Yves here. Philip Pilkington makes an interesting argument in this post, namely, that the method preferred among mainstream economists for managing the economy encourages investors to speculate in financial instruments rather than invest in real economy assets and projects.
By Philip Pilkington, a writer and research assistant at Kingston University in London. You can follow him on Twitter @pilkingtonphil
Metaphysics is a use of language that conveys no factual information, describes no logical relations nor gives precise constructions and yet is calculated to affect conduct.
– Joan Robinson
After the Reagan and Thatcher governments experimented with monetarism in the late-1970s and early-1980s, something fundamental changed in the way most economies in the world were managed. This era has become known to many as that of “neoliberalism” and is usually thought to be characterised by free-market dogmatism, a hostility to labour, financialisation and trade liberalisation.
All of this is true, of course, but it is not widely known outside of economic circles what changed in the minds of economists. After all, monetarism soon faded into the ether – a failed superstition. What replaced it was, in fact, a regime based on interest rate targeting. Economists and central bankers became generally suspicious of governments’ ability to manage their economies and instead invested heavily in the notion that independent central banks could do the job better.
The truth of the matter? Much more likely that this was a power-grab – after all, it was generally economists that ran the central banks. But what is interesting for our purposes is the rot that the economists used to justify this state of affairs; rot that, at the very same time, ensured that they would not bear any responsibility for their actions and recommendations. What they needed, of course, was a metaphysical law and it is to this that we now turn.
This economic theory today, as it prevails in the pseudo-sophisticated minds of most central bankers and economists, is tortured in its assumptions, absurd in its axioms. But like all good metaphysical constructions, it comes with a rather simple message. The message is that fiscal policy – that is government spending and taxation – is largely ineffective and only results in inflation over any sustained period of time (that is, the mysterious “long run” of the neoclassicals). Instead then we must look to monetary policy and especially the control of interest rates for salvation. The idea is that there exists, at any given moment in time, a certain interest rate that will perfectly balance all forces in the economy; a great harmonising principle that must be upheld with devotion and awe.
This theory, although it is its modern form exerts fascination on most economists, is actually quite old. Already shades of it could be detected in the 19th century, but it was finally formalised by the Swedish economist Knut Wicksell in 1898. Wicksell claimed that there were two distinct rates of interest. First, there is the “money rate of interest”; this is the worldly rate of interest that we all see and it effectively sets the price of borrowed money. More fundamentally however, there is the “natural rate of interest”; this is an altogether metaphysical construction that can only be shown to exist in highly abstract models built on extremely unrealistic assumptions. The categorical imperative then becomes to divine the natural rate through exercises in metaphysical speculation and force the money rate into line with it. By doing this we will, apparently, achieve economic salvation.
The natural rate of old came under attack in the 1920s and 1930s by John Maynard Keynes and Piero Sraffa, but there is no need to go into that here. (A refutation of the more modern “natural rate” hypothesis can be found in this paper by Philip Arestis and Malcolm Sawyer). What is important for us to understand is the unworldly nature of the theory.
The economists and the central bankers build their metaphysical models out of which they derive a natural rate of interest. (Of course, to use the term “derive” here is slightly misleading as they are, as good metaphysicians, only deriving something which they themselves have constructed – that is, they are engaged in building self-contained metaphysical systems out of tautological statements). They then assume that their extremely unrealistic metaphysical models are a near perfect approximation of the real world. Finally, they seek to bring their metaphysical models down from heaven to earth by engaging in pseudo-empirical estimations of the natural rate of interest with which they then (in theory, at least) use as a benchmark to set the money rate of interest – in the US this would be the short-term overnight interest rate or the Federal Funds rate.
So why, they must think, are we not today delivered to an economic paradise? There are a great many get-out-of-jail-free clauses the sophist can throw around to insulate themselves from criticism; from central bank incompetence to estimation error. The mutterings of charlatans do not here interest us, however, but we shall return to the benefits that accrue to economists who adhere to this dogma later. For now let us now turn to the reality of interest rate targeting – that is, its actual effects on our very worldly economies.
For our purposes we will take the United States as an example of an economy that has, in the past 45 or so years, been run largely on the principles of interest rate targeting. We will look at the post-WWII era which we will roughly divide into two phases.
The first phase, running from approximately 1945 to 1969, we will refer to as the “Keynesian era”. This is the era in which economies were largely run based on rational, practical policies and economists broadly accepted that government played a large role in stabilising the economy. The second phase, running approximately from 1969 to today, we will refer to as the “monetary policy era”. This is the era in which economists and central bankers broadly agreed that attempts by governments to stabilise their economies would only yield negative results and that it was up to the central banks to steer the economy. (These are slightly different periodisations than those usually associated with Keynesian policy versus monetary policy; we shall discuss this further below).
I. Diminishing Returns
Monetary policy came back into fashion in the US around 1969, but from then up until around 1982 it was basically used as a means to (attempt to) control inflation – it was also justified with an altogether different batch of metaphysics, but the effects were nonetheless the same.
Was it successful? Some economists think that it was but in fact, as we have shown elsewhere before, it was basically a disaster. Because at this stage of the game, the central bankers and their ideologues in academia had yet to find their particular Holy Grail – that is, interest rate targeting – and instead they tried to justify their high interest rate policies with monetarist voodoo. Nothing worked out as it was supposed to. The central bankers proved completely unable to target the rate of growth of the money supply – which was, of course, what they claimed they were doing – but after their dismal failure and their throwing the economy into the most serious recession since the Great Depression, they were more than happy to take credit for the fall in inflation that resulted from falling oil prices (rising prices being the key cause of the prior inflation).
After the Federal Reserve and other central bankers took credit for the falling inflation a founding myth was born: namely, that of the omnipotent central banker; the Master of the Universe; the Maestro – and so on. It was out of this myth that the metaphysics of interest rate targeting would be used to solidify the new era. There is an irony here, of course. Because it was out of the failure of their stated policies that central bankers began claiming that they alone were competent enough to steer the economy. And what emerged from this great lie? Paradise? Utopia? Not quite.
