Economists are supposed to monitor and analyze the economy, warn us if risks are getting out of hand, and advise us on how to make things runs more effectively — right?
Well, even though that’s what most people expect from economists, it’s not at all how they see their role, warns CFA and and behavioral economist Daniel Nevins.
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Economists, he cautions, are modelers. They pursue academic lines of thought in order to make their models more perfect. They live in a universe of equations and presumptions about equilibrium states and other chimerical mathematical perfections that don’t exist in real life.
In short, they are the wrong people to advise us, Nevins claims, as they have no clue how the imperfect world we live in actually works.
In his book Economics For Independent Thinkers, he argues that we need a new, more accurate and useful way of studying the economy:
However far you go back, you can find economists who had a more realistic approach to how humans actually behave, than the way that mainstreamers assume they behave in the models that the Fed uses to pick winners and losers.
You mentioned credit cycles, business environment, and behavioral economics. What I’ve done is to say, “Okay. We know that the modeling approach, the systems of equations approach doesn’t work. But instead of starting completely from scratch, what can we find in the economics literature that is maybe more realistic?”
And the interesting thing is that if you look at the work that was done, the state of the profession before the 1930s, before Keynesianism took hold, you can find a lot of work that was quite sensible.
I think where that points is towards this notion that when we think about economic volatility, there are really three things that we need to bring together:
One is the behavioral side. And we have to be realistic about the way that people really process information, the way that they truly make decisions.
The second has to do with the way businesses operate and all the challenges that businesses face to gain and retain profitability. That’s something that economists were intently focused on before Keynesianism and then it became kind of sidelined afterwards because all of these models assumed that businesses didn’t have any challenges.
If you pick apart the standard models that the Fed uses that are taught in PhD programs, they assume that business are always profitable, they always sell all of their output instantaneously, and they know exactly what their customers want, and businesses don’t struggle. So, that’s another thing we need to correct that you can find a lot of useful research if you know where to look (before Keynesianism and at the nontraditional schools that have continued in the older approaches).
And then the third thing is the credit side where mainstream economics is just so off-target, especially in their models that exclude any role for banks. Effectively, mainstream economists have made assumptions about the way money works and the way banks work that just flat do not match how they actually work in real life. That’s something that’s hugely critical to understanding economic volatility and understanding financial crises. But even regular business cycles have a lot to do with the ebbs and flows of bank lending. And banks just aren’t included in standard macroeconomic models(…)
Until you understand that the economic profession is really not doing anything like what I would say they should be doing—studying these things that go wrong, the recessions and depressions and crises—you might not realize that we shouldn’t really be relying on mainstream economists to tell us how policies should be crafted, to tell us what risks might be out there. We need a different approach.
Click the play button below to listen to Chris’ interview with Daniel Nevins (46m:19s).
Chris Martenson: Welcome, everyone, to this Peak Prosperity podcast. I am your host Chris Martenson, and it is February 20, 2018. Now, as you’re probably aware, one of the great flaws of classical economics is that it assumes that people are rational. Humans are not rational. We’re rationalizers. Big difference.
The other thing conventional economics gets wrong is, well, pretty much everything. It insists that giant, complex open systems, like a dynamic and growing economy, can be expressed in closed-form equations that literally were last improved in the 1700s before the second law of thermodynamics was even expressed and understood.
To talk with us today about mainstream economics, why it’s important to you, where it gets it wrong, and how it can be improved, is Daniel Nevins. He’s a CFA. He’s invested professionally for 30 years, including more than a decade at both J.P. Morgan and SEI investments. And he’s perhaps best known for his behavioral economics research which was included in the curriculum for the Chartered Financial Analyst Program and earned him recognition as one of the founders of goals-based investing.
He has an economics degree from the Wharton School of Business and a degree from the University of Pennsylvania’s Engineering School. Daniel, welcome to the program.
