The blog is divided into different sections, accessed from the menu bar above.
The Introduction just has 3 posts, and points out that if we want an economy that provides enough for everyone, then we need to be able to produce enough (so we’re concerned with productivity), and we need to be able to distribute what is produced, which means enabling everyone to earn the means to acquire what is produced.
The posts in the Models section provide an explanation of key economics jargon. More to the point, it describes the key elements of the economy you need to understand and how these relate to each other, by presenting simplified models of an economy.
Money begins the empirical work. It looks at how money is created in the modern economy and the implications this has for the functioning of the economy.
Productivity then goes back to the core concepts, and looks at the relationship between productivity, investment and saving. As well as highlighting a particular role for financial markets, it concludes by looking at the significance of business saving as a source for investment.
So in the next section, Financial Markets, we “follow the money”, and look at how businesses are using their savings (their undistributed profits). This section draws on brilliant work by certain economists in recent years who have studied the actual reality of what is happening in these markets. The evidence confirms the ideas presented in the Productivity section, and starts to hazily indicate the path we need to tread to create a functioning economy.
Most of the content up to this point is exploring the question of how we create an economy that produces enough. The next section, Distribution, looks at how we create an economy that can distribute what is produced to everyone, and enable everyone to earn the means to participate in the economy. It is facile to say that all we need to do is redistribute wealth from the rich to the poor – we need an economy that itself distributes wealth effectively. In fact, the way that wealth is distributed itself impacts on the productivity of the economy. The conclusions from this section cohere neatly with those from previous sections of the blog.
Finally, there is one section left for me to complete, on what is required to enable society to move towards such an economy, and what is preventing such progress.
That’s an overview of what this blog covers so far and what I intend to add. A detailed summary of each of the completed sections is provided below.
But first, to explain the flow of ideas in a little bit more detail, I should point out that I didn’t start the blog with a detailed plan of where I wanted to go. As described on the About page, in my studies of economics I’ve discovered things that I feel everyone needs to understand. I felt it would be useful to me to hone my thinking by writing about it, and an enjoyable exercise to try and make this complex information clear and accessible. But I didn’t have a grand plan or theory, and I didn’t really know how to put it altogether. Rather than let this put me off, I decided just to start, with a general sense of direction but no grand plan.
But as I was writing, two things happened. First of all, it really has honed my thinking. I think I’m clear on what I want to say until I try to write, and then find that what I thought would be 1 post becomes 2 or 3, as I cover the nuances to my satisfaction. As a result, I have clearly failed in my attempt to write in a way that anyone can understand. The blog frequently gets bogged down in detail, but this detail matters if you truly want to understand what is going in our economy. As a result, I’ve seen my reading numbers plummet – it’s far too heavy for most people.
The second thing is that while I’ve been writing, I’ve still been studying. The empirical work in the Financial Markets section in particular I only came across after I had started the blog. More to the point, I was looking for this empirical research because the theoretical ideas in the Models and Productivity sections indicated that I should look for papers that detailed the flows of wealth inside financial markets. While this further study confirmed my original ideas, it also honed and clarified them (just as writing has done), and has furnished me with yet more detail that fortunately it is too late to include!
So my goal at present is to complete the current train of thought of the blog to its logical conclusion, while continuing my studies. And I hope that by the end it will have clarified my thinking on the content such that I can finally write a short series of brief posts summarising everything, that is widely accessible and understandable but doesn’t compromise on accuracy.
But in the meantime, all the detail is on the blog, in a logical sequence of posts. I wouldn’t expect anyone to wade through all its content now, which is the length of a short book. But below is a detailed summary of each section. Where the content looks interesting to you, the links are there to jump straight to that section of the blog.