The simple fact is that the era of interest rate targeting has been, well, something of a disaster. That this would have been the case would not have surprised the old Post-Keynesian economists. As Steve Randy Waldman has pointed out over at his excellent Interfluidity blog, the Polish economist Michal Kalecki predicted what would likely happen should central bank’s begin to rely on monetary policy as their primary tool of choice. In 1943 – yes, 1943! – Kalecki wrote:
The rate of interest or income tax [might be] reduced in a slump but not increased in the subsequent boom. In this case the boom will last longer, but it must end in a new slump: one reduction in the rate of interest or income tax does not, of course, eliminate the forces which cause cyclical fluctuations in a capitalist economy. In the new slump it will be necessary to reduce the rate of interest or income tax again and so on. Thus in the not too remote future, the rate of interest would have to be negative and income tax would have to be replaced by an income subsidy. The same would arise if it were attempted to maintain full employment by stimulating private investment: the rate of interest and income tax would have to be reduced continuously.
And after 1982 when interest rates began to be used to stimulate economic activity this is precisely what happened. Waldman provides us with this rather stark graph in order to illustrate the confirmation of Kalecki’s thesis:
Yes, the Federal Reserve was able to keep the economy on a growth path – albeit one that was vastly inferior to that during the Keynesian era – but in order to do so they basically had to keep dropping the interest rate after every recession and not bring it back to its previous level after the recovery had set in. What we got then was seriously diminishing returns from monetary policy right up until after the 2008 financial crisis when interest rate targeting became completely ineffective as a means to return the economy to anything resembling full employment.
II. Increased Uncertainty
One of the other, often overlooked, negative consequences of using monetary policy as the key tool of macroeconomic stabilisation is that it is, by definition, a tool that uses instability to try to generate stability and this has serious consequences for economic development. Whereas fiscal policy seeks to glide the economy to full employment through delicately balancing effective spending, monetary policy relies on “shocking” the economy in the desired direction. Naturally, this greatly heightens uncertainty amongst the business community.
Imagine a representative firm earning a rate of profit on their investments of 8% per year. Now, if the central bank raises interest rates to stall the economy this will have two negative consequences for the firm in question. First of all, any outstanding debt that the firm has will cost more to service. Secondly, and perhaps more importantly, their prior investments will start looking a lot less promising. If the interest rate is set at, say, 3% then the firm could make 3% merely by buying perfectly safe government bonds. Now, the spread between their rate of profit and this rate of interest – in our example, 8% – 3% = 5% – may be sufficient to compensate for any risk the firm incurs through its investments. But if the rate of interest rises to, say, 4%, these investments may no longer appear worthwhile because the spread between the rate of profit and the risk free rate of interest will be only 4%.
What this means is that firms have to price into their investments the likelihood that the central bank will raise interest rates in the coming year. Thus, as the British Post-Keynesian economists Nicholas Kaldor knew well, if an economy is being stabilised through interest rate manipulation alone, firms will be far more cautious about making real productive investments and will favour speculating in bond and other financial markets. Kaldor put it as such in his seminal 1958 paper “Monetary Policy, Economic Stability and Growth”:
If bond prices were subject to vast and rapid fluctuations [due to the central bank manipulating the interest rate to steer the economy], the speculative risks involved in long-term loans of any kind would be very much greater than they are now [i.e. in the Keynesian era], and the average price for parting with liquidity would be considerably higher. The capital market would become far more speculative, and would function far less efficiently as an instrument for allocating savings – new issues would be more difficult to launch, and long-run considerations of profitability would play a subordinate role in the allocation of funds. As Keynes said, when the capital investment of a country “becomes a by-product of the activity of a casino, the job is likely to be ill-done”.
And things have gone exactly as Kaldor predicted that they would. In our era of monetary policy primacy investors have become far less inclined to pour funds into real investment, as can clearly be seen in the case of the US in the below graph.
The reader can probably make out from that chart that prior to 1969 the average growth in the rate of investment (red line) was significantly higher than after 1969 when monetary policy (blue line) became an increasingly important tool to manage the economy. The average growth in the rate of investment between 1947 and 1968 was 1.31% per year while the average growth in the rate of investment between 1969 and 2012 was 0.9% – a decline of over 31%. If we take the monetary policy era as having started in 1979 rather than in 1969 – we mention this only because it is the typical periodisation, whereas if we look at the data it’s clear that monetary policy came into favour in 1969 – but if we take the year 1979 as our starting point we achieve broadly the same, if not an even more dramatic, result: between 1947 and 1979 the average growth in the rate of investment was 1.25% per year, while between 1979 and 2012 it was 0.78% – a decline of over 37%.
Meanwhile, the capital markets have indeed turned into a giant speculative casino. Interest rate targeting is, of course, not wholly to blame for these shifts, but it absolutely is a key factor. And indeed, most economists and policymakers would claim that this era’s prosperity (or lack thereof), which they refer to as the “Great Moderation”, is a result of the new “scientific” interest rate targeting policies. In reality, by using monetary policy shocks to steer the economy central banks are driving out the good investment and encouraging speculative Ponzi rubbish in the financial markets.
In light of these considerations why then do economists and central bankers continue to favour monetary policy targets based on their phantom natural rate of interest? Well, first of all most are not properly aware of the above considerations because they do not fit into their metaphysical models. But even if they were made aware it is more than likely that they would dismiss them and cling to their models.
Why? One reason is because the profession is largely dominated by unimaginative technocrats and bean-counters. The models give them a strict set of rules that they can follow. And Lord knows that technocrats love rules! Rules not only insulate the weak-willed from blame but they also give them enormous power; namely, the power to implement the rules. How much guilt has been absolved over the course of human history through an appeal to a person “only following the rules”? One can imagine, quite a bit.
Thus, the profession can spend its time teaching nonsense on the basis that it is internally consistent nonsense and central bankers can spend their time chasing metaphysical phantoms by running econometric regressions based on spuriously constructed theories. This is not a bad way to live; clinging to power, yet insulated from reality and blame through recourse to divinely inspired rules.
The reader should not underestimate the power of rules in this regard. Rules allow policymakers and economists to wield enormous power without incurring any responsibility. After all, a man can be fired for his incompetence – but if he was just following the rules… well… Likewise, a teacher can be criticised for not understanding his subject sufficiently to wield the position he wields – but if he can follow the curriculum… well… Rules allow incompetent fools to grasp the reins of power and hold them fast.
The Place of Monetary Policy in an Enlightened Society
If, however, the profession were to one day take responsibility for their actions, what would we do with regards monetary policy? Well, if we were to begin running our economies as they were run in the Keynesian era monetary policy would have to take a back seat to fiscal measures. Let us now turn to consider two alternative uses of monetary policy as they might implemented in an enlightened society.