Daniel Nevins: Thank you, Chris. I really appreciate the invite. You guys do great work, and I’m glad to be a part of a podcast.
Chris Martenson: Oh, thank you. So, Daniel, when we say we’re going to be talking about economics, some people are tempted maybe to not even listen to this. Why is it important, today particularly, for the average person—heck, everybody—to understand economics and, more importantly maybe, the ways and methods of mainstream economics and where it’s taking them?
Daniel Nevins: That’s a great start, Chris. And it really leads into where I started my book, because you think about the way that mainstream economists approach the economy. You think about the kind of things that can happen in the economy that affect people, the bad things that happen, recessions, depressions, various types of crises, financial crises, fiscal crises. You would think that the economics profession would define themselves as a group of people that study those types of events. But if you then listen to actually how they define what they do, it’s actually very different than that.
There’s an economist some people may be familiar with up at Harvard named Dani Rodrik. He’s a trade economist. He wrote a book two years ago, I believe, called Economic Rules. It was intended to be a guideline for how economists could conduct their work and how they define themselves. And if you pick up that book and read through it, you’ll see all the way through it, he defines the role of an economist as being, to manage a collection of models.
That’s what he says economics is, and that’s really what the profession says economics is. And it’s not just a collection of models; it’s a collection of what we could call equilibrium models. Mathematical models, all of these models start with a system of equations, a system of mathematical equations and the presumption that you can describe the economy as a system that’s always converging towards this notion of a perfect equilibrium, something where the economy is always at full employment and everything is hunky-dory.
But, in fact, we know that the economy is far from perfect. And until you understand that the economic profession is really not doing anything like what I would say they should be doing—studying these things that go wrong, the recessions and depressions and crises—you might not realize that we shouldn’t really be relying on mainstream economists to tell us how policies should be crafted, to tell us what risks might be out there. We need a different approach. That’s really the premise behind the book that I’ve written, is that there is a better way to think about the economy that doesn’t begin with, “My job as an economist is to sketch out systems of mathematical equations and solve them.” There is a way of thinking about the economy that actually looks at the real things that can happen, the real things that can go wrong, and the risks that we should be watching.
Chris Martenson: Now, there’s a couple ways I want to approach this, because this is important. I mean, this is why I think the average person needs to understand this, is that the economists are really making very, very large decisions about where things are going to go. And in some cases—my view, Daniel—they’re kind of binary; either they get it right or they get it wrong. If they get it wrong, it could be spectacularly wrong, such as with the giant quantitative easing programs which are as much a monetary experiment as a sociological experiment, being conducted by people who are running these crazy closed-form economic models.
And a book that really caught me was called The Origin of Wealth by Eric Beinhocker. And in there, he’s talking about economics. He’s talking about how at a Santa Fe Institute meeting where they had physicists, all Nobel Prize winners or heavy-duty prize winners from all the big, heavy industries out there—physics, chemistry, economics, all that. All the hard scientists were shocked to discover that the economists were still running these closed-form equations, like you said, that seek to describe the world as if it has an equilibrium point.
“If we just do a couple—tweak a couple things, you know what’s going to happen? Well, we’re going to hit this thing called an equilibrium point.” But no such thing actually exists. Yet the way you start your book, chapter one, is with a quote that says, “There’s no one left in economics to argue that the emperor has no clothes.” And then still quoting, “Economist David Colander, writing about his surveys of economics graduate students, in response to a question about what would put them on the fast track, only 33 percent of graduate students sited having a thorough knowledge of the economy. Whereas, 82 percent cited excellence in mathematics.”
Now, how is it that economic students today, Daniel, believe that excellence in mathematics is literally by far the most important tool for achieving the fast track?
Daniel Nevins: Well, I think of the economics profession as really a giant special interest group.
Chris Martenson: Yeah.
