixed rate system, the rate is determined independently of the CB, e.g., convertibility agreed to by treaty or a currency board peg , and the CB is constrained by it. No constraint involved when the CB lets excess reserves accumulate and the overnight rate falls to zero.

33. Anon,

    Yes the open economy is slightly tangential to it – but its just my obsession that I try to bring that in everything 🙂

    Yes there is no bonds in the zero rate proposal – just reserves changing out of deficit spending and changes because of transactions of foreign central banks.

    You are saying that in the present world, bond issuance is not the main culprit – just the central bank interest rate targeting is the culprit. Once the central bank targets an interest rate and whether it pays interest on reserves or not, bonds automatically have to be issued at all maturities because just paying the interest on reserves is not prudent, as you put it. And no bonds is only for the special case.

34. Kumar:

    Remember that banks (or firms through a market) can issue IOUs (as RSJ notes) – you can look into the Real Bills doctrine as to whether bills of exchange used for issuing currency is a destabilizing factor as a historical reference.

    However, while I disagree with RSJ on the importance of value, I won’t take up a discussion here. As said above, Keen (also Minsky) basically say that using a “market” for IOUs (which is as good a definition for banks as any) will necessarily create crises. Although Keen’s accounting is incomplete – his model still illustrates fundamental systemic instabilities.

    Min – look at Minsky per debt as a Ponzi scheme.

    In my view, the crises come from a political fight within the financial sector over dividing up claims. This is reflected in the “real” economy as an over-production crisis – but I happen to think that factor is overstated historically, but that is just my opinion – the over-production (for example, housing) is a symptom, not the cause.

    Per your question about profit realization – while the profit paradox (banks create money/IOUs with offset assets, but don’t create “free” money for profits) – it is true that expanding IOU’s can stand-in as profits for a while – but none of these IOUs forms are universal/public – all are private/contractual and require a market for trading (despite others best efforts to abstract them to close to money (“liquidity”) forms – e.g., derivatives, etc.).

    Remember to include “motion” or time in your model – in other words, while the firm is issued 1000 token and goes about its business, there has to be other entities functioning in different phases of whatever cycle you propose. This is how private IOUs can stand-in for profits for a period of time – I argue that these profits are “unrealized” in aggregate, although particular entities may be able to realize their individual profits. I don’t think you can use MMT to answer your question as it is currently structured.

    By definition, privately-issued IOU cannot be universal/public. At some point during the private IOU expansion, a sufficient number of entities will try to realize their claims at roughly the same time. We can speculate whether they do this in a coordinated fashion and/or whether the dynamics of the system (e.g., maturities lining up at the same time) will force them to do so. They believe the value of their claims will be diluted in the future, so they act to liquidate (transform their IOUs toward the universal). Others quickly follow, hence crisis. Gold was the universal in the past, now it is CB-issued liabilities.

    You can call this a capital accumulation crisis, a debt crisis, an over-production crisis, all related. This process has occurred repeatedly during history – with the exception of the “quiet period” after WWII, financial crises were fairly common – every 7 to 10 years, with larger ones every 15 to 25 years.

    In my humble view, the post-WWII managed economy included a process for controlled profit realization via government fiscal policy with monetary (treasury/CB) and coordinated market mechanisms. It was not perfect by any means, but it represents a brief (30 year) historical experiment that demonstrated some of the components of an improved form of economic/monetary functioning. This was not in the interests of some, and they worked hard over those 30 years to chip away and dismantle this imperfect but very functional system. We live in interesting times.

35. VJ Kumar,

    There is some debate in the literature and I think solving it by words don’t help too much. One has to draw something called transactions flow matrices to address this. Here is an article by Gennaro Zezza on how to do it. Some Simple, Consistent Models of the Monetary Circuit

    There is another way of doing it, if you are ready to go through a lot of inventory and inflation accounting, and I refer you to the text of Wynne Godley and Marc Lavoie called Monetary Economics, in particular chapter 9. The authors say that Graziani has had an influence on their work and it is in the same circuitist attitude.

    I am not sure why some authors keep bringing it up – would like to know.

36. VJ Kumar,

    There is some debate in the literature and I think solving it by words don’t help too much. One has to draw something called transactions flow matrices to address this. Here is an article by Gennaro Zezza on how to do it. Some Simple, Consistent Models of the Monetary Circuit

    There is another way of doing it, if you are ready to go through a lot of inventory and inflation accounting, and I refer you to the text of Wynne Godley and Marc Lavoie called Monetary Economics, in particular chapter 9. The authors say that Graziani has had an influence on their work and it is in the same circuitist attitude.

    I am not sure why some authors keep bringing it up – would like to know.

37. RSJ,

    While we can keep arguing about “you don’t even need banks”, please show us some links to models which do not involve banks and the fact that other IOUs are traded and neoclassical results are not obtained.

    While that is a request for a reference, I certainly don’t wish to get involved in a debate about banks 🙂

38. Ramanan at 1:29 :

    I am familiar with Zezza’a article. There are two issues with his article:

    1. He treats only interest (profits are assumed to be zero if the loan is to be repaid)

    2. The initial loan must include wages *plus* interest payments if the loan is to be repaid, a rather odd constraint.

    Are you aware of a more realistic profit monetizing SFC work ? So far, it seems that the SFC/circuitist work I saw leads to a conclusion(theoretical but maybe not practical) that profits are an aberration and economics is a zero sum game.

    Thanks.

39. VJ,

    One view to take is that since governments run a deficit, profits are possible.

    The second ref I provided has households, firms and banks and firms producing and selling of inventories and accumulating them. Firms and banks are able to pay profits. It is true that firms are indebted to banks forever, but whats the problem ?

    The point about the paradox is that people seem to ignore something or the other when even when writing down the equations. The stock-flow models are the right way of approaching it.

    The paradox of profit seems to be like one Zeno paradox which says that the arrow cannot move.