I didn’t really know where to start but, as mentioned above, realised that the reader needed to understand certain core concepts. I took an approach that I likened to stripping a car engine and then putting it back together again piece by piece. I started with a model of a very simple economy in which everyone buys the same goods each year and companies produce the same – there’s no innovation, no change, no economic ups and downs – and in which the only form of money is physical cash, with no banks or financial assets. I then considered what would happen in such an economy if one person started to save. The simplicity of this economy was the equivalent of stripping back the engine, and the first piece that I plugged in was saving. Over subsequent posts I moved through a series of more complicated models, adding a new component to this economy each time, covering productivity and investment, credit, inflation (and deflation), the money supply and velocity of money, banks, interbank clearing (this is fascinating and essential to understand, trust me), and financial assets.
This is where many of the technical terms mentioned above are explained, but what is more significant are the dynamics of how they interact.
Let’s take one important example. Pretty much everyone “knows” that the government can’t provide enough for everyone by just printing money and giving it out, as this will cause inflation. (Alternatively, you could say that it can’t fund the NHS or pay off the national debt, etc etc…) The basic logic is that companies cannot instantly increase the amount of goods that they produce for sale, so if you increase the money supply you will simply have more money chasing the same amount of goods, and prices will rise.
However, if you have a situation in which firms are struggling for customers, and therefore are laying off staff, or lowering wages, or going bust, and in which the self-employed likewise are finding their incomes going down, it is obvious that they can respond to an increase in demand, and therefore they won’t put up their prices if there is an increase in the money supply, they will simply be able to sell what they already have the capacity to produce at the price they wish to sell it, avoiding lay-offs, wage cuts and bankruptcies.
Clearly, I am describing our economy since the financial crash. This simple explanation makes it very clear that not only was austerity unnecessary, it was actually the wrong policy. We needed the Government to increase spending to stimulate the economy, and it would have recouped must of that additional expenditure through the increased tax revenues that would come from a growing economy. (This is fully explained in this post on “The Magic Money Tree”.)
To make matters worse, throughout this period until the Brexit vote we had exceptionally low inflation, and sometimes even deflation. The Bank of England was actually trying to cause inflation. So the argument that funding Government expenditure through new money would cause inflation was actually an explanation of why this should be done. (Promoting growth through increasing public spending will cause inflation through its impact on the exchange rate rather than more-money-chasing-more-goods, just as the fall in the pound after Brexit has caused inflation in the UK. The full dynamic is explained here.)
I hope the last four paragraphs illustrate how understanding not just what terms mean, but how the different components of the economy interact, can help us quickly and easily understand what is actually going on under the bonnet of the economy.
And in terms of understanding these dynamics, with every new model I introduced in this section I would explore the impact of saving on the newly introduced components, including the “paradox of thrift”, considering saving in a static economy, in a growing economy, saving in an old-fashioned banking system, and saving through financial assets. The significance of this comes out in the section on Productivity, summarised below.
At the end of this section I wrote a summary, found here. Ultimately, it’s not essential to read any of this to understand the rest of the blog, but if you were tempted I would definitely suggest starting with the summary.
Very simply, this section explains how money is created, and to some extent how the monetary system works. (To fully explain the monetary system I would also have to cover monetary policy and foreign exchange markets. It was originally my intention to have sections of the blog on these 2 subjects, but it was all taking too long so I skipped this.)
In a nutshell, money is created whenever a bank makes a loan (and destroyed as that loan is repaid). The only limit on banks’ ability to create new money is their having customers seeking loans that they are confident to lend to, and either not giving out significantly more in loans than they receives in new deposits or being able to borrow on the interbank market to make up the difference.
All of this is explained clearly and briefly, yet in sufficient detail, in 4 weeks of posts starting here, so I’m not going to repeat it here.
You may have in your head the model of fractional reserve banking, in which the banks keep a fraction of their deposits in reserve and loan out the rest, with the central bank controlling the money supply by managing the quantity of reserves. This is the model taught in economics textbooks and it is completely wrong, as explained here.
The way money is created is clearly explained by the Bank of England in a short and clear paper in its March 2014 Quarterly Bulletin. The same paper also confirms that economics textbooks are wrong (it says this 6 times). The paper is continually referenced throughout this section.
