Philip Pilkington: The Liquidity Trap and All That…

By Philip Pilkington, a writer and journalist based in Dublin, Ireland

Recently the mainstream press have done some rather interesting coverage of Modern Monetary Theory (MMT). Particularly good was the Washington Post’s attempt to spell out the key differences between Modern Monetary Theory and standard post-war Keynesianism.

In their piece on MMT, the Post rightly pointed out that after the war there were two distinct brands of Keynesianism. One came down from Keynes himself through his students at Cambridge; the other was essentially invented by the American economist John Hicks and came to dominate academia after the war.

In the coming days we will probably see many commentators expressing confusion over the differences between the two types of Keynesianism. And while there are many threads that one could follow to try to draw what is a very real distinction between the two approaches, we will concern ourselves here with Hick’s old ISLM model and the liquidity trap interpretation of Keynes’ argument.

Hopefully following this thread will tease out some of the differences between the two approaches (differences which Hicks conceded when he rejected his own interpretation of Keynes later in his life). Key among these will be: the post-Keynesian protest in trying to fit Keynes into some engineering diagram straitjacket; the post-Keynesian focus on actual business psychology; the rejection of the so-called ‘loanable funds’ theory; and the post-Keynesian scepticism as to monetary policy.

From the Mists of Time

First, the liquidity trap itself. Keynes deduced it – like he deduced so many other things – but it was only an endnote to a chapter entitled ‘The Psychological and Business Incentives to Liquidity’ in his General Theory of Employment, Money and Interest. The passage in the original – remarkably difficult to find given the muddle surrounding the liquidity trap today – is as follows:

“There is the possibility, for the reasons discussed above, that, after the rate of interest has fallen to a certain level, liquidity-preference may become virtually absolute in the sense that almost everyone prefers cash to holding a debt which yields so low a rate of interest. In this event the monetary authority would have lost effective control over the rate of interest. But whilst this limiting case might become practically important in future, I know of no example of it hitherto. Indeed, owing to the unwillingness of most monetary authorities to deal boldly in debts of long term, there has not been much opportunity for a test. Moreover, if such a situation were to arise, it would mean that the public authority itself could borrow through the banking system on an unlimited scale at a nominal rate of interest.

This passage was seized upon by Hicks and other monetary policy enthusiasts as the nodal point of Keynes’ theory of an economy out of whack. While we won’t get too deep into the details, these economists thought that it was under these specific circumstances that active government fiscal policy was necessary. Yes, some of these ‘ISLMic Keynesians’ would probably have broadly supported the use of fiscal policy even when the economy was not mired in the dreaded liquidity trap, but their theoretical underpinnings for such a recommendation were weak, self-contradictory (having to do with so-called ‘rigidities’ which were otherwise ruled out in their models) and, dare I say, born of naked political motivation.

Keynes, on the other hand, clearly advocated fiscal policy measures even though, in his own words “whilst this limiting case [of the liquidity trap] might become practically important in future, I know of no example of it hitherto”. Here was a man who never saw a so-called liquidity trap in his life, yet whose theory led him to advocate fiscal policy in a manner that he understood to be wholly consistent with logic. In Chapter 12 of the General Theory entitled ‘The State of Long-Term Expectations’ he wrote:

For my own part I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest. I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organizing investment; since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital, calculated on the principles I have described above, will be too great to be offset by any practicable changes in the rate of interest.

Clearly Keynes was sceptical of monetary policy despite the fact that he had never seen a so-called liquidity trap. His analysis – which was not Hicks’ ISLM model – led him to conclude that monetary policy was too weak a tool to manage a capitalist economy. He was right of course; as a means to stimulate growth monetary policy is probably, to a large extent, voodoo – a conjuring trick summoned out of dust to tweak the animal spirits of investors in the good times. And the reason it is still appealed to by the ISLMists? Because without it their criss-crossing totem falls apart and they are once again led to think in terms of business psychology and the real world.

Moving back to our little history, Keynes’ liquidity trap argument was not loved by all and sundry. The British economist Arthur Cecil Pigou, who had received something of a clawing in Keynes’ General Theory, was convinced that even if an economy entered a liquidity trap the self-equilibrating forces of The Market would ensure that everything would return to normal eventually. Pigou thought that if competition were allowed to work its magic wages and prices would fall. This fall in prices would mean that already existing money would become worth more in real terms, so consumption would increase and the economy would exit the liquidity trap as GDP grew – this became known as the ‘Pigou effect’.