40. VJ,

    Quoting G&L page 261

    The discrepancy between the cash flow and entrepreneurial profits becomes an important issue when the value of inventories changes quickly. From equation (8.8), ΔIN = Δin UC + ΔUC in_−1, we know that this will happen under two sets of conditions. First, it can arise because the cost of inventories is rising at a high pace – the case of inflation (ΔUC in_−1). Second, it can also happens when fast-growing firms require fast-growing volumes of inventories (Δin UC). Under these circumstances, while firms may be making large profits, they are continuously required to borrow large amounts from outside sources if they wish to distribute all of their entrepreneurial profits. Indeed, examples can be easily built where profitable firms, with looming profits, face negative cash flows because of their fast-rising inventories (Godley and Cripps 1983: 70).

    The distinction between cash flow and entrepreneurial profits helps to explain the role of credit money. Without credit money – unless inventories valued at cost are matched one for one for loans from the banks – it would be impossible for firms to distribute dividends or at least to distribute as dividends the entire amount of their entrepreneurial profits. Bank loans are a systemic requirement of the monetary production economy.

    So in the economy you are considering, firms can borrow from banks to distribute their profits.

41. Indeed, examples can be easily built where profitable firms, with looming profits, face negative cash flows because of their fast-rising inventories

    This is a serious problem for may small firms that are very “successful.” They cannot manage the necessary cash flow because they don’t have sufficient credit lines established yet to expand with demand for their product. Typically, they seek to be acquired by larger firms that can provide the necessary capital for expansion. But some are even killed by their own “success.”

42. It is true that firms are indebted to banks forever, but whats the problem ?

    As I understand Michael Hudson, the “magic of compound interest” ultimately catches up with ability to service debt. That’s why in ancient times there were periodic debt jubilees, like every seven years, in order to reset. It’s also what bankruptcy laws are supposed to take care of, so that the system does not bog down in debt and become susceptible to massive debt deflation.

    Of course, this is an oversimplification of Hudson’s work. MInsky showed that a lot more is involved in the periodicy of financial cycles.

43. Tom Hickey,

    “I don’t see it that way. It seems to me that in natural rate = zero the CB is allowing a constant by an operational choice, although the CB retains the ability to choose differently. Under a fixed rate system, the rate is determined independently of the CB, e.g., convertibility agreed to by treaty or a currency board peg , and the CB is constrained by it. No constraint involved when the CB lets excess reserves accumulate and the overnight rate falls to zero.”

    Wow, you really want to have your cake and eat it too. The zero natural rate is institutionalized by definition. The central bank becomes a zombie department of the government. There is a commitment by the government to abandon interest rates and active central banking as a tool of monetary policy. The central bank’s independence and its meaningful existence are subsumed by fiscal policy. What you are describing is not a ZNR regime, but a central bank that happens to have rates temporarily at zero. Japan is such a case now.

    Countries abandon a gold peg when it becomes overly constraining and they want to reflate.

    Greece may abandon its Euro “peg” because it wants to reflate through money and the exchange rate rather than deflate wages and spending.

    A ZNR regime may abandon its zero rate institutional structure if it decides it wants more flexibility than taxes and spending to tighten monetary policy. If government bonds or term reserves are outstanding and subject to market pricing, term interest rates will start to incorporate the possibility of moving off the zero “fixed” rate regime.

44. In fixed exchange rates, it is possible for the central bankers to set the interest rates. In other words, there is nothing endogenous about interest rates in fixed exchange rate regimes. This is true even if there is capital mobility and the reason it is true is because of imperfect asset substitutability. If a central bank suspects huge chasing of wealth and a lot of speculative activity and lesser imperfect asset substitutability, it can change the rate. Its a matter of choice and there is nothing automatic about it and is useful to call it exogenous at every point. The movement of the central bank is more appropriately described by its central bank reaction function. The central bank has no choice but to set the rates. Their only option is to vary the short-term rate of interest at which they supply liquidity to the banking system on demand.

45. Ramanan at 3:07 :

    One view to take is that since governments run a deficit, profits are possible.

    It may be an interesting point of view if one could show stock-flow consistent flow of new money from the CB into the capitalist pockets with the presumption that this is the *only* way of monetizing profits, not just one of many possible ways. The implications of such model could be quite unpleasant I am afraid.

    It is true that firms are indebted to banks forever, but whats the problem ?

    Well, if I understand you correctly, the problem is that such a model is unsustainable as the debt grows to infinity, potentially.

46. Ramanan says at 3:28 :

    So in the economy you are considering, firms can borrow from banks to distribute their profits.

    The problem with the above is a potentially infinite debt growth.

47. VJ .. in those models bank loans are matched by the levels of inventories. No blow up of debt occurs.

48. Thanks to Ramanan and pebird for your helpful replies. 🙂

49. Ramanan at 6:48 :

    Sorry, I do not follow. Are you saying that the loan is repaid to the bank in kind ? So that extra goods are converted to monetary profits by the bank ?

    Could you offer a numeric example ?

50. Anon, Wow, you really want to have your cake and eat it too. The zero natural rate is institutionalized by definition. The central bank becomes a zombie department of the government. There is a commitment by the government to abandon interest rates and active central banking as a tool of monetary policy. The central bank’s independence and its meaningful existence are subsumed by fiscal policy. What you are describing is not a ZNR regime, but a central bank that happens to have rates temporarily at zero. Japan is such a case now.

    True, of course. I was referring to the CB allowing excess reserves to accumulate without paying a support rate, allowing the rate to fall to zero. MMT’ers, (“Natural” means IAW law of least action.) Some MMT’ers have advanced this approach.

    Others are more radical. Some people, including me, would like to the “independent” CB’s abolished as anti-capitalistic and anti-democratic. That is not an MMT proposal, however, but a libertarian one (with a small “L”). Hayek and Friedman were for getting rid of the central bank function altogether, and a lot of people on the right are now clamoring for it, because it is essentially a command system rather than a market approach. I would like the CB to recognized as a government function, hence, fully accountable to the voters.

    The historical fact is that when the CB is “independent,” it is run by the elite and is unaccountable to the voters as part of government. The result is that the people controlling rates and regulation consider money’s chief purpose to be as a store of value, hence, the monetary policy is run for the wealthy. That this not public purpose, and it is just wrong-headed in a supposedly democratic society with representative government.

    {Refer to MIchael Hudson’s post to which I provided a link in my 6.26 @ 13:25, where he speaks to CB “independence” and its nefarious consequences.)

51. V. J. Kumar: The problem with the above is a potentially infinite debt growth.

    Ramanan: VJ .. in those models bank loans are matched by the levels of inventories. No blow up of debt occurs.