The correct version of money creation is widely known (outside of orthodox economics) and has been repeatedly described in books and websites. The definitive starting point on this subject in the UK (aside from the Bank of England paper) would have to be the organisation Positive Money. One reason I didn’t start the blog with this section is that it’s been done before so many times, so I tried to be more original with the section on models. However, I couldn’t leave this subject out, and I like to think that the articles on this blog are as clear and as accurate as anything else you will find.
From all this, there is one point that needs to be emphasised. As explained in the Models section, as productivity increases the money supply needs to increase as well. And in our current system this increase only happens when banks make loans. But as these loans are repaid the money supply is reduced. And therefore our economy needs ever increasing levels of private debt, both to replace the money that is being destroyed as loans are repaid and to create the new money needed for increasing productivity. And there is only so much debt that the private sector can sustain. Every major financial crash has been preceded by extremely high levels of private debt.
It is therefore essential to a functioning economy that a certain quantity of new money is created every year that is not tied to private debt. And the only way to do this is for the public sector to create this money. This is not an excuse for the Government to have as big a deficit as it likes: the amount of money needed is linked solely to the growth in productivity, and the Central Bank could give the money directly to the private sector through, for example, corporate tax breaks. But such payments would still be a public sector deficit.
This is the simple fact, and I hope you can clearly see the logic of this. We need public deficits every year, and everything you see in the media and from politicians railing against deficits is wrong. However, these deficits must be funded by newly created money, with the amount determined by economic factors not by the level of spending the Government desires (the Government can spend above this limit through taking out debt in the normal way). The only exception to this is if the economy is over-heating and needs to be slowed down to prevent inflation. All of this is fully explained in this post.
All of this is so clearly explained that this is the only section of the blog that doesn’t close with a summary. The last two posts draw on Perry Mehrling’s description of money as a hierarchy of means of payment, just to give you a little bit more insight into the nature of the monetary system, but it’s really only scratching the surface. Mehrling is one of the foremost scholars on how the monetary system and financial markets actually work in practice, and his “money view” is easily the most useful perspective on this system that you will find. The second of these two posts looks very briefly at foreign exchange and the balance of payments constraint.
However, while fixing our monetary system is an essential step in creating a functioning economy that produces enough for everyone, it’s just one small part of a much bigger picture. This section was just a foundation for where we’re going.
Armed with an understanding of money, we’re ready to look at the critical issue of productivity. If we are to have an economy that provides enough for everyone then we need to be producing enough. This requires not just raw materials but the infrastructure and systems to produce those goods – the factories, the machines, the transport – not to mention the knowledge and the skilled workforce.
This infrastructure needs to be sustained, and innovation and progress requires new infrastructure. All the expenditure on this is known in economics as investment.
In everyday language we think of investment as buying a share or another financial asset. But in economics it specifically means expenditure on this infrastructure (known as fixed capital) as well as spending on increases in inventory.
The difference between the everday and the economic meaning of the term investment can get very confusing. If you buy a financial asset such as a share in a company, you are not investing you are saving – to access your savings you sell the asset, and you hope that it increases in value by more than the interest you could have earned from a bank. But by saying that we invest in financial assets, it can create the illusion that this expenditure will lead to proper investment in the economic meaning of the word. Indeed, economists say that financial markets intermediate saving to investment. But the vast majority of trading in financial markets is trading in what economist Steve Keen calls second-hand assets. Investment only takes places when a firm issues a new asset and then uses the proceeds for investment expenditure.
In looking at the relationship between productivity, investment and saving (and at something known in economics as the saving-investment identity), I reached the following conclusion:
If saving is not channelled to investment the value of all our savings falls. But this fall in value is not necessarily reflected in financial markets – financial assets can be overvalued.
In brief, what the posts about saving in the Models section highlight is that the only way a national economy can save is in its physical store of unsold or unfinished goods and in its physical fixed capital. The saving-investment identity is the formal proof of this. The value of saving will be the same as the value of fixed capital and inventory expansion. The price of financial assets should reflect the latter value, but doesn’t because financial markets are so grossly inefficient and dysfunctional. That’s the crux of the matter, in an nutshell.