Pigou’s argument was rather dim. It did not, for example, take into account the distributional impacts of the real money boost provided by the deflation together with the disproportionate propensity to consume among the different income classes. Nor did it consider the fact that when people see a general decline in prices they might hold back purchases in the hope of more declines, thus reinforcing the deflation spiral. And then there was another, rather enormous problem that was pointed out by the great Polish economist Michal Kalecki: put simply, that the real levels of debt would rise as prices and income fell:

The adjustment required would increase catastrophically the real value of debts, and would consequently lead to wholesale bankruptcy and a ‘confidence crisis’.

While the deflation might – we emphasise the word ‘might’ – encourage those who held money to consume, it would cast debtors deep underwater and massively increase bankruptcies. Kalecki’s point had, of course, already been stated in theoretical form a few years before by Irving Fischer in his ‘The Debt Deflation Theory of Great Depressions’ – especially in this now famous passage. But, of course, such theories are not equilibrium theories and so Pigou could never have accepted them.

Pigou was largely ignored by the new Keynesian orthodoxy. This new orthodoxy, who were otherwise ISLMists to the core, also tended to broadly ignore the liquidity trap argument. Partially this was because they had, like Keynes, never seen such a thing; but partially too because fiscal policy was, due to contemporary government policy, the economic fashion of the day – and if economists are good at nothing else they are quite brilliant at following intellectual fashions.

The New ISLMists

Moving on to recent history – one in which the fashion is undoubtedly monetary policy – the most popular advocate of the ‘liquidity trap’ argument today is Paul Krugman. Krugman had long been familiar with what he thinks to be a liquidity trap problem because of his study of Japan, which went through similar problems to those currently being experienced by the US and the UK after their housing and stock bubbles blew up in 1991.

Krugman is, of course, an avid ISLMist. But prior to this he thought that Pigou’s argument had some merit:

If you really want to know, I had initially believed that the ‘Pigou effect’ might play an important role in the discussion, and needed the intertemporal model to convince myself that it did not.

From his initial Pigovian ideas, Krugman has since moved onto the ISLM model. Although Krugman does recognise that government fiscal stimulus should be used aggressively in the current downturn he understands this only in terms of the ISLM. This leads him not only to fundamentally misunderstand the nature of the problem, but also to call for negative real interest rates. He recommends that in lieu of adequate fiscal policy the central bank should try to scare people into thinking that inflation is just around the corner. This is a rehash of the arguments he put forward in relation to Japan:

[M]onetary policy therefore cannot get the economy to full employment unless the central bank can convince the public that the future inflation rate will be sufficiently high to permit that negative real interest rate… [And] an economy which is in a liquidity trap is an economy that as currently constituted needs expected inflation… (My emphasis)

Negative real interest rates – which essentially mean trying to blackmail savers into investing by threatening to inflate away their savings – are a dubious tactic for number of reasons, none of which can be appreciated from within the ISLM model.

I wrote about some of the potential problems of this approach on this site recently. Put simply, because the ISLMists rely on a toy model with intersecting lines to determine investment behaviour, they cannot even begin to try to think in terms of investor psychology – which is precisely the type of thing that Keynes, plugged into the real world as he was, was interested in. The ISLM model implicitly models robot that, lo and behold, act in their investments as if they were reading the results of an ISLM model. (Tautology, much?). This leads the ISLMists to completely ignore the perverse effects that certain policies may have upon the psychology of the investor. Their ISLM robots only move in one direction when pushed – in the real world investors can go in any number of directions.

Related to this is that by scaring the hell out of investors that inflation is around the corner they may seek to hedge against the perceived threat to their money savings and they may do so by hedging in commodities. This can cause any number of economic problems.

The most obvious of such anomalies in the current situation is gold, the market for which is in an obvious bubble. Now the gold bubble will have few effects on the real economy except for leaving a few convinced gold bugs with ashes in their hands when the whole thing burns – but there are other commodities markets that certainly do have effects on the real economy when they inflate. As former International Petroleum Exchange director Chris Cook argued on this site recently, oil and other commodities markets are probably being inflated right now due to investors hedging against feared inflation. Ironically enough, this produces the feared inflation by raising energy and other prices which in turn push up the CPI.

This is not the first time these issues have been raised. Hedge fund manager Mike Masters, MMT economist Randy Wray and Commodity Futures Trading Commission commissioner Bart Chilton have all noted that massive amounts of money looking for a ‘safe haven’ might be inflating bubbles across the commodities markets and raising prices for consumers.