Daniel Nevins: Generally, special interest groups are typically good for themselves, and they tend to do things that aren’t necessarily good for the greater whole, the greater population. So, I think—just thinking about human nature, humans are self-interested beings. It’s not surprising, I don’t think, that the macro profession evolved the way that it did.
Essentially, the macro profession—And I gave a talk a couple months ago that I began with an excerpt from a biography of John Maynard Keynes. And most people credit John Maynard Keynes with having founded the discipline of macroeconomics with his book, The General Theory, published in 1936. And his predominant—his most prestigious biographer, who’s written about ten books on Keynes, said that when Keynes sat down to write his book, what he was really trying to do was to push a political agenda that he had already been pushing for about six, seven, eight years at that time, which was to get the British government to spend more money.
He was a big proponent of deficit spending. The British economy was not in good shape at that time. And his biographer pretty much laid it out that Keynes’ editorials and his efforts at lobbying politicians hadn’t been successful, so he developed this notion that, “Okay. I need to develop a new theory. And that theory will convince the whole economics profession that we should join this effort to take over the reins of the British economy.” And if you have a goal that ambitious, I think mathematics was the obvious tool with which to make that happen.
Now, Keynes himself didn’t lay out the models that eventually became Keynesianism. He likely—well, he did disagree with a lot of the work that was done before his death, and likely would have disagreed with a lot of the models that followed him. But given the origin of the profession, which was to develop—to fire up and develop a group of technicians and professionals who would tell the policymakers what to do, that kind of puts it into context as to why they revolved around or they rallied around equilibrium models as the way to do that.
Chris Martenson: Now, Daniel, you just described I think earlier, a very important feature of all this, which is that humans are self-interested creatures. Wasn’t it just a little bit too convenient that what Keynes was proposing would also allow politicians to sort of have the easy road? Which is, “Hey, we get to justify more spending in bad times. And of course, when times are good, nobody wants to reel anything in then either.” It really feels like that Keynes did, not to slight him. And I’m sure that he would, as you’ve just sort of indicated, would think that a lot of his core ideas had been, let’s say, distorted over time, if perhaps not misused entirely.
But still, it seemed like a hand-in-glove kind of arrangement where economists were providing the exact sort of feedback information that politicians wanted, which was, “You get to spend, and spend more,” which is politically, usually a very popular decision. Is that a fair way to sort of characterize it, that Keynes hit on a better sort of model of self-interest, at least in part?
Daniel Nevins: Absolutely. And I’ve—that’s probably my biggest pet peeve about the economics profession is that if you go back to before Keynes and look at, say, this country’s economic history, America’s history. The United States was—had a tremendous period of development through the 1800s and the early 1900s, emerging as a global power, largely with the backing of an attitude about governance and an attitude about fiscal policy and government spending that held that you needed to be responsible.
And the economics profession supported that. And you need that, because politicians are, of course, always going to be tempted to take the short-term decisions that aren’t so great in the long term. So, I think you need the economists to be the grown-ups in the room. And with Keynesianism, that whole equation just got turned upside down.
And the economists began to egg the politicians on. And they held them off at first. Dwight Eisenhower was in the old-school mode of being fiscally responsible as Keynesianism was emerging in the 1940s and ‘50s. Well, first Truman and then Eisenhower held them at bay. But then once they grabbed the levers of power, to use a cliché, in the Kennedy administration, it’s been almost all deficits ever since.
Chris Martenson: Right. And so, you just described in a prior book then by Dani Rodrik that these economists are running a collection of models. But really what these collection of models have done has been sort of a make-work program and a—as you said, they’re a special interest group so they get to create the barriers to entry. If you can’t do elegant mathematics, don’t apply.
But, Daniel, there have been a few market shocks over these past couple weeks, kind of minor in the larger sweep of things. But, in fact, the entire history of the Fed, really I think accelerating under Greenspan and continued since, seems to be a long, drawn-out series of ever larger and more dangerous system shocks, financial shocks. It’s safe to say that from public records, the Fed never saw any of this coming. Are you arguing that the collection of models they’re running are not just wrong, but perhaps dangerously wrong?