I. ZIRP: The MMT Approach
The Zero Interest Rate Policy (ZIRP) approach to monetary policy is that which is generally supported by Modern Monetary Theorists (MMTers). They argue – best articulated in Warren Mosler and Mathew Forstater’s 2005 paper – that the “natural rate of interest” is, in fact, zero. This is because, as they rightly point out, if the government did not voluntarily issue debt and instead simply spent newly created money the short-term interest rate would fall to zero (a very different conception of the “natural rate of interest” than that held by the metaphysicians who run our central banks and economics departments!).
The idea underlying this is that the main tool of economic management should be fiscal policy. If the economy is operating with significant excess capacity (i.e. high levels of unemployment) the government should cut taxes and increase spending. Whereas, if the economy is operating close to full capacity (i.e. at full employment) government spending should be cut and taxes increased. In such an environment, they argue, there would be no need for using interest rate shocks to steer the economy.
The elegance of this approach is that it essentially strangles the free-loading rentier who relies on shifts in monetary policy to collect government-subsidised cash in the form of interest payments on government debt. If the economy were consistently run at zero-level interest rates, investors would be forced to invest in real goods and services rather than in government and related debt instruments. Given that the economy would also be being run at close to full employment the risks that potential real investors would have to bear would be substantially lower as they could be sure that the government was always guaranteeing that there would be a market for their goods and services. Finally, the interest repayments on borrowing by productive investors would be extremely low, giving even more of an incentive to invest in tangible goods and services.
II. Fine-Tuning: The Kaldor Approach
The other approach that might be taken to monetary policy in a society not run by metaphysicians and haruspices would be the “Kadorian” or “fine-tuning” approach. In his previously cited 1958 paper, Kaldor noted that although Keynesian policies were extremely good at maintaining a steady rate of investment and growth, they could not deal with fluctuations in the level of inventories.
Capitalists tend to increase investment in inventories when they think an uncertain event might be around the corner – the simplest example of this being a rise in the price of raw materials due to weather conditions. This would cause them to borrow at the short-term rate of interest in order to avail of the lower prices of production, increase their holding of inventories and buffer themselves against future rises in production costs. The problem with this was that if the economy was running close to full capacity (i.e. full employment) any sudden increase in production needed to build up inventories would lead to a squeeze on resources and possible inflation.
Kaldor thus suggested that because capitalists borrowed almost exclusively at the short-term rate of interest to build inventories, it could be increased at times when central banks thought that capitalists were about to build inventory while the economy was at full capacity. Kaldor wrote:
[The] function of credit control [i.e. monetary policy] should be sought in stabilising investment in stocks (i.e. in offsetting spontaneous tendencies to instability in inventory investment), and not in the control of investment in fixed capital or the control of consumption which can far more appropriately be secured by other instruments.
Kaldor’s comments can be seen today in light of the fact that it was indeed an external shock to the prices of raw materials (oil) which in the 1970s set off an uncontrollable inflation. But even in his classic essay he remained sceptical that monetary policy alone could secure price stability in case of rises in the price of raw materials. For this reason he also advocated that countries work together to secure buffer stocks of raw materials in case of shortfalls. Today, in light of the events that took place in the 1970s, he might have added policymakers should be mindful of the domestic economic effects their foreign policy decisions might have.
In truth there is merit in both the MMT and the Kaldorian approach. And one might also add to them that monetary policy might be used to target a country’s exchange rate. Moving into the future we already see ZIRP in place and some economists have become dimly aware that inventory accumulation is an important potential component of macroeconomic destabilisation. However, for as long as the economists and the central bankers continue to believe in their monetary policy metaphysics, in their “natural rate of interest”, and in the powers wielded in the money markets, we will, at best, stumble from success to success or, more probably, trip over failure after failure.
I have a degree in economics, but I stopped reading this mid way even though I agree with the premise and suspect it is largely correct. Why did I stop? Because it is boring, interminable and largely incomprehensible to non members of the economics fraternity, 99% of whom are paid shills of elite myths and cannot be expected to read through stuff like this and won’t.
Monetary policy isn’t monetary and isn’t a policy. It’s a con the objective of which is to enrich bond dealers and bankers at the expense of everyone else. Non economists don’t need to know any more about it than that. What is required is not ‘economic’ analysis but political response. Economics is twentieth (and twenty-first) century religion, the glue that cements power relations. Where is Luther when we need him? Where is Mark Twain when we need him? Where is Keynes when we need him? He was not only brilliant but understandable and clear in what he wrote.
Speak for yourself, I’m not an economist, but this was quite gripping an article that gave intriguing food for thought. I may not have understood everything, but the basic lines of thought were not difficult at all to understand. Especially that historical tidbit about Kalecki basically predicting the second great depression in 1943 was just fascinating. Now I just want to do nasty things to anybody that says “nobody could have seen this coming”. Lies, damned lies, conventional “wisdom”.
I empathize with both of the above comments. However, on this topic, I think everyone (including the author) should pay at least minimal service to balancing ideas with actions. The Cat is bigger than the Bell. The Bell is bigger than a Mouse.
Sometimes I think the only economist we really need for diagnosis of how the system works is Marx :)
“I’m b-o-o-o-r-ed!” Well, go outside and play, then.
Joe Plumber could not care less…the excellent article by Pilkington means nothing to the vast majority of Americans who are consumed with their job and some entertainment that diverts their attention from day-to-day business. Just what and where do citizens exercise their action while Obama persecutes whistle-blowers.
I try to read anything that explains the present economic problems and I especially like to hear about how things can be made better. I appreciate all those people who try to do that and this article is included in my appreciation.
As an economist I well understand jake chase comment. Aside from all the negative comments that follow on his comment, think of economics as religion which is driven by a deeply inculcated cadre of capitalist believers on Wall St and Main Street that have been secure in their minds that cannot foresee and wish not any other alternative. Think of those in November who shouted out “Obama is a socialist”. The contradictions of capitalism (and economics as practised) are not on the radar screen of Americans. Capitalism for plutocrats of every stripe.
Somewhat disagree with you Jake. Philip’s article above is quite the most compelling and cogent thing he has written on NC, that I have read. Though granted I’m only a simple Computer Scientist.
I do accept that Neo- economists and Republican fellow travellers need to be weaned off the tired ruse of calling White Black in multiple loud and persistent voices. But as long as it works to bamboozle enough people, then I guess they will carry on doing it.