Of course, the model-obsessed ISLMists will truck out their criss-crossing totems once more to ‘prove’ that supply and demand in the oil and other markets cannot be tampered with by hedgers and speculators (presumably they would say the same about the gold market, although it would take quite a twisted mind to explain why the ‘real’ demand for gold has more than doubled since the financial crisis). Harking back to undergraduate level economic models is a weak move and would, I think, be laughed at by real world investors who are nowhere so naïve about commodity markets.

ISLMists would, as usual, be better off reading Keynes himself who in his Treatise on Money spelled out the possibility of what he called ‘commodity inflation’. But alas, they probably will not. After all investors piling out of dollars and into commodities to hedge against inflation in the current environment doesn’t look like how their ISLM robots should be acting during a so-called liquidity trap. And when models are worshiped like totems it is reality that is to be ignored rather than an anomalous reading recognised for what it is.

Death of the Loanable Funds Doctrine

In truth the liquidity trap argument is basically meaningless in how it relates to a modern economy with a modern banking system. This is because, as followers of Keynes and his students have now known for over 30 years, the amount of money in a modern economy is determined by the demand for said money and not its supply. This is a key difference between the standard ISLM Keynesians and the post-Keynesians which should be stressed as much as possible.

The only control that central banks have over the supply of money is through the exogenously determined interest rate which, as everyone knows, is set through open market operations (OMOs). This means that if we whip up a model the supply function of money will be represented by a horizontal line, indicating the infinite elasticity of the supply of money. One of Keynes’ most eminent students, Nicholas Kaldor, put it as such:

The supply of money is infinitely elastic – or rather it cannot be distinguished from the demand for money.

We won’t get into the reasons that this is the case as they are quite complex, but the reader can consult the mounds of theoretical and empirical material that has accumulated over the past few decades in Post-Keynesian circles. Instead let us see what consequences such an argument has for those that adhere to the liquidity trap theory.

Any good ISLMist will tell you that if the supply for money is indeed infinitely elastic then the Holy Model is truly cooked and the liquidity trap theory burns up with it. Why? Because if we plot a horizontal line representing the supply of money (LM) across the ISLM model we will see that the investment-saving function (IS) is then always moving along a horizontal line which, in the standard ISLM model, only occurs when a liquidity trap is hit.

Monetary economist Marc Lavoie sums it up rather well in his book Foundations of Post-Keynesian Economic Analysis:

In a theory of endogenous credit money, the role attributed to liquidity preference by the earlier neoclassical Keynesians loses its significance. The preference of the public for holding money does not play any role, either in the determination of the rate of interest or in that of employment.

This means that the liquidity trap argument is reduced to being a rather bland statement about the fact that interest rates are not leading to increased confidence rather than a fancy modelled theory about how investment is determined. The reason that the ISLM turns up such boring results when confronted with the endogenous theory of money is because the ISLM model itself is reductionist and faulty.

Indeed, those researching and theorising in the tradition of Keynes have come very far from the old liquidity trap arguments and the ISLM doctrines. But the mainstream, with their collective head buried in a model, remain painfully unaware.

Refocusing the Issues

While it would take us rather too far off topic to go into any detail on where economic commentators should be looking for the causes of the current stagnation, a few comments should be made in passing because these subtle theoretical differences have enormous real world consequences.

First of all, the world around us is not as the old models would have it. Where the models might expect mild deflation we have persistent but mild inflation and this even with unemployment at high levels. This inflation, as alluded to above, is in part due to the very policy choices by economists who apply pseudo-Keynesian models to analyse the world around them. Before they are to understand a single thing beyond the ends of their noses, economic analysts have to stop abstracting so violently away from the real world and seriously ask themselves why their models come up lacking when confronted with the facts.

Secondly, and tied to this, models like the ISLM are reductionist in the extreme and should be thrown out immediately. Not only do they fail to integrate many aspects of Keynes’ own analysis (as was later recognised by the creator of the ISLM himself), but they essentially fall apart when confronted with certain important realities of our modern world – especially those realities that have to do with credit and the real processes of credit creation in modern economies.

I will no doubt be chastised for not supplying a replacement for the ISLM. This is a ridiculous criticism to be made of a short essay focused on the liquidity trap. But there are mounds of real Keynesian research and theory out there for the interested reader to explore. As for a replacement for the ISLM… frankly, the model should never have existed and should anything resembling it ever come into existence again it should be immediately thrown out.