    And as Minsky observes, those models are based on simplistic assumption. In reality, the debt does eventually “blow up,” due to financial instability. As long as IOU’s remain good, the chain remains unbroken. But when they don’t, then the chain breaks.

52. R,

    I can’t give you a ref! The standard models assume bonds. No equity or banks. I’m not saying that this is a good thing. Then you have models that have banks lending to firms — again not a description of reality. And of course neither of these models makes a distinction between long and short term rates. I haven’t seen a macro model that has anything other than a 1 period bond, for example. There are partial equilibrium financial models that look at this, but no macro –i.e. economy-wide — models.

    A good model would have households borrowing from banks and firms borrowing from the credit markets, together with forward-looking optimization. The model would also contain the institutional constraints placed on banks that determine how much they can arbitrage their own funding costs to control other people’s funding costs. You would have different effects from a household debt bubble versus a firm investment bubble.

    But counting models isn’t an argument.

    The point is that, in order to have profits, all you need are the IOUs. Once you can buy and sell both goods and financial assets, then you have a flexible money supply and the possibility of sustained profits even in a non-ponzi manner. The IOUs are what allow this to happen, not bank debt per se, although a serious model needs to include bank debt as well as credit market debt.

53. @Tom,

    That’s why in ancient times there were periodic debt jubilees, like every seven years, in order to reset.

    Thats not exactly how I understand it. God (via the Mosaic Law) had the Isrealites assign the lands via allotment for them to use for 7 years. At the end of the 7 years, it was re-alloted (crop rotation?) within the tribes, they reassigned the use of the land via a new allotment (they cast lots again). Larger families and those with more agricultural wherewithall would get more lots to cast. One could not convey the land during the allotment as it was not theirs to sell (it was Gods). One could sort of rent it out for the remander of the 7 year period (it was not considered a “debt” as you could not charge interest ie the natural rate of interest is zero) for some sort of participation (this type of event was probably due to death in the family/change in capabilities/illness?) , but this was revokeable at any time for the balance of the 7 years by the one who received the original allotment, and otherwise went back for reassignment at the end of the original 7 year period so the “tennant” couldnt be locked in to serfdom due to signing a sub-prime mortgage for 30 years. God prevented the Rentier. This was God’s way of establishing a Job Guaranty as it provided every family a proportionate way to earn a living for themselves by Law and the specific arrangements were refreshed every 7 years.
    Resp,

54. Tom Hickey: “The historical fact is that when the CB is “independent,” it is run by the elite and is unaccountable to the voters as part of government. The result is that the people controlling rates and regulation consider money’s chief purpose to be as a store of value, hence, the monetary policy is run for the wealthy.”

    Indeed. But right now it is the function of money as a medium of exchange that is most important.

55. Matt, see Michael Hudson, The Lost Tradition of Biblical Debt Cancellation

    Also his Thinking the Unthinkable: A Debt Write Down, and Jubilee Year Clean Slate

56. But right now it is the function of money as a medium of exchange that is most important.

    Exactly. The problem is lagging aggregate demand (not enough medium of exchange circulating) rather than inflation/inflationary expectations (corruption of store of value).

    But the CB’s are neoliberal institutions and their mission to promote “investment” and protect the value of money as a store of value. As a result they are promoting austerity, either right away (Europe) or as soon as possible (US).

    But as Michael Hudson observes in the link about it’s more devious than that. The objective to transfer wealth from the middle class to the financial sector, i.e., the wealthy, in order to make them whole. This is being done by the president under the idea that 1) what is good for the financial sector is good for the country (NOT), and 2) that future “obligations” are unsustainable (NOT). It is another rip off, pure and simple.

    As Winterspeak observes here and here the financial sector is pro-cyclical and depends on demand, not the reverse.

57. Tom Hickey says: Saturday, June 26, 2010 at 13:25 Hudson’s analysis ….. It’s pretty devastating.

    Dear Tom H,

    Michael of course, sees everything through a focused historical ‘lens darkly’, reflecting probably quite accurately on political and economic history, forces past and present in societies – but not on the broad sweep of being human.

    Are there enough good people in the world with enough understanding to resist such forces?

    I think so – why? Same history: no-one yet has broken the human spirit, enslaved the human soul, captured the human imagination or fettered the creativity and power of discrimination of the human mind; stopped a sentient human being from feeling what they do, or expressing it in song – only broken irreplaceable, uniquely human bodies on a rack. In every land, freedom is a human passion; the human heart ever seeks peace.

    It’s just greed we are dealing with here. An ‘imperfection’ as I understand it.

    Cheers …

    jrbarch

58. VJ,

    As I said, the paradox of profits is like one of Zeno’s paradoxes which says that the arrow cannot move. The opposition to any solution such as debt blowing up is like offering another of Zeno’s paradox which says that sum of a infinite series is infinite and one cannot cross the ground (because for that one has to cross half of it, half of the remaining, half of the remaining etc.).

    In the steady state, it is possible for the total loans to be finite and equal to the level of inventories and the producers paying an interest on it and still making a profit and banks getting interest income out of the loans from firms etc. You have to look at the math, difficult to say it in words without going through another round of questions on the explanations.

    These are the two Zeno paradoxes I am talking of

    That which is in locomotion must arrive at the half-way stage before it arrives at the goal.

    It’s similar to

    In a race, the quickest runner can never overtake the slowest, since the pursuer must first reach the point whence the pursued started, so that the slower must always hold a lead.

    The Zeno paradox analogy is my own but the fact is I don’t see any problem with the paradox of profit. However, it offers some insights and the role of credit money.

59. Missed the first one is If everything when it occupies an equal space is at rest, and if that which is in locomotion is always occupying such a space at any moment, the flying arrow is therefore motionless. (ref: Wikipedia)

60. Thank god for differential calculus, or we could never get from point A to point B.

    Zumar: If you want to create a completely closed model, where everything reconciles at the end of whatever cycle your model has, without any monetary injection, you of course end up in a paradox.

    But if you are going to have IOUs (whether from banks or some other entity), you need to put time in your model at which point at the end of any given cycle, there will be outstanding IOU balances which represent your monetary expansion. The aggregate financial value of these IOUs can never be “extinguished”, they represent anticipated future growth, and a continuous expansion is required for stability. At least, that is my assertion.