Standard economics textbooks often say that the identity holds because savings are the source of funding for investment. This is incorrect empirically, and also not consistent with the logic of the identity itself, as explained in two posts starting here.
All the frenetic demand for assets simply pushes up asset prices, causing the recurrent bubbles we’ve come to know and love. And because financial assets are overpriced, the fundamental value of our savings tied up in those assets (such as pension funds) is far less than we think – but we only get to find out when the next crash wipes the value off those funds. Meanwhile, those inflated prices soak up our savings without redistributing them back to the real economy through investment, productivity falls and our economy slows down. This is how the “paradox of thrift” operates in the modern economy, and the constant attention to the dynamics of saving in the Models section of the blog, referred to above, was to lay the foundation for understanding this.
This exactly describes the economy right now: asset markets are in a huge bubble that is waiting to burst (causing the next financial crash) yet the economy hasn’t been able to recover from the last crash, with growth remaining pathetically weak, particularly wage growth. Underpinning this is extremely weak productivity growth that concerns and bemuses economists and politicians (described in the 2nd half of this post).
And yes, this blog explains it all. If you think this description is too brief and I haven’t adequately justified my position, there’s 14 weeks of posts in this section for you to read! There’s an incredible amount of technical detail in this, not least in the penultimate post where I showed how the undistributed profits of businesses (business saving) should be the primary source of investment funding. I love the meticulous precision of how it all fits together, but I think for most readers it was pretty tough going.
So the final post gives a more detailed summary, but if you’re interested in this topic it’s probably worth jumping straight into the detail of the weekly posts from here.
The analysis in the Productivity section suggests that the functioning of financial markets is critical to the success of the economy. This led me to seek out research on these markets that was based purely on the reality of what they actually do, not theoretical notions of what they ought to be doing, and I discovered the incredible work of Perry Mehrling and Zoltan Pozsar.
This section of the blog starts with Pozsar’s work on institutional cash pools. You’ve probably never heard of them, few people have. Pozsar’s initial 2011 paper for the IMF was the first to analyse them. I was incredibly excited when I discovered this paper (in April 2017) – my family thought I was very sad, or a bit mad. His work confirmed exactly what I was expecting to find, based on the analysis presented in this blog.
Large groups of corporations are retaining huge profits, for various reasons, in institutional cash pools. The minimum size of these pools is $1bn. Instead of reinvesting these earnings (their business saving) into their own productivity, they are seeking out safe, short-term assets.
Along with the two other types of cash pool – cash balances of institutional investors and foreign exchange reserves of central banks – the impact of such huge concentrations of wealth is to create a dangerously unbalanced and unstable economy. All the detail of this is set out in the first 7 posts of this section, and it’s really heavy going.
In essence, Pozsar’s conclusion is that there is a need to correct these imbalances by redistributing wealth: taxing these cash pools and redistributing the wealth back to households, and similarly reducing foreign exchange reserves by redistributing them among households.
These conclusions are so politically unpalatable that when he worked for US Department of the Treasury he dismissed them in a sentence (page 64), and instead proposed what was politically viable. But scientific analysis of the evidence points to the need for the steps summarised above. He is not proposing this redistribution of wealth due to any notions of justice or fairness (he now works as an investment banker, he just wants to know how markets work so he can make money out of them) – this redistribution is necessary to make the financial system, and therefore the economy as a whole, stable. You can read more on this here.
I spend a lot time on Pozsar, because it’s a description of arguably the most significant dynamic in financial markets from before the crash right up until 2015. (Since 2017 there have been further changes, which Pozsar has described in circulars he writes for Credit Suisse – “Global Money Notes” – I don’t have an adequate grasp on this constantly changing picture to write about it.) To shed light on financial markets from different angles, I then wrote posts on Quantitative Easing and on William Lazonick’s work on stock buybacks.
The former is a detailed description of how QE worked and its effects, which were principally to re-inflate the asset price bubble rather than stimulate the real economy. The latter is a summary of Lazonick’s empirical work showing how corporations are using their retained earnings (business saving) to buyback their own shares, again keeping share prices artificially high (thereby ensuring that executives get their bonuses).