Economists need to become more flexible – and flexibility is not built into these models. (Nor are they built into their supposedly more ‘sophisticated’ but equally reductionist DSGE cousins). These models are constructed in a manner that excludes contradiction, especially empirical contradiction, and so they lead to ignorance and prejudice rather than to new discoveries. The models also, as we never tire of pointing out, allow their adherents to avoid thinking about how economic agents might react in psychological terms. This was a key aspect of Keynes’ analysis and one that gave it such power.

The models are like calculators in that they add up the limited variables inputted neatly but allow us a handy excuse to stop thinking – and given sufficient ‘training’ in these models the user will inevitably become something of a calculator himself.

As for the liquidity trap? When it was invented it was nothing but a footnote that its author brushed aside. Today it is a fad theory that explains away the pressing need to take a good hard look at what is going on around us. Confine the bloody thing to the dustbin of history where it belongs!

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  1. Jon A

    On Krugman – as a regular reader of his blog (and this one too of course), I don’t think he’s necessarily looking to scare people into thinking there’s inflation. I think he genuinely wants there to be inflation. Yes, that does mean inflation of prices, but it also means inflation of wages, and inflation of debt (easier to pay off).

    Philip, you seem to agree with Krugman that debt deflation is an awful prospect, so then what do you do to avoid it? Fiscal policy is something that you seem to advocate (which would lead to inflation), and it’s something that Krugman advocates now and in 2009 (saying ‘it wasn’t enough’ at the time). And Krugman is pretty firm that monetary policy alone won’t get us out of the liquidity trap…that’s the ‘trap’ part, right? No matter how much you pull down the interest rate, you won’t spur more borrowing or more lending because demand is insufficient (due to those psychological factors you mention…Krugman would call that ‘insufficient demand’).

    I guess I’m coming off as a Krugman cheerleader here, but I feel like his words are being twisted, and a more holistic view of the current situation from his perspective is being omitted. He’s very much in favor of fiscal policy (and for the political will to achieve it) over a purely monetary policy. Monetary policy at best will just keep things floating along with little prospect of an economic upturn.

    1. Philip Pilkington

      “Yes, that does mean inflation of prices, but it also means inflation of wages, and inflation of debt (easier to pay off).”

      That’s the key issue.

      No policy-maker or economist can inflate all these things at the same time. Indeed, how can we inflate wages?

      This is fantasy. We cannot inflate certain variables. And we must admit this. Thinking otherwise is silly and destructive.

      There’s only one variable we can absolutely inflate: investment.

      1. BruceNY

        What do you mean “there is only one variable we can inflate: investment”? I think it is tied to your comment on the “investment-saving line always moving horizontal” if money supply is infinite, but I am not very familiar with the model so I don’t understand what “infinite investment” expresses itself as in the real world, so to speak.

          1. BruceNY

            The formula for IS includes Government spending (G) and “Investment” (I) as independent variables. Investment is defined as private in the model.

            So what can be inflated again? If money supply is infinite the government can “spend” as much of the money it supplies as it wants? Well, no kidding.

            I don’t think that is what the author was trying to say when he referred to “inflating Investment”, but I could be wrong.

          2. Philip Pilkington

            Yes, that is what I meant. Government can spend. And that is the only really reliable variable.

            Interest rates can be lowered too, but these generally have more so psychological effects on investment rather than anything else and are not reliable. (Also they raise other problems as highlighted in the piece).

      2. darms

        I have some savings and my returns right now are around 1%. No way in hell am I going into the stock or bond market as I don’t trust those weasels one bit. I would love to see some inflation as the interest rates on my savings would (hopefully) rise. Frankly I’ve thought about opening a safety deposit box and putting some cash in there. While it won’t earn anything it’s not earning anything now and at least it would still be there.

      3. Jose

        Via deficit spending we can also increase Government expenditure and consumption.

        Also, the liquidity trap argument – even if wrong – implies a horizontal LM curve which means that under the terms of the IS/LM model only fiscal policy can be effective in increasing GDP by moving the IS curve to the right.

        So the IS/LM model and its cousin the loanable funds model and the liquidity trap etc. may well exist only inside the minds of neoclassical economists – yet the conclusions to be derived from a horizontal LM curve point towards a (correct) deficit spending solution for the present slump.

        In the end we should not really care whether the liquidity trap hypothesis favoured by Krugman has sound theoretical or empirical underpinnings. What counts is that a celebrity economist like him is on the right side of the political debate, clamouring for increased aggegate demand to get us out of the crisis. If the rest of the profession followed him public opinion would no doubt also turn around and put real pressure on the politicians and bankers, forcing them to amend their present austerian-induced policy disaster.