Finance and economics people long ago crawled up their own buttcracks into a mythical world of fantasy and math puzzles, but meanwhile out here in the real world, were actual people live in actual reality, everything is falling apart.
Moneymen and economists, along with their gobedlygook fancy theories that self-justify their own existence, must be erradicated before we can progress as a society.
We could undertake this voluntarily and undergo a bit of pain that can be dealt with as we excise the parasites. Or we can put it off as long as possible and let nature run its course–with an added big heaping helping of extra horriffic existential pain in the process as we undergo a horrifying collapse. Hmm, I wonder which one of those options people will go for.
Anyway, you all might as well start getting ready. So: rabbits, solar panels, and ammo. Get them while you still can.
‘We will take the United States as an example of an economy that has, in the past 45 or so years, been run largely on the principles of interest rate targeting.’
In fact, the Federal Reserve has been setting a discount rate since it began operations in November 1914. The history of Federal Reserve discount rates from 1914 to 1941 is posted here, starting on page 439. Maybe you should read it sometime:
‘If the government did not voluntarily issue debt and instead simply spent newly created money the short-term interest rate would fall to zero.’
HA HA HA HA! MMT theorists are like the 5-year-old child who, upon first becoming aware of the unpleasant fact of scarcity, tells mommy that ‘they’ should just give us everything we need.
Not surprising for a child. But adults advocating for magic money trees are a bizarrity that shocks the conscience. And their infantile delusion lacks the entertainment value of folk tales about leprechauns with pots of gold.
Gee whizz… the Fed has been setting monetary targets since 1914??? Darn, must have missed that… *Sarcasm*
The point of the above piece was that monetary policy became the PRIMARY tool after 1979, a shift which was started in 1979 and rationalised after the failure of monetarism.
Learn to read, friend.
“…a shift which started in 1969…”
“Adults advocating for magic money trees?” That sounds like competition for the Fed (and the banks).
Banks don’t need deposits, they just need reserves. Reserves are created by the Fed. You take some worthless loans (or bonds) down to the Fed and hock them if they are somewhat worthless, or sell them if they are totally worthless. Voila, you have reserves. Now, if you’re a bank, the Fed pays you 3% on those reserves, so there’s no reason to loan them out, or buy ten year Treasuries yielding 1.4%, so nobody who has managed to save money can earn anything on it, but don’t worry, because inflation has been defined out of existence, so there isn’t any, and while his capital lasts a saver can still live. That’s why our existing monetary system is so perfect and those MMTers should be villified and, ideally, ignored.
another snide NC reference to alternative realities. :)
This time it’s not Defendant Smith but noted commenter Jim Haygood — now Defendant Haygood. You owe a fine of $1.15 payable whenever you get around to it for “supercilious condescension”.
I’ve always surmised the post WW2 boom in the U.S. economy would have happened no matter what, almost, because Europe’s manufacturing base was destroyed and there was so much pent up demand in the US after demobilization, plus demographics was favorable, plus Europe had to get rebuilt.
Also, it somebody had invented a marketable device that tripled combustion engine efficiency during the oil price shock (conspiracy theorists say these devices have been invented but suppressed through murder and intimidation), the inflation shock wouldn’t have mattered that much.
Sequential and even multi-variate Cartesian analyses always seem to leave out variables, no matter what school of thought guides it. Economics is 16 equations and 19 unknowns no matter what. I am now working on a theory of economics that makes sense but progress is slow, I admit that, usually because of distractions like Adele youtube videos. At any given point in time there is nothing real but the movement of people’s arms and legs and fingers in various forms of conflict or cooperation. That has to be the final reality and anything to do with “resources” or “money” or “profit” has to start there and reckon with that as a first principle. The second principle is that “stocks” of money are only forms of imagination and “flows” of money are forms of cooperation. The stock/flow confusion is rampant in economics. However to say something is only imagination does not mean it is not real, it’s just that the nature of its reality is not the same as the nature of physical reality. It is an alternate reality that everyone agrees to believe.
“… “stocks” of money are only forms of imagination and “flows” of money are forms of cooperation…. However to say something is only imagination does not mean it is not real, it’s just that the nature of its reality is not the same as the nature of physical reality. It is an alternate reality that everyone agrees to believe.”
How long will it be before we realize that “money” is no longer a “thing,” but a fiction used to organize society and preserve the power structure, analagous to titles and boundaries?
I realized that about 11 months ago riding the bus and looking out the window at people walking in and out of stores. At their arms and legs moving thinking about what is real and what isen’t real. That gave me a mind shot.
The other mind shot from a few years ago is that money is a metaphor for the life force, which is why it’s intimately (no pun intended) bound up with sexuality. And why people with lots of money are given a defference which transcends all rational justification. It’s an unconscious energy at work.
The breakdown of tribal structures of consciousness — with their totems, taboos and caste systems that regulated personal interactions — left a vacuum for an alternate organizing principle. this is one reason money arose, to compensate for the confusion between strangers who did not have totem, taboo or caste to regulate their interactions and cooperations.
I’d call this one facet of a psychoanalytical theory of the origin of money. This is also a bus-ride mind shot, but I had previously read quite a lot of books about religious anthropology which prepped me. So when the shot came, I recognized what it was.
I’m sure I’m right. I have no doubt at all about it. but I don’t think it’s metaphysical. I think it’s more meaningful than that. There’s more to it, of course, but I can’t type it all here now because I’m technically at work.
I’m technically having lunch so I can post one more thing.
If I recall, Dan Kervick is an expert in analytical metaphysics so maybe he can critique Ms. Robinson’s rather superciliously condescending definition of metaphysics.
She may be exposing herself to the threat of a fine of $1.15 payable at her convenience. Mr. Kervick can make that call, as a deputy of mine. Sincerely, Officer DT Tremens, NFL, GED, Magonia Thought Police Patrol
Re: Imaginary Economics
They keep trying to use real AND imaginary numbers in imaginary math space. Theirs are real. Ours our imaginary.
Could you please stop this practice in your new theory?
I suggest restricting it to the real number set only.
Just a suggestion.