    To simplify things, set the discount/interest of your IOUs at 0%, so that profits/capital are solely a function of firm activity. Once that is working, you can split profits between real and financial by modeling an interest rate on IOUs.

    Also, you may want to consider modeling contraction as well as growth – and this is the Achilles heel of the system.

    The problem is that the system is designed to deal with 80% of reality. It moves great in one direction (growth), but when there is a contraction, it’s like running sewage through the fresh water pipes.

    Whether this is stable or not depends on your time horizon and how you view human nature.

61. Ramanan:

    Thank you for your input.

    I do not see though the Zeno paradoxes’ relevancy where the underlier is the notion of infinity which is not the case with finite number of accounting transactions forming (allegedly) monetary profit. Besides, if one is willing to adopt the point-set continuum framework, a.k.a secondary school calculus, the paradoxes cease to exist in such a framework(of course one may be unwilling to adopt such a model as not being ‘true’ to reality, or for other reasons, but at least there is a consistent model !).

    One would hope that, with MMT ascribing so much importance to correct accounting of money flows between various entities, there may be a non-hand-wavy but rather numeric explanation of monetizing profits.

    Disclaimer: the above comment is not intended to diminish the importance of the MMT world-view despite its obvious limitations that may exist only in my imagination 🙂

62. pebird at 1:25 :

    
    If you want to create a completely closed model, where everything reconciles at the end of whatever cycle your model has, without any monetary injection, you of course end up in a paradox.
    

    But the private sector, taken as whole in the accounting/stock flow/balance MMT sense, is just such “a completely closed model”. Would you suggest that monetizing profits happens *only* when the government inject money into the private sector ?

    Thanks.

63. VJ,

    My point on bringing in the Zeno’s paradoxes was just to illustrate the nature of the paradox of profit. I am totally unsure about why it is an issue. Some questions cannot be put in words and you won’t find the solution using just words. As I said, in the G&L reference I provided, they indeed have things not ending up in any paradox. Its a dynamical model and is as close to the theory of monetary circuit as possible. All stocks and flows are taken care of.

    I haven’t seen the MMT’ers discussing the profit paradox.

64. V J Kumar: “A capitalist/”firm” takes a loan of 1000 tokens. Then, the firm spends the loan on production factors, for simplicity only on wages. The workers make products and consume all the output paying 1000 tokens. The “firm”pays back 1000 tokens worth of principal, but cannot pay interest or realize monetary profits – there is no tokens to do that.

    “If, hypothetically, the “firm” tries to charge more than 1000 (to realize a profit), there is no one to pay as there is no additional money on hands in the form of wages.”

    OC, money could be added to the economy by the gov’t. 🙂

    But I think that there is another way. Suppose that there is another firm that borrows money, but goes bankrupt. The bank writes down the loss, but meanwhile there is money in circulation that can go to the profits of the first firm. 🙂

    Capitalists talk about the freedom to fail. But actually, isn’t failure necessary to the overall system?

65. pebird:

    I’ve shortened my name for convenience, but it caused my prev. message to be re-moderated and possibly lost. Here’s what I wrote earlier(apologies for likely double-posting):

    pebird at 1:25 :

    If you want to create a completely closed model, where everything reconciles at the end of whatever cycle your model has, without any monetary injection, you of course end up in a paradox.

    But the private sector, taken as whole in the accounting/stock flow/balance MMT sense, is just such “a completely closed model”. Would you suggest that monetizing profits happens *only* when the government inject money into the private sector ?

    Thanks.

66. Min at 2:04 :

    money could be added to the economy by the gov’t.

    That’s what I thought MMT’ers might have in the back of their minds. The notion has some uncomfortable implications, ‘the government lining up the pockets of greedy capitalists with profits’ being one of them.

    
    Suppose that there is another firm that borrows money, but goes bankrupt. The bank writes down the loss, but meanwhile there is money in circulation that can go to the profits of the first firm
    

    I believe Zazzaro (?sp) tried that approach — profits at the expense of failed companies — that leads to the idea of zero-sum in the absence of growth since the bank has to lose part of its capital due to the bad loan write off.

    Thanks.

67. Yes, the private sector is a closed model – and without government (or the private sector functioning as one through a smooth issuance of expanding private IOU’s), you will hit your paradox.

    I don’t suggest that monetizing profits happens (e.g., occurs as an event) only when the government injects funds. But some “injection” is required. Any number of private financial forms can also monetize profits, and theoretically could continue to do so IF there was some kind of regulator between the real economy and the financial sectors.

    Now of course there is a regulator – it’s called the market and crises – and many of us assert this is a stupid way to regulate and besides, it is completely game-able if you have enough power/resources at your disposal. You would have to believe that without conscious/public regulation, interests between private entities will always align. Well, they do in long run, say the classical economists. And Keynes noted that “in the long run we are all dead”, in other words – freedom and equality in the long run is meaningless.

    So, if the private sector could act “fairly” – and the idea that pricing mechanisms, competition and supply/demand can do this are ridiculous (IMHO) – then basically the private sector would provide what the government does. I believe this is kind of the libertarian view – but it implies a very weird notion of human nature.

    If you believe in a stocks and flow model, you have to recognize that there are lags in certain functions and the system will self-adapt over time to take these lags into account (of course, creating new lags). Realization of profits is one of those lagging functions (and a critical one). My view is that government spending acts to “lubricate” the smooth functioning of the system via growth and profit realization. Profits can be realized through any number of financial forms – as long as participants are confident they can be transformed into whatever universal form is in place (currently CB liabilities – money).

    If that is true, it kind of corresponds to what the Fed has been doing over the last couple years. Now, they are only guaranteeing certain kinds of financial forms, unfortunately I cannot securitize my expected lifetime income (unless we want to argue that this is what a mortgage truly is) and get bailed out during a crisis, but government spending that creates some demand helps a little bit.

    I think you need to take a more macro view – trying to model a mechanism where a particular government spending quantum gets traced through the system and finally ends up in some financier’s wallet is like trying to understand hydraulics by tracing individual H20 molecules. Let me tell you, I tried this with thinking through the timing of government debt issuance and government spending a few weeks ago and ended up with some 500+ comment (on another blog site) thread that proved I was on the absolute wrong track.