Daniel Nevins: I think so. I think that any—I would say that any reasonable assessment of what happened in the housing boom and bust would hold the Fed partially accountable for it. Of course, the Fed denies it. You know, they’ve got a huge apparatus that’s in place to create narratives that suggest that, “No, no, no, it had nothing to do with our policies.”
There was a paper that the Boston Fed put out a few years back that I critiqued that basically said there was absolutely nothing we could do because it was a bubble. And the study of bubbles is too young for anyone—any honest economist to claim that the Fed should have done anything to understand what was happening in the housing sector. And any honest economist would have admitted that this was entirely out of our control.
Now, of course, the occurrence of bubbles and the study of bubbles really isn’t that young. There’s plenty of economists who’ve—there’s Kindleberger’s famous work in the 1970s on Manias, Panics, and Crashes. There’s—Robert Shiller wrote a book that was all about bubbles. It was a bestseller in I think ’99, Irrational Exuberance. So, the behavioral theorists have been studying the behaviors that give rise to the bubbles and that lead to volatility in the financial markets for a long time.
But the Fed has stuck to this really, I would say, implausible view that they did nothing wrong. But—and one of the things that I’ve tried to lay out in the books—it’s not the main focus of the book that I wrote. I tried to make it as nonpartisan as I can. And I’m focused more on how investors and businesspeople might evaluate economic risks in a way that would be better than mainstream economists evaluate them.
But I do touch on the dangerous path that fiscal policy has taken and some of the problems with monetary policy, which I would say certainly had a big role to play in recent bubbles and busts. And going forward, I think one of the biggest risks is going to be where monetary policy and fiscal policy come together. Because if you go back, the last time we had a Fed governor who actually paid a lot of attention to avoiding markets and the economy getting to exuberant on the upside, it would be Paul Volcker who crushed inflation in the early 1980s.
One of the things that’s not that well known about Volcker is he was working aggressively behind the scenes. And it’s known now because biographies have been written and so forth. But he was basically telling Congress all through the early ‘80s that they needed to fight the fiscal policy, fiscal policy was on a dangerous path, and if they didn’t, he would keep interest rates high.
He was not going to go along with a situation where the U.S. Government was running long-term risks on a both fiscal and monetary policy basis. Well, we don’t have that anymore. We don’t have central bankers who think about these long-term risks as much as I would say they should. They’re certainly not behinds the scenes telling congresspeople and people in the administration that they’d better not let the deficit get out of hand or they’re going to aggressively hike interest rates, at least not in the way that Volcker did.
And I think going forward, that’s one of the biggest risks is where monetary and fiscal policy intersect, because it’s the fact that the Fed has kept rates so low for so long that’s helped fuel some of the complacency that we see in fiscal policy. I can’t remember who it was, but somebody a few years back—I think it might have been Kyle Bass said that whenever he talks to congresspeople about the dangerous path that we’re on in a fiscal policy basis, they’ll say, “Well, look at the ten-year bonds. It doesn’t matter, because rates are low.”
So, the Fed is abetting that. And I think going forward, that’s the risk that people aren’t aware of. I think most people generally understand that the Fed had a big part to play in the housing boom and bust. Going forward, I think it’s probably a fiscal crisis that they likely have their fingerprints on.
Chris Martenson: I would go further than that. I would agree with all that. And I’ve been a huge critic of the Fed ever since Greenspan came into power. And he’s called the maestro, but honestly, I think he mumbles incoherently. I don’t understand—I disagree with so much of his framework. His whole idea that derivatives had somehow off-loaded risk as if it had been shot into outer space never to be seen again was just stupid, easily disproven. I think both commonsensically but also through models.