I have always wondered about the oil shock. Why did our plutocrats allow five or six Arab sheiks to quadriple the oil price? Why do we have an Army? My conclusion was convenience. The Arabs needed the banks to park the money. The banks could recycle it at an enormous profit. The price of everything could skyrocket, validating existing real investment, and workers had to work three times as hard to make ends meet. Remember how the youngest generation was dropping out left and right? I had two friends working in big time law firms (they didn’t know one another) who separately quit and moved to Vermont farms. Never heard from either of them again. The oil shock pretty much ended our experiment with unconventional living, didn’t it? Nothing important happens for no reason. Andrew Mellon or David Rockefeller or today’s equivalent is always at the top pushing levers and pulling strings. Did you know The Wizard of Oz was a populist fable about money?
I heard it explained way back then that the Arabs, po’ed at Nixon for going off the international gold standard (where Arabs took gold instead of dollars), realized they could raise the price of oil in dollars to compensate. Then our financiers began lauding them about their new found investment prowess – deploying fiat capital to buy up US stuff – and celebrating the fact that Arabs finally severed their love affair with the “Barbarous Relic” [and bought citi]. Or something like that.
Re: Wizard of Oz.
Been waiting on the sequel. Tornado hits Kansas City, KS and uproots it, spinning it round and round and round again, till finally Kansas City gently lites on Missouri. Dorothy [Stephanie Kelton] and the rest of her new found crew follow the yellow brick road to Oz. It ends with Toto pulling back the drapery on the printing press machine, and we find that The Bernank is really just a nice old man. They both get in a hot air balloon and float back to Kansas, leaving everyone else in Qz wondering what to do about all the flying monkeys. Haven’t figured out the middle part yet. Greenspan in drag as the Wicked Witch of the West? dunno. Haven’t thunk it thru that much yet.
The oil shock to come will make everyone experiment with unconventional living.
For a detailed answer to this pick up a copy of F. William Engdahl’s, A Century of War (1992, 2004). He explains how the whole deal was engineered and announced well in advance of it having occurred. At least it’s the best explanation I have yet come across and it is pretty much verified, albeit very technically, in David E. Spiro’s The Hidden Hand of American Hegemony (1999)
“However to say something is only imagination does not mean it is not real, it’s just that the nature of its reality is not the same as the nature of physical reality. It is an alternate reality that everyone agrees to believe.”
craazy – having read, and greatly appreciated, you for awhile now, I am beginning to think that the above might just be a self-description …. :)
I always love Jim’s comments. I learn things I never knew. Like the real problem in our economy is scarcity of goods! Who knew? And that social security is not self-funded because politicians stole the trillions out of the lock box and put IOU’s in the place of the actual money. And that the US government is not good for those IOU’s because that money is earmarked for poor people. I learn so much everyday from Mr Haygood. Let’s all give thanks to the man and his generosity of spirit for imparting his wisdom to all of us submentals.
Sheer nonsense Jim. Outside of the capacity of the real economy to produce actual goods and services there are no natural limits to the money that the Federal Reserve may issue forth for public purpose.
We can have scarcity in oranges or pork bellies but not in money. How on Earth can something that is created out of thin air, such as Money, be scarce? Are you perhaps not aware that financiual assets are different from real assets?
Pretty much agree.
There is one point however at the very beginning that he is inexact on:
“The truth of the matter? Much more likely that this was a power-grab – after all, it was generally economists that ran the central banks.”
Who chooses the economists? I would say the truer statement is that it is the financiers who run the central banks and pick the economists that parrot their views — and that, by sheer COINCIDENCE, makes them rich and keeps them rich when they demonstrably f*ck up ;)
There are all sorts of “economists” willing to challenge orthodoxy – but none at the FED, or at the banks…or in government because….well, the financiers buy the economists at the FED and buy the appointers of the FED in government…
I have no doubt that there are economists at the FED and elsewhere that are sincere and even intelligent. Just so, it is hard to get someone at the Vatican to consider (or state out loud) atheism even POSSIBLE.
I think Pilkingon has it reversed: No investor would ever follow the ramblings of an economist, but an investor will accept any arguments that supports his or her position. Investors decided on the money-chasing-money framework for the “returns” (albeit a long-term chimera) offered. Economists backed up this movement with arguments of their own, trying to maintain relevancy for an increasingly irrelevant discipline… at least, the way it has been traditionally taught and used.
Huh ? The markets hang on Bernanke pronouncements. And the biggest single rule among US investors is “don’t fight the Fed.” The Fed is run by monetary economists. Ergo, investors VERY MUCH listen to economists.
Labor, the labor markets, unemployment, public job creation, labor’s share of productivity growth, if there is any, and supposedly there has been since the mid-1990’s – all avoided by the shift away from fiscal policy and the focus on monetary policy. Even in writing critically about these trends, you don’t get to the unemployment side until the MMT discussion. In that sense, the article mirrors what has taken place in the political economy. This trend deeply affects what the Democratic Party is willing to put on the table as policy solutions, even in the most daunting and damaging of economic times, ones we are still living under. Let’s keep hammering away at it; thanks.
Ah yes, here we go:
“But what is interesting for our purposes is the rot that the economists used to justify this state of affairs; rot that, at the very same time, ensured that they would not bear any responsibility for their actions and recommendations.”
Which ties into this statement on neoliberalism from an Oxford journal which I had linked to previously – very good if you want a more scholarly look at neoliberalism:
“Therefore, possible morally reprehensible developments would not be the responsibility of capitalism as a system, but that of individuals operating within capitalism. Making capitalism more moral would make no sense; what is required is an increased ethical responsibility by individuals.”
So, let’s recap, the economists conceived of an idea by which they were left blameless.
The neoliberal politicians also conceived of an idea by which “the system” – doodidoo, who could that be? – didn’t bear any of the responibility, rather it was the individual who was to blame for their own lot in life.
Hmmm, blaming the individual while the elite classes remain virginal?
Making it seem as if – ooops – the system just works that way and no one had any idea how it all just happened, right?
No where have I heard similar such statements?
Oh, that’s right:
Marx’s theory of alienation (interstitial addition, mine):
The capitalist economy’s arrangement of the relations of production provokes social conflict by pitting worker against worker, in a competition for “higher wages”, thereby alienating them from their mutual economic interests; the effect is a false consciousness, which is a form of ideologic control exercised by the capitalist bourgeoisie. (See: Cultural hegemony) Furthermore, in the capitalist mode of production, the philosophic collusion of religion [or politico-economic theory] in justifying the relations of production facilitates the realisation, and then worsens, the alienation (Entfremdung) of the worker from his and her humanity; it is a socio-economic role independent of religion being “the opiate of the masses”.