There are then 3 posts looking at why financial markets are so dysfunctional. The second of these explains the difference between uncertainty and risk – the latter you can calculate a probability for, but the former is simply unknown. Many economists and market analysts treat uncertainty as if it were risk so that they can create mathematical models. The problem is these models are not good at predicting market behaviour because this behaviour does not follow patterns of mathematical risk (e.g. the normal distribution). This neatly brings us to the master, Hyman Minsky, and his “financial instability hypothesis”. Ignored in his lifetime, Minsky has basically been proved right by events this century, and his theory is briefly summarised in this post, providing a useful framework to understand the behaviour of financial markets.
The conclusion of all this is that financial markets require management and coordination, which has to be a role of the state. This proposition will usually induce howls of protest based on political ideology rather than scientific analysis of facts. So I wrote one post pointing out that, in fact, any publicly listed company is publicly owned, and then one post briefly summarising Mariana Mazzucato’s groundbreaking empirical work on the actual role the state has played in innovation, particularly in the United States (of all places), in the development of the internet, biotechnology, nanotechnology, pharmaceuticals and renewable energy.
Covering Mazzucato’s work in a single post highlights just how summarised this section had become towards the end – it’s unbalanced compared to the detail on Pozsar’s work, but I reached a point I just wanted to push on more quickly to a conclusion. (Also, Pozsar’s work is so specialist and covering such a little-known, complex area, that I think it took that many posts to try and make it clear and intelligible.)
The section ends with a summary, followed by a post that brings together some of the ideas for change that emerge from the content of the blog so far. The purpose in this is to not to make recommendations, or set out some kind of manifesto for change, but rather just to help the reader start to see some of the practical implications of all the analysis on the blog so far.
In this section, the blog changes direction. Everything up to this point has been looking at the question of how we create an economy that produces enough. Now we are looking at the question of how we distribute that productivity.
This section is not saying that to provide enough for everyone we should simply redistribute wealth from those who have it to those who do not. Rather, it looks at the way the distribution of wealth affects the growth of the economy: we need to structure the economy such that everyone is able to earn enough to purchase what they need, and hence we need to distribute the capacity to produce. In addition, we have to acknowledge the environmental impacts of continuous increases in production – to prevent this we want increases in productivity to enable the poorest to have enough to survive, and also to reduce the work hours and the intensity of production (which itself damages the environment). These points are all covered in more detail in the opening post.
The next post describes how increases in productivity tend to lead to lower wages or higher unemployment (there are exceptions, covered in the post). Mainstream economic theory argues that this should not matter – the savings to business owners (their increased profits) and to consumers (in lower prices) are spent elsewhere in the economy, and over time the free market will balance everything out. The reality, that you can see all around you, is that regions hit by a decline in a major industry can spiral down and never recover, as the loss of income lowers demand for all the other small businesses serving the region. I illustrate this using the economic decline in South Wales following the closure of the coal mines (an example I know well).
The next post returns to the failure of mainstream theory to explain this. It points out that because there is a finite limit to how much the human race can consume (limited by the number of people and the time they have to consume), then it is logically possible that this limit could be reached without employing every member of the human race. If everything is left to the market, the excess people simply starve!
And while this may seem like a ridiculous example, in fact economists are starting to consider the impact of automation. This post summarises a fascinating paper by Lord Adair Turner (former chair of the Financial Services Authority in the UK) in which he points out that we are well down the path of automating every job and function that can be possibly be automated. While it is not just around the corner, he suggests we are talking 50-100 years rather than 300-500 years. The outcome in the foreseeable future, he says, is ghettoes for the wealthy to live and holiday in, while the rest live in cities competing for low paid, menial jobs.
As one example, driverless cars are certainly on the horizon, and this post highlights their likely impact as they replace professional drivers and put millions out of work. Will these job losses finally enable people to see the problems with free market fundamentalism? Or will it leave them ripe for exploitation by the latest generation of populist demagogues?