And starting this piece before with this idea that the Boston Fed came out with this like really disingenuous piece of research saying, “Gosh, bubbles haven’t been studied enough. So, we can’t really—What can we say?” As you mentioned, bubbles are actually not that hard to understand. They’re very well characterized. They involve a collection of things. But two of the most important features are how humans behave—“Hey, guess what? We know that. We’ve been through enough of these. We get it.”—and credit.
If you don’t have ample credit, you can’t have a bubble. That’s a feature at least of every single bubble. We don’t have examples of bubbles that have sort of arisen without credit. And so, the Fed is of course the ultimate keeper of how much credit is in the system. So, really just, you know, when I hear somebody from the Fed trying to articulate that they didn’t have a role in this or they don’t understand it well enough, all that, I literally hear the sound of somebody lying out loud or somebody who’s not intelligent enough to hold the position they’re in. I don’t—that’s about as kind as I can be.
Daniel Nevins: And I think it comes back to, this is a special interest group. And anybody’s who’s worked in an organization understands the pressures that organizations, greater groups of people with common interests, the kind of pressures that brings to bear. And in the financial market, I know through years of working in investment firms, that you don’t survive investment firms doing things or making decisions that don’t support the short and the long-term profitability of those businesses.
And if you’re at the Fed, you don’t survive being at the Fed—There have been some interesting—some journalists have done some interesting investigations into that and compiled some really interesting quotes and inside views as to the real pressure that the Fed exerts on the whole economics profession. And how obsequious—how economists who are or aren’t on the Fed payroll—and what’s not really understood, I don’t think, as much as it probably should be, is how many economists are on the Fed’s payroll.
Because it’s not just the economists who work for them. It’s all the projects they farm out. There are so many economists who feel that the Fed is really the superior entity in their world and they really need to get in line with the Fed narrative.
I mean, that paper that we both referred to, the Boston Fed paper, the thing that really got me about that is they suggested that the Fed had not had any part in lending standards becoming too loose because lending standards didn’t get too loose. And they used a single chart to demonstrate that, which looked at one particular metric in Massachusetts. So, it’s the Boston Fed. Which happened to be one of the—And if you think about the house price index that Case-Shiller puts out—they’ve got 20 cities—Massachusetts didn’t really have much of a boom/bust.
So, if you’re going to study the housing crisis, you need to look at Vegas; you need to look at Phoenix; you need to look at California and Florida. To take a single metric that didn’t tell the whole picture—and it was pretty obvious that these were economists who were under great pressure to support a narrative. And they cherry-picked the data to support that narrative. It’s really, I think, how groups of people work, how organizations work.
Chris Martenson: It is. And I think that’s one of the key things that needs to be sort of demystified for people is the idea that the Fed is not this omnipotent organization of saints and gods and goddesses and all of that; that it’s an institution. It’s got the usual bureaucratic incentives and disincentives to be this way or that.
And so, what you were talking before is that the role of the Fed really is the keeper of the monetary policy. They ought to be the adults in the room. It’s not just that they take the punch bowl away when the party’s raging, but they really shouldn’t let the party get going. And they should be looking out for the long-term interests, which Paul Volcker did. Right? And since Paul Volcker, we’ve decided deficits don’t matter and debts don’t matter and all that.
But any study of history says, Yeah, no, they do. They catch up with you eventually, and when it comes, the more you’ve allowed those excesses and deformations to exist, the harder the adjustment, if not the more damaging, if not disruptive, if not actually destructive to the overall basis of the country.
And this is the thing that drives me nuts about the Fed, as sort of the keepers of the economics profession. So, I’ll sort of focus on them for a second, Daniel, is this, is that they pick winners and losers. That’s what they do. They don’t create wealth. They don’t create the conditions for wealth. They pick winners and losers. They’ve decided that the uber-wealthy are going to become even wealthier. So, they have now the largest—one of the largest wealth gaps in history; also one of the largest income gaps, all of which can be tied to Fed policy.