JSmith: “Which ties into this statement on neoliberalism from an Oxford journal which I had linked to previously – very good if you want a more scholarly look at neoliberalism”
Thanks for the link. Very nice article.
“Disappear UP into their own theories.” Fixed it for ya.
Yet another example of how PP’s thinking and writing is transforming the economic profession’s understanding of itself and how much colateral damage it has caused the rest of us in the last 60 years. Death to the economist! Long live the economist! Thank you, Phillip.
The function of modern economists is to provide pseudo-intellectual rationales that give cover to the looting of the kleptocrats. They have like all our elites whether in politics, the judiciary, or the media the appearance of power, but in reality, they are all servants of the rich, all cogs in the machine known as kleptocracy.
Bernanke can move markets for a day or two, but he can not change them. If he tried, his “power” would be stripped from him in a second. The same can be said of Obama, the supposedly most powerful man on the planet. He talks about raising taxes on the rich, actually just letting tax rates on the upper income brackets return to their already low Clinton era levels. The effects on the rich will be minimal, but in exchange he wants to use this as a pretext to gut the last bastions of middle class security, Medicare and Social Security. Cutting through the noise, who does Obama serve, the 99% or the 1%?
Interest rate targeting came into its own with Volcker in the late 70s and early 80s. It was foundational to the construction of kleptocracy. It was the major conduit in the transfer of wealth away from workers and the middle class to the rich. Increases in workers’ wages were suppressed as inflationary allowing all the gains in productivity over the last 40 years to flow to the rich.
As labor’s power was broken, interest rates could drop lower and lower. This was not to stimulate the economy but to aid in the blowing of bubbles. It is all really a matter of definitions. Rises in workers’ wages even if in line with productivity gains were inflationary by definition and to be combatted, but bubbles, although they are inherently much more destructive (at least to the 99%), are not considered inflationary. They could not be combatted, so the rationale goes, because they can’t even be predicted. This, of course, has always been a load of horse hockey. Anything that could qualify as a bubble creates distortions in the economy big enough to be seen years before the peak and bust. Not only does the Fed not combat bubbles it promotes them, and again this is no surprise. As recent history as shown, while the rich take bigger hits in the bust, their fortunes return quickly whereas the losses to the rest of us do not recover. This leaves the rich proportionately even wealthier and more powerful than they were before the bubble.
Back in the time, I saw Volcker as an accessory in enabling the election of Reagan (wittingly or not). As a nice person and optimist, I hope he was unwitting.
Excellent work, Phil! Very illuminating.
“Yes, the Federal Reserve was able to keep the economy on a growth path, but in order to do so they basically had to keep dropping the interest rate after every recession and not bring it back to its previous level after the recovery had set in.”
And why exactly would Fed have to do that? Never mind, since there’s another very simple explanation for decrease in interest rates – Fisher equation, which states that nominal interest rate can be decomposed into real rate and inflation premium. Since inflation went down, nominal interest rates went also down. In other words, your first graph proves nothing.
“if an economy is being stabilised through interest rate manipulation alone, firms will be far more cautious about making real productive investments and will favour speculating in bond and other financial markets.”
If interest rates fluctuate more, investments in financial asets would also be less attractive. But never mind, because interest rates have not been actually more volatile in the second period (I got that from eyeballing FRED charts, but if you claim otherwise, a reference to some specific estimates showing higher volatility would be nice). And ratio of investment to GDP has been relatively stable since WW2, fluctuating between 14-18%. So even if this mechanism was plausible, it’s not supported by empirical evidence.
“The Zero Interest Rate Policy (ZIRP) approach to monetary policy is that which is generally supported by Modern Monetary Theorists (MMTers). They argue that the “natural rate of interest” is, in fact, zero.”
In mainstream economics, this is known also as the Friedman rule, named by … wait for it … Milton Friedman. So the article, full of anger and hostility towards monetarism, eventually reaches the same policy conclusions as those advocated by its leading proponent. Isn’t it ironic?
(1) Your investment chart is wrong. You’re deviding by GDP. But GDP contains investment, so if investment is lower this will be (and is) reflected in the GDP figures. The correct way to measure investment is the growth in the rate as I have done above. By doing this we find a 31-37% decline of the rate of growth of investment since the start of the monetary policy era (depending on when you measure that).
(2) If you “eyeballed” the chart of the Fed funds rate and concluded that interest rates were just as stable after 1969 as they were between 1945 and 1969 then you cannot read charts and I cannot help you. Maybe take a class?
(3) The monetarists favour monetary targets. The MMTers don’t. You cannot draw conclusions from similar things that each group says unless you understand the context — which you apparently don’t.
(4) Of course financial markets be more attractive if there is higher interest rate volatility because there will be more opportunities for speculation and arbitage trading. Do you know how financial markets work at all? Do you know why they dislike the current ZIRP policies? If not I suggest you read up on it before mouthing off.
(1) Yes, investment is part of GDP, so if its share is stable, that means its relative importance to other elements of GDP doesn’t change over time. In math, if Y = I + C, and I/Y is stable over time, then also I/C is stable.
(2) Here, plot of month-to-month changes in 3M treasury bill yield. Apart from increased volatility in 1970s, I don’t see any significant increase in volatility over say last 30 years. Please, enlighten me.
(3) You’re thinking about other Friedman rule, the one about fixed money growth rate. But no, Friedman also argued that central banks should target zero nominal rate.
(4) Right, because a firm which was planning to build a new factory, will instead, after observing higher volatility in interest rates, start arbitraging fixed-income derivatives, making buckets of money because apparently nobody else noticed the same thing. Any more fairy tales?
For traditional assets like bonds, more volatile interest rates will result in their more volatile prices and returns, which would make them, ceteris paribus, less attractive investments. That’s Finance 101.
(1) We’re not concerned with share of investment to GDP. Because if GDP is lower due to a fall in investment — which is, in fact, the case — then despite the fact that investment growth is poor it will remain stable to GDP. This hides the fact that the growth of investment is diminished. If you don’t understand this I suggest you stop trying to handle data altogether.
(2) You can even see it in that chart. But all you have to do is look at the changes in the Fed funds rate. The rate jumps all over the place from 1969 onwards. This is what we’re concerned with. If you don’t undertand why we’re concerned with this reread the article.
