Archive for May, 2011

Is economics a real science?

If economics would like to consider itself a “science”, then it should be willing to be subjected to genuine scientific scrutiny.

The next 10-20 years will offer us perhaps the most damning expose of the fallacy of modern economics. The true test of a scientific theory is its ability to make testable predictions. Therefore we should compare the expectations laid out by mainstream economics with those from less orthodox origins.

Relentless (linear) growth is assumed to be possible, as long as mankind adopts the bureaucratic / technocratic prescriptions of the economic preisthood. This is the Solow growth model embeded in neoclassical economics.

By contrast in 1972 predictions of global economic growth, population and resources were made by the Club of Rome team’s “Limits to Growth”. The predictions made by this report are consistent with the field of Ecological Economics which places the human economy WITHIN the worlds natural resources. So far, their predictions are worryingly accurate:

(Chart Courtesy of Charles Hall’s Revisiting the Limits to Growth)

The Club of Rome’s model offers a considerably more plausible representation of the world economy than that postulated by traditional economics. The model relies on stocks and flows of various inputs and outputs, the rate at which is dictated by certain rules and feedback loops. Key aspects of the model are:
1) the world has a finite set of resources
2) industrial production requires resource inputs
3) the rate at which these resource draw downs are occuring are not underestimated
4) the consequence of resource extraction & consumption yields pollution

Therefore, the model does not disobey basic laws of physics, such as thermo-dynamics. So from a theoretical point of view it is superior to any Neoclassical model no matter how elaborate their mathematical prowess. Mathematics should represent reality, not replace it; and the Club of Rome model achieves this.

From a practical view, the model predicts world food per capita peaking in about 2010. Real world events are bearing this out. The model also predicts peak resource extraction (steepest decline of the blue line) between 2010 and 2020. Many in the “Peak Oil” community share this synopsis. Peak Industrial Output per capita, and Peak Services per Capita are also predicted to be on the cusp of steep declines.

If the next 5-10 years follow these trends then it will become even more untenable for the traditional economists to hold sway over the population and politicians.

But even more foreboding is that it is just as plausible for many in positions of power and influence to try and distract and deny these problems publicly, whilst privately understanding this dynamic. Instead of informing, educating and preparing the nation for the unsettling future, many in power may simply resort to hoarding wealth, influence and access to these dwindling resources.

Portentous times, indeed.


“From a physics perspective it seems natural to suppose that economic wealth is an abstract representation of a capacity to do something. If so, then economic value, adjusted for things like inflation, should be directly proportional to the rate ( in Watts) at which civilization consumes energy (e.g. coal, oil, uranium, etc.). Nothing in the universe happens without energy being transformed from one form to another. The global economy should be no exception.”

Thermodynamics of civilization growth


A more indepth discussion of the LTG book and the academic assualt against it see:,club_of_rome_revisted.pdf

Categories: Economics, Energy

How a bank works: modern miracle or just a mirage?

The major function of a bank is its role of Intermediation, whereby the requisite demands of lenders and borrowers are brought together for mutual benefit.

This Intermediation can be split in to two key functions for banks. The first is maturity transformation, whereby banks borrow money in the short term (e.g. instantly available deposits) and lend out over the long term (e.g. a 20 year mortgage). This places a bank in the unfortunate position of being vulnerable to a liquidity squeeze whereby lenders could withdraw deposits quicker than a bank could liberate its assets (especially if pressured to accept “fire-sale” prices). As a result of this, banks need to provide credibility and trust to lenders (i.e. shareholders and retail depositors).

In return for handling this transformation (borrowing short and lending long), banks are rewarded through extracting a profit, provided that this trust is honoured.

This maturity transformation is also known as Liquidity transformation. Creating a seemingly liquid (i.e. highly mobile) financial sector has been at the forefront of intellectual and political aspirations. We are constantly told how the global economy needs this liquidity that the banks create inorder to provide us with the lavish lifestyles we lead. If this liquidity seizes up, so will our real economy.

But does the world really need bucket loads of liquidity sloshing around? Why do we need the equivalent of one year’s global GDP to be traded twice over on a daily basis by the financial sector? What purpose is there for this relentless Liquidity Pimping?

The answer is as follows:

Liquidity = fabricated marginally-backed leverage!