They’ve also decided that the people who are going to pay for this are pensions and savers; absolute nightmares going on in that regard. In the issue of savers, they’ve taken an entire generation and said, Here’s a missing trillion dollars of savings interest income that you’re not going to have. The bank’s got that. We decided they needed that instead of you. And because you didn’t get it, now there’s an entire generation that doesn’t have that same trillion that will go into small and medium-sized enterprise formation, which is a typical flow of those funds from one generation to a younger generation who want to start businesses.
So, in your studies in looking at all of this, does that sort of view comport at all with what you came up with, and if so, should economics really be in the position of attempting to macro-engineer Soviet production quota style? Should they be picking the macro winners and losers and generational winners and losers?
Daniel Nevins: No, I don’t think they should. And I agree with everything you’ve said, Chris. I think there are some really interesting paradoxes. You mentioned the effect that low rates have on savers. Well, the Fed is basically a Keynesian institution because Keynesianism is the dominant theory in the economics profession and certainly the dominant approach at the Fed.
And one of the paradoxes there is that John Maynard Keynes was a big proponent of low interest rates. So, they’re true to his low interest rate biases. But John Maynard Keynes also devised his theory at a time when he liked low interest rates, because he thought that by lowering interest rates, you were helping the lower classes and giving the bill to the rentier class. So, he saw that as an egalitarian policy.
But fast-forward 70, 80 years, and that’s not true anymore. The class that’s most damaged by low interest rates is the class of retirees who are living on the income on their bond holdings. So, it’s just one of so many paradoxes that come into play when you think about how the Fed conducts its policies and picking winners and losers as you say.
Chris Martenson: Yeah. That has social consequences and ultimately political consequences. I don’t think people can really understand what’s happened with Brexit, with the Trump election, with what’s happening politically all across Europe, what’s probably going to continue to happen politically in the United States, with this fracturization and polarization. Much of that, to me, is just the stresses that accumulate when you have a big powerful institution picking winners and losers.
It’s deeply unfair. And we’re social beings. And so, that has to factor in. And what I like is that what you’re building towards in this book of yours, which is Economics for Independent Thinkers—People should get out there and find that. We’ll tell you at the end of this podcast how you can get there. But you’re building towards this alternative view of what we really—more comprehensive view of what economics needs to include, which is three big pieces.
A credit cycle; and the challenges and threats and opportunities that exist in the business environment is the second piece; and then the third big piece, which is behaviors and incentives. So, you have a background in behavioral economics. To me, that—I’ve interviewed and we’ve done some work with Elliot. We’re big believers in, that you should just study how people actually behave, not how you think they should.
And that seems to be a really important cornerstone of this particular story. It’s, A, is it fair to say that mainstream economics still hasn’t got its collective modeling behaviors around what humans actually are? And secondarily, in your experience, what is it that—what is the state of behavioral economics? Is it ready for primetime? Do we know enough to begin to wrap that part of this experience set into our decision-making?
Daniel Nevins: Sure. Those are both really good questions. I think we have to be careful about saying that behavioral economics necessarily leads to an answer in terms of, “Here’s the research I’ve done in behavioral economics. And here’s the policy that it produces.” But I think what’s clear—and really not just—not only from all the research that’s accumulated in that field over the last 40 years, but also from those before the research studies and the last studies that were being conducted, those economists who didn’t join the Keynesian tribe or the monetarist tribe and who recognized the role of behavior.
So, however far you go back, you can find economists who had a more realistic approach to how humans actually behave, than the way that mainstreamers assume they behave in the models that they use to pick winners and losers, as you say.
So, the way that I structured my book—You mentioned the credit cycles, business environment, and behavioral economics. What I’ve done is to say, “Okay. We know that the modeling approach, the systems of equations approach doesn’t work. But instead of starting completely from scratch, what can we find in the economics literature that is maybe more realistic?” And the interesting thing is that if you look at the work that was done, the state of the profession before the 1930s, before Keynesianism took hold, you can find a lot of work that was quite sensible.