(3) You’re still taking that rule out of context.
(4) Yes, a firm will increase investments across the financial markets. You do realise that this is precisely what happened, right? Here’s your “fairy tale”:
Clearly then, invested funds are seeking more and more profits in finance rather than in real investment. This is not surprising. If interest rates move more so too will the financial markets. More financial firms will be set up and investors will gravitate toward these rather than toward finance.
I really think you need to do a little more homework before shooting your mouth off.
Should read: “…rather than real investment…”.
Not: “…rather than finance…”
“For traditional assets like bonds, more volatile interest rates will result in their more volatile prices and returns, which would make them, ceteris paribus, less attractive investments. That’s Finance 101.”
Hahaha! As naive as a newborn babe. Are you an economist perchance?
Here’s a hint on what the markets actually think of volatility:
“Without volatility day traders and short term traders will have little opportunity for short term gains. Longer term investors prefer the opposite and look for investments that head generally in one direction, up or down with little volatility. Volatility should not be confused with the direction of a financial instrument.”
So, what happens if markets become volatile? As Kaldor said, short-term speculation becomes preferable to longer term investment. Shock!
“Never mind, since there’s another very simple explanation for decrease in interest rates – Fisher equation, which states that nominal interest rate can be decomposed into real rate and inflation premium. Since inflation went down, nominal interest rates went also down. In other words, your first graph proves nothing.”
Just noticed this. The argument is completely wrong, but I’ll leave that aside because you didn’t do your homework (which I’m not surprised at because your arguments are poorly thought through).
Look at the inflation rate versus the Fed funds rate:
Inflation as stabilised since 1983, but the Fedhad to keep dropping rates after this to keep the economy growing. Just as Waldman’s chart indicates.
Inflation premium depends on expected inflation. While inflation stabilized in early 1980’s, it’s quite possible that it took some time for inflation explectations to drop. In fact, this is exactly what estimates of inflation expectations show.
That’s completely irrelevant. The Fed was dropping the interest rates in this period to manage economic growth — everone knows that.
I don’t think you’re really worth arguing with, to be honest. I hope you don’t manage any money, that’s all I can say.
Also, if you compare your chart with the Fed funds rate over the period you’ll see that there is no correlation. After 1998, for example, inflation expectations are fairly stable. But the Fed changes the interest rate a number of times.
“Economists and central bankers became generally suspicious of governments ability to manage their economies and instead invested heavily in the notion that independent central bankers could do a better job. The truth of the matter? More likely this was a power grab, after all it was generally economists that ran the central banks.”
Philip, from my perspective, you may be on the cusp of some important insights—like the possible historical origins of the managerial perspective(taken for granted by you as the best form of governance) as well as the nature of the current power struggle among, now predatory professionals of different skill sets and ideologies, to run things in collusion with the plutocrats.
Could it be that the accelerated movement from the farm to the industrial city in the late 19th century resulted in a viewpoint which reflected the greater impersonality and fluidity of the urban-industrial environment. Such a perspective then replaced the largely self-sufficient farmer with the supposed necessity of a managerial formation of some sort(eventually to become economists, using Philips example, of any ideological slant) whose primary job was the development of a set of laws or techniques of constant watchfulness over ceaselessly interacting urban citizens.
Proper administration, thru careful adjustment (whether Keynesian, neo-liberal or eventually post-Keynesian) has now became the accepted norm of governance.
But it is the destruction(not the sophistication) of these concentrations of modern bureaucratic power which may be the precondition for democratic renewal.
“you may be on the cusp of some important insights…the nature of the current power struggle among, now predatory professionals of different skill sets and ideologies, to run things in collusion with the plutocrats.”
Where do you see that?
“They then assume that their extremely unrealistic metaphysical models are a near perfect approximation of the real world. Finally, they seek to bring their metaphysical models down from heaven to earth by engaging in pseudo-empirical estimations …”
Another example of the Fallacy of Misplaced Concreteness – seems to me you can use that to critique all the economic theory/formula nonsense without even having to delve into “motivation” …
Good post, good read, interesting angle.
But…I’m only half sold to the idea of MMT.
I’ll sell the other half when a group of economist and\or financier will put forth a “mechanically functioning” macroeconomic framework, with exchange rates and capital flows and all that sexy sounding plumbing hardware…
They’ll also have to address resource scarcity and depletion.
Some commodity are more essential than others …and markets are fickle.
My advice to MMT proponents. Your theory must cover every angle…and I mean EVERY ANGLE.
P.S. I’ve recently watched “Modern Money and Public Purpose #2” with Stephanie Kelton and Warren Mosler.
Mr. Mosler was asked a question regarding [exchange rates] that I didn’t quite get, but his answer sounded a lot like market “mechanism would likely settle things nicely”.
I might have misunderstood, truth be told, my mind wasn’t sharp&crisp as I watched the video …but I was a little thrown off or disconcerted by that particular aspect. Maybe a post by the man himself (or a link) regarding this issue would be a good idea.
… Bill Mitchell, or M. Hudson or Steve Keen or whomever can articulate a vision of a realistically implementable system of *international **resource flow** management* that would RATCHET up living conditions with a clearly rapid and continuous rate of progress without much “accidental” economic melodrama.
Until then, I’ll stay on the fence; not because I want to, because it really is truly just a self imposed constraint ;-)
Yep, I agree. Currently MMT lacks a firm link with natural resources. There is, in my view, a natural rate of interest: one for every process and it is dependent on i) the energy efficiency of the process and ii) its time efficiency. Thus, one may well get an aggregate ‘natural rate’, but it is unclear whether this is any more meaningful than an aggregate personality and whether it should be implemented by policy. I’d argue that setting a rate makes it de facto unnatural. Keen and group’s work on entropy may make these links eventually clear because the interest rates reflect the entropic nature of the processes.
Because there must be natural rates of interest (every process increases entropy, some more than others), even a natural rate in aggregate, the MMT ZIRP cannot work. Spending money into existence is in principle no more feasible than spending oil into existence. It appears to work because every one is in effect being rationed to smaller portions when money is spent by the government. When the government spends money into existence, it has not produced anything any more than a counterfeiter has. Whether this is illegal or legal is -completely- besides the point, it is exactly the same process.