68. VJ Kumar: “I believe Zazzaro (?sp) tried that approach – profits at the expense of failed companies – that leads to the idea of zero-sum in the absence of growth since the bank has to lose part of its capital due to the bad loan write off.”

    According to economists, markets are not in general zero-sum. But that is in terms of utility, not money.

    In any finite time period, the private sector is zero sum in terms of money, if loss write-offs are included in the accounting. Right?

69. pebird:

    Thank you for your comments !

    
    I think you need to take a more macro view – trying to model a mechanism where a particular government spending quantum gets traced through the system and finally ends up in some financier’s wallet is like trying to understand hydraulics by tracing individual H20 molecules. Let me tell you,
    

    It would be an interesting trace if possible at all– macro without micro seems to be on too shaky a foundation here, though.

    
    I tried this with thinking through the timing of government debt issuance and government spending a few weeks ago and ended up with some 500+ comment (on another blog site) thread that proved I was on the absolute wrong track
    

    Could you please provide a reference ? I’d be curious to see the comments.

70. @Tom,
    Thanks for those Hudson links! (i intend to read the one on Babylon several times over I have never seen work like that)

    I did not know that such debt forgiveness was practiced as widely in the Ancient world…seems the potentates would periodically do it to gain political favor with the masses of subjects when it got out of control and edict some form of restrictions but then it would come right back again (ancient version of the repeal of Glass-Steagall)….The God of Israel seemed to want to prevent it in the first place…that apparently didnt work out too well for them either at least so far! 🙂

    But I dont know if I agree with it for now. Alot of these banksters probably are in hock the most: boats, 20m house in hamptons, condos, planes, etc…maybe a ‘bottom up’ jubilee, absolve ourselves of the first $250k of household debt and first $100k of student loans…maybe…
    Resp,

71. Matt, I think that the top end of town wants a jubilee for itself, but not for the rest of us.

    You are right. A lot of wealthy people are either in hock on underwater assets or holding paper that is worthless.

    The “austerity” movement emanating from the top is the mechanism for the jubilee for themselves. Government forbearance allows them to not to have to disclose insolvency, and preferential treatment permits them to extract their losses from workers, sticking “lesser people” with the bill for their own excesses. A devilish plan, to be sure, but that’s what it boils down to. It’s pure predation.

72. I recommend Hudson’s Financial Capitalism versus Industrial Capitalism (Doc file)

    These discussions would benefit from a distinction of what banks do versus what non-financial firms do. And another distinction between credit markets and banks. There is a war between bank profits and non-financial profits, as they fight over the same pool of profits; and there is a war between investment banks and other investors — e.g. pension funds — as they trade against each other, with the banks busily robbing everyone else, due to their institutional backing and lower funding costs. Hudson’s piece highlights the consequences of both.

73. Tom,

    When reading Hudson, it is really hard to avoid recalling Carroll Quigley’s “Tragedy and Hope.” In particular: “The powers of financial capitalism had another far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent meetings and conferences. The apex of the systems was to be the Bank for International Settlements in Basel, Switzerland, a private bank owned and controlled by the world’s central banks which were themselves private corporations. Each central bank…sought to dominate its government by its ability to control Treasury loans, to manipulate foreign exchanges, to influence the level of economic activity in the country, and to influence cooperative politicians by subsequent economic rewards in the business world.”

74. RSJ, exactly. At the top, this is a conflict over splitting the pie between rent-seeking and productive investment, with finance gaining an increasing cut over recent years. Simultaneously, financial and industrial capitalists are allied against workers because they believe that lower compensation is to the advantage of both of them, and they are seeking to harness the power of the state through capture to advance their shared purpose.

75. Roger, Professor Quigley (who was teaching history at Georgetown University when I was a student) had it right. Since he wrote these words, the direction has been clear. It is epitomized by the BIS, the IMF World Bank, etc., and especially the EMU, in which the ECB is a central bank without a corresponding political counterpart, there being no European sovereign central government. The push will be on for currencies managed by central banks like the EMU, to whom sovereign governments cede monetary sovereignty. The end in view is a single global currency managed by a world bank without a corresponding democratic world government. That consolidates the control of wealth without political accountability, which is the overall objective.

    This is the real motive behind central bank independence in the first place – which is why I am opposed to this institutionally as anti-democratic. While the New World Order conspiracy theorists are confused about the facts and issues, the basic insight that independent central banking is anti-democratic and threatens liberty is correct. As Michael Hudson observes, the road to serfdom now lies through debt peonage to financial capitalism rather than the totalitarian communism that Hayek opposed. Financial capitalism now depends on central bank “independence” and state capture to operate freely.

    The wealthy have always distrusted democracy, which is a reason that most democracies are representational rather than direct. These are in effect oligarchies controlled by the powerful and influential through state capture. The result is de facto oligarchy, specifically plutocracy. These people think that this is a natural state since they are the ones who have come out on top, or share in the genes that came out on top. Hence, they rule by “evolutionary” right, which is just another form of the ancient idea of aristocracy based on birth. We see this is the BP chairman’s calling his victims “the small people” and Alan Simpson’s echo of it in ‘the lesser people.”

76. Tom Hickey: “The wealthy have always distrusted democracy, which is a reason that most democracies are representational rather than direct.”

    Tom, historically I think that you are right. 🙂 However, having experienced direct democracy in California, I have little good to say for it. There is usually no real deliberation, only ads and sound bites. I vote against everything on principle, since even your friends will try to slip something by. 🙁

77. @VJK:

    Start with this one (only 90 comments):

    https://billmitchell.org/blog/?p=9956

    And here is the reference to Marshall Auerback’s post (with 580+ comments) at Warren Mosler’s Center of the Universe Blog:

    http://moslereconomics.com/2010/05/14/marshalls-latest/

    Have fun!!

78. pebird:

    Thanks !