        1. Philip Pilkington

          You’re right. But I’m not sure if we should simply accept the fact that the mainstream are drawing the right conclusions from the wrong analysis. The wrong analysis causes them to call for dodgy policies (like negative real interest rates). It also allows them to misunderstand what’s going on when the economy is back on track.

  2. jsmith

    “The only control that central banks have over the supply of money is through the exogenously determined interest rate which, as everyone knows, is set through open market operations (OMOs).”

    Now even though LIBOR and the rates set through OMOs are notthe same thing, don’t they serve much the same purposes as concerns the actualy flow of capital etc etc?

    Here’s how Wikipedia (yes, I love its simplicity) describes the difference – for example – between the federal funds rate and LIBOR:

    “The target federal funds rate is a target interest rate that is set by the FOMC for implementing U.S. monetary policies.
    “The (effective) federal funds rate is achieved through open market operations at the Domestic Trading Desk at the Federal Reserve Bank of New York which deals primarily in domestic securities (U.S. Treasury and federal agencies’ securities).[7]
    “LIBOR is calculated from prevailing interest rates between highly credit-worthy institutions.
    “LIBOR may or may not be used to derive business terms. It is not fixed beforehand and is not meant to have macroeconomic ramifications”

    LIBOR isn’t meant to have ramifications but it does.

    Yes, as you claim the exongenous rate plays a part from the central bank end while the rate determined by the key players – ie. LIBOR – must also play a part.

    Now, to my real question:

    Recenly Schwab has tried suing banks over what they claim is the fraudulent nature of LIBOR.

    Here’s the link and key sentences:

    Charles Schwab Corp, the discount brokerage and money manager, has filed two lawsuits accusing 11 major banks of conspiring to manipulate Libor, which is used to set interest rates on hundreds of trillions of dollars of securities.

    According to complaints filed Tuesday with the U.S. District Court in San Francisco, where Schwab is based, the banks violated antitrust, racketeering and securities laws by teaming up to depress the London Interbank Offered Rate, a floating benchmark for what banks charge each other on short-term loans.

    Schwab’s lawsuits said the collusion deprived it of returns on tens of billions of dollars of Libor-based investments that the company and eight of its money market and ultra-short term bond mutual funds made from 2007 to early 2011.”

    With all that being said, what can be said about the veracity or lack thereof of the OMO procedures?

    I mean, now that LIBOR is coming under scrutiny is it really that much of a stretch to also begin to question the workings of the OMOs and the central banks all of which are made up of the very same banks that Schwab is claiming is manipulation 100s of trillions of dollars in assets?

    I’m not looking to for an answer as much as a comment as to the credibility of the mechanisms that you included in your article as somewhat of a deus ex machina.

    The exogenous determination of interest rates sounds great but is it really exogenous if the same players who are allegedly manipulating LIBOR are the players involved in determing the funds rates?

    How can a rational person not be so cynical as to think that the entire racket is fraudelent from the get-go?

    1. Piano Racer

      “How can a rational person not be so cynical as to think that the entire racket is fraudelent from the get-go?”

      They cannot (not be cynical), because it is (fraudulent). Not only is it fraudulent, but it is coercive and downright evil due to the requirement of the threat of violence and caging should you wish to use an alternative to their paper/electronic nonsense.

      MMT is just lipstick on a pig, and as an Irishman Phil should be ashamed for promoting such foolishness.

  3. mmckinl

    There wouldn’t be a liquidity trap if we didn’t create our money through debt but through a public central bank that crested our currency and credit without debt.

    This debate over the two types of Keynesism is another straw man dedicated as is the fresh water – salt water debate that completely ignores private bank fractional reserve banking.

    The elephant in the living room is fractional reserve banking and its reliance on infinite growth to survive. The debate we should be having is how we move into a sustainable banking/ financial system.

    1. John Regan

      Allow me to suggest for a sustainable banking/monetary system:

      Briefly, it starts with a jubilee, in which all debts are legally canceled except for 1) existing currency; and 2) bank deposits. The only debts remaining, therefore, would be the government’s obligation to redeem the currency and the banks’ obligation to return deposits.

      This will ensure that there is still “money”.

      Next, the currency and deposits will be redeemable in gold, since they have to be redeemable in something and there are good historical reasons for gold redeemablity. The dollar value to be assigned by law to gold to accomplish this is easily ascertainable – a simple ratio of the dollars required by the amount of gold the government has – but the number would undoubtedly be shockingly high, something on the order of $30K per ounce.