Every economic transaction is, at heart, a barter process. This is absolutely essential to understand. Barter is a trade of good/service for good/service. It is not a trade of good/service for a token or a trade of a token for good/service. It does appear that way because tokens permit the two ‘halves’ of the barter process to be separated in time and space much like an electron and a hole in a piece of matter can be separated in space and time. Much mischief arises from attributing supernatural powers (e.g. economic growth) to the tokens themselves, the apparent powers arise merely from the ability to use tokens to perpetrate deceit. Ignoring the act of barter that must be completed produces merely Placebo Economics and enables parasitism on the true barter process.
Yes, we would have to be very mindful of the entropy effect of a sudden, sustained surge in activity and consumption.
On the other hand, the system we currently have is certainly not (if we consent to being lucid for a second and marvel at the orgy…) the epitome of a judiciously constrained resource allocation system. As currently “programmed”, Progress is not a goal in itself, it’s an incidence brought about by the constraints.
*Positive side effect: it nurtured efficiency.
*Negative side effect: it requires rapid turn-over, planned obsolescence, massive security and vast quantity of mediocrity to fill “market need”.
Waste is inevitable, but we’d be well advised to make it a little more worthwhile than it is now.
I disagree with your point about the ZIRP\No debt-money printing. I think it could very well work, theoretically. Because an economy as complex as what we have now carries way too much imponderables. We live in an age where we can easily take out the drudgery of life by filling the needs of food and shelter without resorting to trailer parks and wood frame constructed shithole apartments. After that, what’s most valuable is feeding the mind. Art, information, knowledge—The things you can give away without loosing them yourself…
We must do what we must …and enable what should be enabled.
That was the merit of the Keynesian revolution. It’s not because there’s no gold in the goddamn coffer that we must sit in the rocking chair and wait for death.
I must also disagree with your concept of money. But that’s to be expected, I don’t agree with anyone’s concept of money.
I don’t think it’s a barter transaction…and I don’t think it’s a variable storage of value either, although we try very hard to rationalize it as such because it’s easier on the mind and the conscience.
I think if you could imagine yourself in a Star Trek era setting you would then be best guided towards my understanding of what money truly is.
Very simply put, money is a decentralized resource transfer authorization. It is not systemized as such YET, that’s why we have 99 times more friction than function in our “growth” engine. But that’s in my humble opinion what it will have to morph into.
Forgive me if I misinterpret your point, but this “Very simply put, money is a decentralized resource transfer authorization” sounds to me like we have views on money that may be in close agreement. Without the authorization part, one either has theft or one has a gift. The need for authorization implicitly acknowledges that the other ‘half’ of the barter may occur somewhere/sometime else.
tiebie66:Every economic transaction is, at heart, a barter process. This is absolutely essential to understand. Barter is a trade of good/service for good/service. Absolutely wrong. The heart of mainstream, commodity theory neoclassical UnEconomics. Utterly unlike any economy ever. The time separation is essential. Time is Money! Collapsing it is an infinitely misleading simplification. The “barter process” is Marx’s (& Aristotle’s) C-M-C (Commodity-Money-Commodity ) collapsed into a fictional C-C.
Any production, any division of labor requires credit = debt = trust. Even cavemen making arrows – if there is an arrow-head chipper, and a fletcher for the feathers. The trust between them is credit, the pre-money, that makes cavemen making arrows a Commodity-Money-Commodity process. It is barter analysis that ignores reality, not monetary analysis, which analyzes both money & “reality” – the trade in real goods and services – essentially always for money.
Spending money into existence is in principle no more feasible than spending oil into existence. It appears to work because every one is in effect being rationed to smaller portions when money is spent by the government. Absolutely not! Yes, this can happen. It is usually characterized as demand-driven inflation. But it is a very rare phenomenon, almost always seen only during wars. The money spent enables, embodies cooperation, division of labor, which enables more production – just like with cavemen.
All that MMT says is to take the people who are not being employed by the private sector using previous “decentralized resource transfer authorizations” (a pretty good phrase, WorldisMorphing, reminiscent of Georg Simmel’s idea of money as a universal claim or bill of exchange on all merchants – or somedamnsuch phrase) and provide them with new DRTAs -IN RETURN FOR real, valuable work, whatever work that society wants them to perform. A DRTA in return for a transfer of real resources to the state, resources that would otherwise be destroyed. That this is less inflationary, more wealth-creating than forcing them to beg, borrow or steal, or live at public expense is utterly obvious. It has worked very well, whenever it was even half-heartedly tried.
The only error you make, WorldisMorphing, is characterizing ZIRP as “no debt”. Currency is absolutely just as much debt as interest paying bonds are. We already have an MMT system. We just need to use it! True, some use atrocious terminology – and MMT, economics education suffers as a result.
It is an empirical fact that human economies are usually run in a stupendously idiotic way, where something purely ideal “money” is ficitiously identified with something “real” and therefore people are deceived into thinking there could be an overall scarcity of money, which leads to the monetary authority, usually the state, forcing millions to not work for their own and everyone else’s betterment, against their will, for no speakable reason at all.
[“The only error you make, WorldisMorphing, is characterizing ZIRP as “no debt”.”]
I was referring to government spending not technically needing to be “financed” by bonds issuance…
But for the record, I think ZIRP would work most of the time. Fiscal policy could probably take care of the money supply, but there could be enough reasons to not do away with central banking interest rate management altogether…Not sure though, will have to think about it some more…
Thanks Philip, outside of Steve Keen and one or two of the MMTers, you are one of the very few commentators worth reading regularly. Too bad that they dropped the Economics department at Western Sydney University, perhaps you can lure Keen to Kingston . . . it could be a good fit.
Any kind of good dessert recipes for low fat, low cholesterol, low sodium diet?
Robert Brenner argues in Economics of Global Turbulence that the decline in the profit rate of the advanced capitalist economies, U.S., Germany, and Japan is a result of overproduction and oversupply along the same timelines as the article’s interest rate target thesis, with the profit rate being the engine of growth for capitalist economies. As a result, per the argument, the monetarist interest rate targeting policy is a reaction to this problem.
[“The only error you make, WorldisMorphing, is characterizing ZIRP as “no debt”.”]
I was referring to government spending not technically needing to be “financed” by bonds issuance…
But for the record, I think ZIRP would work most of the time. Fiscal policy could probably take care of the money supply, but there could be enough reasons to not do away with central banking interest rate management altogether…Not sure though, will have to think about it some more…
Sorry…meant as a reply to Calgacus above…
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