79. Min, there has been a debate in political philosophy over forms of government extending at least to Plato’s Republic. Direct democracy has usually been associated with mob rule, that is, the rule of the uneducated and unwashed, i.e., of those not capable of governing themselves, let alone anyone else. Plato and Aristotle held that the rule of “men of virtue (arete) were the best (aristoi) and they should rule. Aristocracy originally meant the rule of the best, who would take the common interest to heart and rule intelligently for the common good. Plato thought that the rule of the philosopher-king, the wisest person in the state, was superior, and Aristotle preferred the rule of many to the rule of one, so he choose aristocracy. But for both, this was meritocracy, rather than either nepotism or eugenics.

    In Western civilization, the idea grew that the people in charge must be the people most fit, and this was related to birth, even though they didn’t understand genetics then. So monarchy became the rule of the most fit, and aristocracy the rule of the best-bred. We know where that ended up, and it wasn’t pretty. Lots of people literally lost their heads.

    In England, John Locke and Adam Smith were primary contributors to Enlightenment political thought – in France, Montesquieu, Voltaire, and Rousseau. But there were many other influences, including the Protestant Reformation, the rise of capitalism and industry, the development of science and technology, and the spread of knowledge through the invention of printing. These influences culminated in the American and French Revolutions that established the foundations of modern representative democracy.

    The founders were educated men of property. They believed themselves and their kind to be the aristoi of the ancient concept of meritocracy, and they sought to create a form of government that would establish this class as the governing class in the new democracies. The way to this was to temper the vote by electing representatives and creating checks and balances so that no faction could get so much of a leg up as to take over. We have been struggling with that model ever since, and have vastly improved it by ending slavery and extending universal suffrage.

    But the way American democracy is set up make is far simply for the powerful and influential to capture the state, and they can justify this on the grounds that they are the meritocracy. Apparently, this is what the right believes. Even Libertarian Rand Paul is telling us to trust BP.

    The left holds that this thinking is obsolete, and the US has grown up through the imposition of universal education and the development of modern communications and transportation technology. Unlike the past, most everyone is literate and has traveled outside their home town. Moreover, with freedom of speech and the press, voters can educate themselves on the issues. Therefore, we should trust the process and let people make their own decisions instead of allowing a privileged class do so in the name of greater virtue or expertise.

    Politically, the right trusts authority, and the left doesn’t. It trusts the people. This is where libertarians and leftist radicals agree.

    Will the “rabble” choose “bread and circuses” given the chance, as the right fears? Or will they rise above narrow self-interest and vote for what Europeans call “solidarity.” I’ll take my chances on the later over the present state of affairs, where the wealthy and powerful have captured the state and run to their own advantage at the expense of the common good. It is historical fact that most wealth has been gained by privatizing the commons.

80. Unfortunately, Tom, there isn’t a clear delineation of rent-seeking versus productive investment — that is only known by model a priori and somewhat in reality ex-post. Corporate profits after tax were huge in the 1960s — larger than the biggest profits we experienced at the peak of our last boom — and that was in an environment in which corporate tax rates were much higher than they are now, both statuatory as well as effective. And corporate profits include financial sector profits.

    What has happened in the last bubble was really a compensation explosion in FIRE, which dwarfed the earnings boom. I.e. the rents were labor-rents, not capital rents.

    This is in some sense a truism, because when you lower the cost of capital for the financial industry — for a single industry, instead of for all industries, by definition their earnings do not increase to fill up the gap, because the market cost of equity, which is set by all industries, cannot require this. As a result, you end up with excess labor rents in that industry. In the process, human and financial resources are drawn to these unproductive activities. I know several people who left engineering — developing actual and useful products — and were dragooned into working for wall-street because their pay was 2.5 times higher. Brilliant engineers are now getting paid 300K/year to reduce the latency of high frequency trading operations a few micro-seconds when they could be used to improve the reliability of back end data storage, phone service, or video-conferencing.

    It’s an enormous waste of resources directly caused by a combination of low interbank rates, lax capital requirements, and allowing banks to purchase higher yielding credit market assets with their uniquely low funding costs.

    And this is not to say that industrial capitalism is “good” — you really need a model to argue one way or another. On the one hand, the enormous corporate profits in the 50s and 60s were in some sense an artifact of the long term interest rate environment of that era, with very high equity premiums paid by an extremely risk averse and conservative pool of investors.

    On the other hand, to the degree that those profits were driven by an investment boom that yielded higher future output, there might not be anything “wrong” with that level of profits.

    It all depends on the model, and from that model will come your definition of rentier, as you will necessarily need to distinguish between a payment arising out of an economic rent from a payment justified by an increase in marginal product — i.e. between payments to “productive” and “unproductive” recipients.

    But we can all agree that the glory days of Taylor rule-style interest rate targeting coincided with an enormous flow of economic rents to the financial sector. Whether that is a casual relationship or not will depend on the model that you are using.

81. I don’t disagree, RSJ. My point was simply that FIRE has taken an increasing share of GDP over recent years and this can be viewed as the relative decline in productive investment, especially in domestic manufacturing. Every firm makes some contribution for which it is entitled to a reasonable profit as ROI. However, the difference between “reasonable profit” as ROI, e.g., in terms of historical precedent, and excess profit is a form of rent. Industry becomes rent-seeking when it attempts to use its political clout to reduce the bargaining power of labor and tip the scale in its favor, for example.

    However, the return to FIRE as grown way out of proportion to any justifiable contribution to society. It is now cutting out a huge piece of the pie for itself, and insulated itself from ordinary taxes, etc. It has become chiefly motivated by rent-seeking and has sought to use its political clout to improve its position in this respect.

    I am not sure that current models can adequately reflect the political maneuvering that has been at the bottom of the marginalization of labor by business and the outright grab by FIRE. This is not market capitalism, it is predation through state capture.

82. “Labor-rents”

    Ha ha ha ha ha ha ha ha ha

    Let’s confuse activity with entities, hooray. The proletariat hiding as butlers, cooks, drivers and maids – I am not supposed to be rude on this blog – please understand how much I am holding back.

    If someone provides a service, now they are labor – oh, please.

    This is in every sense a false-ism – in what way did the FIRE employees maintain their rent power? Even the Lehman directors and EVPs had no say when it counted – good bye, just like other non-unionized labor – they had great monopoly power, those FIRE employees.

    Good lord, the last 30 years with no education in class and social strata analysis, and this is what we get.