In other words, the liquidity is a complete fiction. A bank acts as if it has the whole value of a fixed asset (say a mortgage on a house) at its full disposal in cash terms. Clearly in reality the cash equivalent of this asset isn’t available to it in immediate or “liquid” sense. The house hasn’t been sold to realise the cash. Therefore, the bank operates with a form of leverage that is only partially backed-up in the real world. This quote from an article about a similar issue in the 1800s explains it well:

“because money was invested in industry through the medium of securities, or fictitious capital, there was an illusion that the capital thus invested was “mobile,” or to use the modern terminology, “liquid.” The individual investor can always transform his share of stock into a sum of money – all he has to do is sell it. But Marx pointed out that this has nothing to do with the “mobilization” of society’s real capital. Money invested in heavy industry is fixed. “

Fictitious Capital (see the section “Marx on the Mobilier”)

So the whole concept of whether a society actually wants or needs this fictitious liquidity is never actually discussed. Every debate or discussion commences with the assumption that a modern society needs this liquidity. Banks may need this liquidity (in order to generate scope for leveraged profit making), but the truth of the matter is that the social benefits are greatly over-exaggerated, if not harmful. See this article Is the finance sector good value?

Now, moving on to the second key role for a bank; risk transformation. In this capacity, a bank undertakes to control or mitigate the different levels of risk that it holds as assets (e.g. loans). This takes the role of the bank trying to protect itself from the potential abuse of trust by borrowers. By choosing the word “transformation“ one is led to believe that banks can perform tangible changes to the extent of risk that they are exposed to, however a better choice of word would be risk mitigation.

This is because risk in its pure and aggregate sense is not strictly acquired by banks and then mystically detoxified into a safer level. To believe otherwise, is to assume that banks can “spread risk and somehow magically evaporate it in the vast complexity of the financial galaxy”. Banks receive the right to profit from appropriately containing or avoiding risk, not because of their ability to convert the risk to a less hazardous state. The risk still exists in the system. For more details see my ICB Submission – Nov 2010

Again, this is a fundamental misunderstanding amongst the public (and academics). We presume that modern banking is effective, neccessary and safe. Nothing could be further from the truth.

The very premises of modern banking – risk transformation and maturity transformation – are actually convoluted sleights of hand !! In reality, they can’t actually reduce risk (it can’t magically go away!) or equally create liquidity from nothing. It’s just an illusion acquired through an exploitation of the public’s confidence. In other words; deceit.

Categories: Finance and money

A Predator State – the worst bits of Capitalism, Communism and Feudalism

We live in a Capitalist country, right? We believe in the power of markets, don’t we? That’s what seperates us from the spectre of Communism that haunted us from the 1950s to end of the 1980s, isn’t it. And we understand the theory: a Capitalist country achieves the most efficient allocation of resources by facilitating trade & commerce by the practice of prices, and price only. No plans, no dictates, no sentiment. The market connects buyers and sellers, and the price mechanism is what determines appropriate supply and demand to achieve the economic nirvana of equilibrium.

But, just to soften the edges, we have a bit of a heart too. The Gvt still dictates certain aspects, but they are the there to help keep the country and economy moving. A national health service, education, a defense force and social security. A supportive collective spine from which hangs our supple private sector muscles allowing us to punch above our weight. So we actually have a lovely mixed economy with the best that Capitalism & Socialism can offer.

Sounds plausible doesn’t it. But hang on a moment. Following the crisis in 2008 it seems we took a slight detour from this.

In the face of bank collapse our politicians ennacted sizeable bailouts. A state bailout of a private sector business is not a free market solution. In fact quite the opposite. In this instance, the bailouts have protected the lending class (creditors / bond holders) at the expense of the public at large.

The consequence has been Austerity and Inflation. Measures that assure that the lender bears no responsibilty whatsoever for their faulty judgement in lending out in the first place. It is debt maintenance by any means necessary.

Yes we have a mixed economy, but one that is instead the worst of both worlds; privatised profits and yet socialised losses.

It is a form of Crony Capitalism, and a slipperly route back to the retrograde structure of Feudalism. It is what James K Galbraith calls a Predator State. The state as monopoly collector of taxes and corrupt distributor of the spoils to the private sector. This is not the free market vision of Adam Smith:

“What did the new class… set out to do in political terms? The experience of the past decade permits a very simple summary explanation: they set out to take over the state and to run it — not for any ideological project but simply in the way that would bring to them, individually and as a group, the most money, the least disturbed power, and the greatest chance of rescue should something go wrong. That is, they set out to prey on the existing institutions of the American regulatory and welfare system.”

Predator State

But this message isn’t being voiced by any policitician, or even any economic or political commentator. The closest to this I’ve heard lately is from a recently elected Northern European party leader:

“In a true market economy, bad choices get penalized. Instead of accepting losses on unsound investments—which would have led to the probable collapse of some banks—it was decided to transfer the losses to taxpayers via loans, guarantees and opaque constructs”

Why can’t any major mass movement whether from the left or (especially!) the right, the Union’s, the Green’s, the NGOs, Anti-Globalisation or anti-cut movements use explanations such as this to tell the true story of this crisis?

Categories: Finance and money