      This is an opporunity, however. With gold so highly priced in dollar terms, if the price is capped there then the only thing to do with it is sell it to the government. The government can then charge a great deal of “seigniorage” to fund its operations, or – to make loans through the banking system, which should be nationalized inasmuch as it’s pretty much nationalized already. Loans would always be fully backed by the gold the government retains due to seigniorage, so there would be no occasion for fractional reserve lending.

      A moratorium on non-payment evictions to provide stability for people during the transitional period – say, 5 years.

      And voila. This is how you get there. You do it by law, with the constitution, not by the tinkering of economists, which is how we got where we are now.

      1. mmckinl

        Interesting ideas … I’ll have to mull them over. But we are agreed … we must have a new banking/financial system.

  4. Richard

    We need to be nicer to economists as they have had a tough four years.

    First, as a profession, they thought all was going well and missed the signs that we were heading into a financial crisis.

    Second, as a profession, they treat their theories and the models these produce as the holy grail. Frankly, it really upsets the economists when individuals do not act as their models predict.

    Take quantitative easing for example. The model clearly shows that retirees living off a fixed income should race out and spend all their principal when interest rates drop to zero. It is very upsetting that retirees instead of spending their principal as quickly as possible, cut back on spending instead.

    Third, as a profession, they have been shown to be wearing the Emperor’s new clothes and this is not a pretty sight. The lack of thinking about what were the true causes of the financial crisis is astounding, but that hasn’t stopped the profession from pounding on the table with its latest solution.

    Take bank book capital for example. In theory, it is there to absorb losses. In practice, it isn’t (did you see any TBTF bank in the US recognize all its losses — hint, Yves thinks the second mortgages on their books are of highly questionable value). So why are economists pounding on the table for higher capital levels?

    1. darms

      F*ck most economists, we still have major names claiming “tax cuts pay for themselves” and the ‘Laffer curve’ is legitimate. Honestly what ought to be out there is that after 40+ years of ‘trickle down’ that ‘theory’ has been forcefully and practically proven to be 100% BULLSHIT. Yet it goes on. I am so glad to not have children.

  5. BillG

    MMT is the politician’s dream – the more government spending the better – defecits don’t matter – just spend it baby – more stimulus – more – more – more.

  6. digi_owl

    Working my way thru Steve Keen’s book “Debunking Economics” i bump into the claim that Keynes talked favorably about the works of Marx in his later years.

    And following the video series from David Harvey’s lectures, i find it interesting how much is hiding in the various volumes of Capital. Sadly it is overlooked because of a bunch of leftist radicals used choice passages to cause upheaval (for the best of reasons, but then there is that road to hell) and so it got branded taboo.

    It seems that economy, in all its mainstream form is hell bent on seeing man as the reasoning animal. Instead we are the rationalizing animal, because no other animal seems to spend much time dreaming up reasons about why they hunt or graze.

    1. Curiositykilledmycat


      Followers of Marx were more of the revolutionary bent, but it was of course written in marx that there would be a natural progression from capitalism to socialism, but what really made Marx quite possibly the greatest economic and social writer ever was his truly deep analysis, which was far beyond anything anyone has written before or since. Whereas one could point to flaws in one’s thinking like in John Stuart Mills, or in others, Marx was flawless in his thinking and in his deep knowledge. That’s why there was never a real rebuttal of Marx’s works, because you can’t rebut historical claims. They had to focus on ideology, and thats what people continue to do today.

  7. Hugh

    As always the built in assumption is that, while the models may be bad, the economy is essentially sound, and the economists, although wrong, are acting in good faith. In a kleptocracy, however, this is not true. The economy is geared toward looting and the models are simply propaganda to hide that fact.

    1. skippy

      I would add, who cares what template is used or what nomenclature is assigned and what changes are made, when the same people will be running the show.

      Skippy… management problems are not solved by tweaking the SOP…. eh… Yves.

  8. idahofreeman

    An “obvious” bubble in gold? Your economic beliefs clearly are influencing your investment opinions – which probably should be left out of the article anyway. Gold, to many, represents a physical store of value in a corrupt, debt-money fiat system. Make fun of gold all you want, but at least suggest an alternative that provides the same benefits – physical, portable, fungible, etc.

        1. skippy

          LOL… in relationships with others.

          Skippy… freeman… are you free from the environment, what a dead end of thought.

          1. RW Jones

            He thinks that when the world has come to an end he will emerge from his bunker and that his gold will be worth something.

    1. F. Beard

      People should obviously be allowed to transact private business with anything they want including PMs. However, in a true free market of private money creation and usage , PMs would quickly be left behind by more sensible private money forms, I would bet.