    Wages are not rents – sorry to pop that idea – but this is pretty basic. I get analogies and all that, but stay more or less on the rails.

    If you want to talk about the financial sector sucking up educated resources to service a political/economic elite – sure I get that, but labor rents?

    Please, stick to zero interest rate bound arguments, I won’t bother you there.

83. pebird, I agree that “labor-rents” is quaint. But RSJ obviously (see his link) means excessive compensation in finance, which is widely recognized as not only beyond reasonable contribution, hence, a “rent” socially and economically, but also as constituting an incentive to reckless behavior, if not actual cheating, and as such, a factor in creating the crisis. I would put a lot of the money paid to military contractors aka mercenaries as “labor-rent” in this sense, since they are being paid multiples of what the military used to pay its personnel to do the same thing. It’s all of a piece with crony capitalism.

84. Tom:

    Thanks, I slept on it and realized I over-reacted.

    I actually think “service-rents” is a better description and I would put professional athletes, lawyers, physicians and such in that category – the ability to monopolize based on some organization to restrict supply of the service they provide, etc., etc.

    In my view a rent can be viewed as cost over and above what would be expected the market to deliver due to some kind of monopolizing activities. Property rents are natural in that space is limited, hence whoever gets there first has an advantage. Human nature is such to consolidate and exclude for advantage. I just don’t see how financial workers exhibited any monopolizing behaviors – yes, their skills (quants, programming, modeling) provided them the opportunity to get high paying jobs, but I just didn’t see any rent-seeking behavior at the “labor” level.

    I just objected to the word “labor” in RSJ’s context. It was also inconsistent: does that mean technology workers were able to extract such “rents” during the dot-com bubble. I don’t see the point beyond the obvious the financial industry hired the best and brightest, grabbed us by the balls and robbed us, but why blame labor?

85. Tom:

    Also, thinking about this – I wonder if RSJ meant CEO/executive compensation as rent? In which case, I would agree with rent, but object to the term “labor”, for (I hope) obvious reasons.

    Anyway, I didn’t need to fly off the handle.

86. pebird, the economic jargon is production, distribution, and consumption with the factors of production being capital, land, and labor. Capital means investment in the means of production (ownership), and labor means the folks involved in production that are not owners of the means of production. In this conceptual model, management falls into the worker category rather than the owner category.

    Rent as extraction in excess of contribution has to have some basis, and as you say, this is usually due to some monopoly advantage created by exclusivity limiting competition. For example, the CIA just justified hiring Blackwater – oops, sorry, they changed their name to Xe due to bad publicity – in spite of all the controversy, because it doesn’t have any other options. Well, the conditions were created to produce this monopoly through no-bid contracting. It’s a part of crony capitalism. Similarly in the professions, conditions are created through licensing boards and such gateways in order to limit the number of professionals so as to perpetuate higher than necessary compensation than there would be if there were more competition. There is actually a push on by existing yoga teachers to create a licensing board in order to create a monopoly advantage, using various pretexts such as expert knowledge and skill.

    Crime (“cheating”) is also rent extraction in that it makes no economic contribution (unless one counts the employment it creates through the work of regulators, security forces, prison construction and employment, lawyers, etc.)

    I just don’t see how financial workers exhibited any monopolizing behaviors – yes, their skills (quants, programming, modeling) provided them the opportunity to get high paying jobs, but I just didn’t see any rent-seeking behavior at the “labor” level.

    I agree that the employees do not seem to have been directly involved in creating the conditions for the excessive compensation that they received. I would write it off to a financial system that is rotten to the core. After extracting as much rent as it can, it “spreads the wealth” among the cronies. That’s the way a crime syndicate works, and according to William K. Black, that’s just what the big operations were and still are, since they are above the law and are accountable to no one.

    Maybe the employees were not directly involved. But isn’t this sort of like the defense of many Nazis at Nuremberg that they were “just following orders”? The evidence seems to be that many at least were aware of the scams they were party to.

87. Paul Krugman is the first major economic voice calling “depression.” This is a sixteen inch round across the bow the administration that no one on the bridge can missing seeing, especially Larry Summers.

88. Tom,

    I thought that the speech of the Indian Prime Minister Manmohan Singh at the G-20 summit was much better than any policy maker, economic advisor or leader out there.

    Remarks by the Prime Minister Dr.Manmohan Singh at the Toronto G-20 Summit

    Following is the text of Prime Minister, Dr. Manmohan Singh’s remarks at the G-20 Summit in Toronto on June 27, 2010.

    “Mr. Chairman,

    The central problem we face today is how to ensure protect global growth in a situation where markets have become very nervous about debt sustainability, especially in some countries in the Eurozone. Concerns about debt sustainability normally suggest a need for fiscal contraction. But circumstances are not normal. The recovery is still fragile and private demand in the industrialized countries is likely to remain weak. Contractionary policies, if followed by many industrialized countries simultaneously, could provoke a double dip recession. This would have very negative effects on developing countries, and on the prospects for achieving the Millennium Development Goals.

    I recognize that there are uncertainties and it is difficult to strike the right balance. But on the whole, I feel the risks of destabilizing the recovery are too great. We have a much greater risk of deflation than inflation. We must, therefore, give primacy to consolidating the recovery, while also taking measured steps to deal with sovereign debt problems.

    This calls for careful coordination of policies among the G-20. It is precisely for this purpose that we agreed in Pittsburgh to work on a Framework to deliver strong and sustainable growth. The outcome of Phase I of this process, which is now before us, sheds valuable light on the policy responses needed in different groups of countries.

    Fiscal consolidation must obviously have high priority in those advanced deficit countries that are experiencing exceptional fiscal stress and where markets have signaled serious concern. However, other advanced countries should opt for a much more calibrated exit from stimulus. We should adopt a carefully differentiated approach, reflecting the circumstances of individual countries.

    The time phasing of fiscal action is also important. Markets may well be reassured by credible steps by major industrialized countries, which impact the fiscal deficit significantly over time, even if the immediate impact is more limited.

    Developing countries need to rebalance their strategies to rely less upon exports and more on domestic demand. In many developing countries, this is best done through increased investment directed to infrastructure. This will sustain growth in the short run by offsetting the contractionary effect of lower exports. It will also increase growth potential in the medium term, by addressing the supply side constraints.