But we don’t want to stand in the way of such progress. We want increases in productivity to enable us to provide enough for everyone, with everyone working a limited amount of hours, in good conditions, for decent pay. But in simple terms, a new labour-saving technology means someone, somewhere losing their job. How do we stop this inexorable process of gradually making more and more of the human race redundant? How do we enable those who lose their jobs, and those regions that lose their major sources of employment, to share in the increased productivity and wealth of society as a whole?
We need to distribute the capacity to produce, and this is where the blog can draw on its earlier material. First of all, Mariana Mazzucato’s work, summarised in the ‘Financial Markets’ section, has demonstrated that growth in any industry has been dependent on state planning and investment. And in addition, the blog has demonstrated in some detail how dysfunctional financial markets currently are, and the critical need for regulation and coordination to ensure that these markets do actually channel saving towards investment in the most needed industries (such as green energy).
As this post explains, it is pretty obvious to see that this state investment and this coordination of financial markets can both be utilised to channel investment into regions and nations where job creation is most needed. Such action will strengthen the economy as a whole – this is the whole point of this section of the blog, that a more even distribution of wealth stimulates demand and strengthens the entire economy.
You constantly hear mainstream economists talking about “supply-side economics”. What they mean by this is that the way to stimulate growth is to focus on the efficiency of businesses supplying goods – and that means lower wages, less regulation and lower taxes. Everything I’ve presented in this section of the blog is demonstrating the critical role of demand in stimulating the economy. If the economy is structured such that everyone has an income, this creates demand for goods and services that stimulates production and investment. It’s a virtuous circle – the production of goods provides employment, which provides income, which sustains the demand for goods, which enables the production of goods…
This is all summarised in this post, which serves as a summary of the whole section. Then just 3 days after posting it I came across a paper from a mainstream economist (a former Bank of England economist) providing empirical evidence for these conclusions, so added an extra post summarising this.
And what this all adds up to is that it is in everyone’s interest to ensure a more even distribution of wealth, even the richest in society, because the economy as a whole will become more productive and more stable. I complement this point by looking at the work of Richard Wilkinson and Kate Pickett in their seminal book The Spirit Level. This is an analysis of hundreds of scientific studies conducted over decades, studying the correlation of the distribution of wealth with a comprehensive range of social problems, such as poor health, educational performance and crime. Across the board, the results always demonstrate that countries with the greatest wealth inequality have the worst levels of such problems. This is even true of the richest in these societies.
The wealthiest people in countries like the USA and UK will have much worse outcomes across all these areas of wellbeing than the wealthiest in countries like Japan and Denmark. And this even though the wealthiest in the USA and UK will be richer in monetary terms, because these countries are richer. Greater equality really does make everyone better off.
So having completed this discussion on the importance of the distribution of wealth on the progress of the economy, I then consider these ideas in light of the 7 ideas for change I had presented at the end of the section on ‘Financial Markets’. However, I don’t draw this together into some kind of “programme”. The purpose is merely to highlight what conclusions are emerging from the detail on the blog, not produce some pointless “armchair manifesto”.
But one thing that must stand out just from this Overview page, never mind the detailed posts themselves, is the extent to which the conclusions fly in the face of mainstream economics. Even if someone’s knowledge of economics is limited to what they’ve learnt from the news or conversations in the pub, everything on this blog must sound just plain wrong. Not least among this is the role for state intervention that keeps coming up.
Yet everything on this blog builds up from empirically observable facts and logical argument. If it sounds wrong to you, then point out the factual or logical flaws. What everyone thinks they know about economics is so divorced from reality that it could be likened to the myths that primitive societies believed to explain the world around them.
So the final section of the blog is going to examine the origin of these myths. This time the empirical facts will not be about the economic world around us today, they will be facts of history. It will look at how the most materially developed nations in the world achieved their economic growth, and how they maintained their dominant position in the world. And we will look at what we can learn from this about how we can actually change it – how do we practically go about building an economy that provides enough for everyone.