    2. Mel

      A disadvantage to gold is that, if one person or a few people get hold of all of it, then the whole economy must shut down, and there is no recourse. Maybe a huge mining operation could help, but it would be on a scale that only the people with all the gold could afford to do it.

      The way things are, with a very few people holding all our fictitious money, we could get out of the trap if we played the game that way. The people administering the rules aren’t playing the game that way, but there’s at least no physical barrier.

      Gold at $30K/oz would raise hob with electronics and dentistry, too.

      1. John Regan

        There are plenty of problems no matter which way you go. The question is which set of problems are more manageable. Millions of foreclosures, evictions and homeless people are not manageable.

        I’ve never understood this idea that people would, or even could, “hoard” gold simply because it backs dollars, any more than they would otherwise, though I’ve heard that before. Perhaps you have an explanation.

        And yes, $30K per ounce gold will pose some difficulties. I think the one you cite – the effect on dentistry and electronics – could be easily addressed by the government.

        You can get gold from sea water. Maybe that would be feasible at $30K per ounce. I have little doubt that at that price a lot of people would go into the gold mining business, but that would be all right – we’d need the liquidity.

        1. F. Beard

          There are plenty of problems no matter which way you go. John Regan

          Says who? You?

          Hey Skippy, are you going to challenge this glib goldbug or what?

        2. Mel

          I haven’t worked out the details, but why have a few thousand people grabbed almost all the fiat currency ever willed into existence, and why are they preventing it circulating through the economy? I think people could hoard gold as a means of exchange for about the same reasons. Keynes felt obliged to defend his ideas in _The General Theory_ when they described a liquidity crunch, but that was just because no one had yet seen such a thing. We don’t have that problem; we can just read the news.

          Actual reasons? A projected sense of power?

          A scholar came through here a month or so ago with a long essay concerning the exchange value of money. It couldn’t tell the whole story, I thought. Gross Global Product is 60-something trillion dollars — yet outstanding derivatives contracts total around 700-something trillion. What does anybody plan to exchange all that for? I could only imagine that money has a decorative value. Perhaps banksters collect it to make themselves beautiful.

          How do strings of zeros and commas hook to the dopamine pathways in human brains? Inquiring minds need to know. Thinking about how strings of zeros and commas hook to the dopamine pathways hooks to the dopamine pathways.

          1. John Regan

            Thing is, with a jubilee all the derivatives disappear. Everything tangible stays where it is. Everyone’s solvent. Everyone has the same number of dollars they had before in their wallets or bank accounts.

            Think of the freedom.

  9. brazza

    Dear Mr Pilkington:

    I boldly ventured into your maze … confident that sooner or later my peanut brain would manage to connect at least two of the constellation of dots contained therein. Half-way through although seriously oxygen deficient, I persevered, only to find myself tossed violently aside after Kaldor’s quote, when you invited me to “consult the mounds of theoretical and empirical material that has accumulated over the past few decades in Post-Keynesian circles”. A slow and painful death might be preferable …

    My frontal cortex now resembling overcooked noodles I accept ignominious defeat. After a short detour to relieve my liquidity from its trap I might find myself a wheel-chair and doodle aimlessly for the rest of my life, dribbling on my bib.

    1. Piano Racer

      The symptoms you are describing are the results of acute sophistry poisoning, a common ailment among those attempting to give “Modern Monetary Theorists” a fair shake. The well-documented cure is to shut off your computer and self-administer one shot of high-grade whiskey every thirty minutes until unconsciousness ensues.

      Consult the Von Mises institute if your symptoms persist for more than 24 hours.

  10. John Regan

    Personally, I think the liquidity trap is a real thing and that we’ve been in one since the subprime problems in ’07. And you could see it coming before that, too.

    Keynes and MMT are the ones who fundamentally misunderstand the government’s relation to money. The proper role of government wrt to money is to define a monetary unit of account and adminstrate it through bureaus of weights and measures.

    The liquidity trap occurs when all that has been disregarded, the unit of account becomes fiat, and the bulk of a nation’s money is created through lending to individuals and businesses. Without a reference point at the bottom of it all, new money issuance is deemed satisfactory so long as loans are being repaid on schedule. In fact this is the only criterion for monetary balance in such a monetary system. When that changes, and loans are no longer being repaid on schedule, lending constricts, and it cannot be otherwise. It doesn’t matter how much liquidity you supply to lenders, they can’t make loans because the borrowing capacity of the populace has dried up. They are debt saturated.