    Aiming at higher levels of investment despite lower export growth is likely to generate larger current account deficits. This will help rebalance global demand, but it requires an environment in which the higher current account deficits of developing countries can be financed. This requires an expansion in both multilateral and private capital flows.

    Growth in developing countries would be greatly helped if threats of new protectionist measures in industrialized countries are firmly resisted and existing barriers to trade, especially those affecting developing countries, are reduced. In this context, a successful completion of the Doha Development Round is imperative.

    Finally, Mr. Chairman, let me comment briefly on how we in India are handling the situation. Thanks to an effective fiscal and monetary stimulus, we were able to contain the effect of the global crisis on our economy. After growing at 9 percent for four years before the crisis, our economy averaged about 7 percent growth in last two years. We expect to grow by 8.5 percent in 2010-11 and we hope to go back to 9 percent by 2011-12.

    This is an ambitious goal and we recognize that we have much to do to achieve it. We are taking steps to reverse the fiscal stimulus we had introduced to deal with the crisis. To this end we have outlined a medium term plan to halve the fiscal deficit by 2013-14.

    We are giving a strong push to investment in infrastructure, relying on private public partnership as much as possible to reduce the burden on scarce public resources.

    We have a sound and well regulated financial sector which was not affected by the crisis. We will persevere with implementing financial sector reforms to support rapid and inclusive growth in the real economy, and also to increase systemic stability in the financial sector.”

89. Ramanan, I agree it’s more sane and humane than most, but it’s still stated in terms of the dominant neoliberal universe of discourse. This is a failed ideology, and it is hurting the developing nations most, not to mention the nations that are not yet emerging and are just resource bins. They will starve.

90. Ramanan,

    Given the failure of MMT to implement zero bonds zero rates, I thought it was an excellent speech.

91. Pebird,

    Yes, Labor is a factor of production, and any factor that is paid more than its marginal product is receiving a rent. There can be labor-rent and capital-rent, and if your model has land, also land-rent. For any factor considered by your model of production, that factor input can receive an economic rent. When it does, the other factors of production must, by necessity, be underpaid.

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

    If you are coming from the point of view of industrial relations, then you would distinguish between “labor” and “management”.

    One common fallacy is to assume that the labor/capital distinction in economics is the same as the labor/management divide in industrial relations.

    Both “labor” and “management” in the IR sense are labor in the economic sense — as a factor of production. Capital is not management — it is the tools and techniques used in production, as well as things like patents, brand names, and market power. Capital rents go to the owners of the firm, to shareholders. The labor rents go to the employees working for the firm — from the CEOs on down to anyone whose pay is in excess of his actual contribution to an increase in final output.

    That is basically everyone working in finance, from the CEO to the software engineer. It is also pretty much every “major” CEO or VP, as well as doctors, lawyers, etc. All of these professions have seen an explosion in income since the 1980 period, while median incomes have stagnated in real terms over that period. One cannot happen without the other. As long as national output continued to grow and capital’s share continued to be constant, then the only way that median wages can stagnate is if top wages rise excessively. That has been the U.S. story.

    The software engineer developing proprietary HFT solutions needs to be paid 300K if the truck driver is to be paid only 50K, even though the truck driver contributes to national output — by moving goods from point A to point B — while the engineer subtracts from national output, by consuming intermediate goods (e.g. equipment, electricity), while contributing nothing to national output.

    Any non-zero income is labor rent for that SW engineer, regardless of how talented or hardworking they are.

    Similarly, even though doctor’s pay has more than doubled in relation to median wages, we can say that they are also receiving economic rents, as their “output” has not doubled, but has increased only at the margin. We do not have double the life expectancy or double the well-being that we had in 1950. The improvements have been marginal. And yet compensation has increased at rate faster than in the productive sector, where improvements have been exponential.

    That is another example of an economic-rent, even though most doctors are hardworking and talented. Any compensation in excess of your contribution to final output is a rent, that necessarily deprives someone else, forcing them to contribute more than their own compensation. The big story here has been labor-rents in certain top fields and a super-star compensation scheme.

92. Manmohan Singh’s influences are far from neoliberal, having studied economics at Cambridge. He is a man of experience. He had been the governor of the Reserve bank of India in the 80s and became the Finance Minister in 1991, when India was near the “day of reckoning” – she had just a couple of weeks worth of foreign reserves for imports. He created policies so that the deep crisis doesn’t last long. He is far from being a monetarist and knows how the monetary system works more than most economists. He steered the country in a different path. Recently as the Prime Minister, he was one of the architect of the National Rural Employment Guarantee Act.

    The fiscal norm – the public debt/gdp rising without limit is an implausibility. It leads to rapid currency falls, problems in the external sector and problems with acceptability of currency and nobody knows this better than Manmohan Singh.

    Its these events I mentioned that I have in mind when I used phrases such as “scars from the past”

93. Ramanan, I totally agree that he a smart man and a good guy. But hee needs to stand up to the Western “Great Powers” and tell it like it is instead of playing nice with these idiots that want to run the world and still think that India is theirs. And I am not referring just to the immediate financial situation. As you well know it goes a lot deeper than that. India should start taking its rightful place in the world on its own terms, and let the Western powers know that the West is the new kid on the block, not India.

    India and China were civilized when Europeans were still tribal illiterates, clad in animal skins. India and China were run over by the West relatively recently, and India and China need to start taking back their power and put the West in its place. Neither India nor China has a tradition of imperialist expansion, and they were melting pots long before America, absorbing different peoples and cultures into their civilization. The West is fond of criticizing India for its caste system, and the Chinese for the rigid social stratification of their past, but at least they are up front about it. The West pretends to be equalitarian.

    And so on. You get the drift.

94. Libertarianism (minus its austrian economics component, needless to say) has always made more sense to me in an agrarian context–there, a certain individualism can function in reality and in a qualitative sense. I think it is just fantasy in the exceedingly complex and heterogeneous context of vast urban agglomerations and modern industry–as is the case with “democracy,” and other modern “buzzwords” that are basically now ideological sentimentalisms and propaganda instruments.

    I also agree that Quigley is on the money–which makes a lot of political and economic debate superfluous and also distracting; this favors the powers-that-be, since distraction is a mode of “divide and conquer.”