    The only answer for this that Keynsians have come up with is for the government to act as borrower of last resort. But in that case government deficits explode and you wind up with Greece and the EU.

    In the system that we have, the fact that new money is loaned into existence is not discretionary. There is no other option. Thus if lending isn’t possible, no new money is possible either, and the money supply will stagnate or contract, which of course makes the repayment of existing outstanding loans more and more difficult.

    This is why the “helicopter drop” remarks are intended to be funny. New money cannot be distributed that way. All newly created money must be owed back into the system; that is, someone must borrow it into existence and owe it back. It is the only way in a fiat system to regulate money issuance.

    The subprime “crisis” signaled that the lending saturation point had been reached in the US. Since the country had largely run out of qualified borrowers, loans were made to UNqualified borrowers. There is no one to blame for this except the people who instituted the monetary system in the first place, and they’re all long since dead. The system will always wind up in this spot after a few generations.

    The WaPo article discusses the common MMT inspired idea that taxes are the method for managing the government deficits that occur as the government becomes the borrower of last resort in a liquidity trap, which is just what is happening now. The idea being that the government takes back more and more of the new money that has been issued to ameliorate the deficit issue.

    This is a frighteningly stupid assertion. It seems to contemplate a monetary circle jerk where new money is created through a loan to the government, paid out to whomever as salary or pursuant to a contract, and then the recipient is heavily taxed so as to get most of the money back. At that point, the monetary system is not reflecting or facilitating or serving the real economy, rather it’s the reverse: the real economy is serving the monetary system. To say that this is pointless and perverse is an understatement.

    No theory of money and credit is worth a largely hungry and homeless populace, yet this is what is happening all over the globe: the theory is more precious than reality to those who get to make the decisions. We have government by so-called “technocrats” who are devoted to an idea rather than their subjects. And the idea is ridiculous.

    The answer to all this is redeemable money that can exist and be newly issued apart from being loaned. But to get there from where we are will require a jubilee, because all the debt that has piled up cannot be paid back.

    And it will take a constitutional amendment.

    But this is a good thing. People need to recover their sense of self-government.

  11. Fiver

    Yes. We absolutely must have MORE demand. More. More. More. We must not share. We must never slow down. We must produce as if our very existence depended on it no matter how vast the mountains of goods. We must produce so much the “other half” (and today it’s at least half) can be consigned to a “service” economy of soul-destroying McJobs and cable education and never be heard from again.

    It just isn’t enough:

    That there’s at least a $500 billion/yr corporate advertising bill imploring us to consume 24/7.

    That 6 decades after the utter folly of mass consumption economics first broke in from the margins of academia into the popular consciousness, everything is still made to break or throw away. I-Pad 3 anyone? How about that piece of construction crap that now passes for a house? Who cares, so long as it is “new”?

    That we’ve already had centuries of ruthless resource plundering and carnage visited on the weakest people everywhere (as in all of the indigenous peoples of Latin America, Africa, Australia, Canada, the US, and Asia), or that the yearly increase in consumption of non-renewable resources and destruction of VITAL renewables now dwarfs total human impacts but a historical blink ago.

    That ‘advanced’ economies for 8 decades have been considered to be “healthy” when the level of measured activity approaches that of Total War (output, employment, “productivity” etc.) and all activity measured is deemed positive – never considering that Total War was the very definition of Total Waste.

    Yes, just give us a good liberal friend of privilege and power, a loyal servant of King and Country (the State), who can once again balance the unquestioned right of the elite to create a completely separate economy of limitless wants for themselves with the mere needs of the constant stream of the newly redundant for a DEMAND-creating Mcjob, while the vast bulk of all State spending ends up in the pockets of the sons and daughters of the professional, administrative, technocratic, corporate, political and opinion-making sectors of the elite middle class.

    Keyne’s beneficent State is now of course long gone – replaced by a diseased entity suffering advanced institutional corruption and rot now wholly captured and subsumed by the globalized versions of the financial/corporate power structures he never laid a glove on.

    Of course, if in keeping with Everyman’s Mandarin Keynes, one is a eugenicist, the problem of the “poor” will end once we embark on a controlled program of genetic breeding.

    Wiki, even in a sketch, provides some rather important insight into what exactly it was Keynes was attempting to do, and NOT to do, in a world that no longer exists:

  12. BT

    Even Krugman admits that he ‘translates’ his thinking into ISLM-speak ‘for simplicity’.

    Go to Steve Keen for a more realistic and dynamic model of credit creation. Neil Wilson has modified it to make it accounting and stock-flow consistent.

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