And I think where that points is towards this notion that when we think about economic volatility, there are really three things that we need to bring together. One is the behavioral side. And we have to be realistic about the way that people really process information, the way that they truly make decisions. The second has to do with the way businesses operate and all the challenges that businesses face to gain and retain profitability. That’s something that economists were intently focused on before Keynesianism and then it became kind of a sidelight afterwards because all of these models assumed that businesses didn’t have any challenge.
If you pick apart the standard models that the Fed uses that are taught in PhD programs, they assume that business are always profitable, they always sell all of their output instantaneously, and they know exactly what their customers want, and businesses don’t struggle. So, that’s another thing we need to correct that you can find a lot of useful research if you know where to look. If you look before Keynesianism and if you look at some of the nontraditional schools that have continued that older tradition.
And then the third thing is the credit side where mainstream economics is just so off-target in their models that exclude any role for banks. Effectively, mainstream economists have made assumptions about the way money works and the way banks work that just flat do not match how they actually work in real life. And that’s something that’s hugely critical to understanding economic volatility, understanding certainly financial crises. But even regular business cycles have a lot to do with the ebbs and flows of bank lending. And banks just aren’t included in standard macroeconomic models.
Chris Martenson: Daniel, that’s really one of the things that drives me more than a little nuts, because it seems so devoid of just common sense, is this idea that mainstream economics does ignore the role of credit of banking. Steve Keen and other non-mainstream economists make excellent cases for why debt and credit cycles are not only important but perhaps the most important central feature of understanding and predicting the economy, financial shocks, output growth, all the rest.
This is why it drives me a little nuts. It seems so blinkingly obvious that credit growth is absolutely critical to everything that happens in our economy, including bubbles if you go too far on this end, the whole nine yards. And yet it really seems very marginalized to the point that I’ve never heard anybody from the Fed really talk about what fiscal deficits and long-term debt accumulation might really mean or that we might have too much credit in the system or what it means that student debt is—They just ignore it all.
So, let’s really talk about this, because I think this is one of the most important features for people to understand. We follow something at Peak Prosperity called the credit impulse, which is not just how much credit, but on a percentage basis, how fast is it growing. Because it turns out it’s really predictive of where things are going to go.
Let’s start here with this, because it’s a big topic. How is it that mainstream economics has managed to overlook this feature so comprehensively?
Daniel Nevins: That’s a great question. And I think all the evidence, Chris, points toward mainstream economists going back to about—And I actually cover the history of some of this in my book, going back to the latter half of the 19th century, I don’t think economists really understood what really happens when a bank makes a loan.
They don’t seem to have understood that what a bank charter does, a commercial bank charter, is it gives a commercial bank the right to deliver the proceeds of a loan by creating a deposit for the borrower. And that’s a hugely significant economic thing, because what it means is that banks, commercial banks can inject purchasing power directly into the economy without requiring any prior saving or any prior income.
So, a bank loan is different than what would take place if, say, Chris, you were to loan me a million dollars. Right? If you were to loan me a million dollars, you’re sacrificing a million dollars of your own purchasing power, and I’m gaining a million dollars of purchasing power. And the net effect is zero.
A bank loan is very different, because what the bank charter does is it says that commercial banks can create that money. But that’s something that economists seems to have struggled with. And some of the interesting things you can read—One of the old-time economists who was really strong on this is Joseph Schumpeter who did a lot of work in the ‘20s, ‘30s, and ‘40s. And he really studied that question quite closely and pointed out, showed that back in the 18th century and the early 19th century, economists actually understood banking.
At that time, you didn’t have full-time professional economists. A lot of the people who were writing about economic events had other professions. They were bankers; they were businesspeople. And they understood banking. But then what happened is that professional economists emerged. I picture it as an economist sitting in an office and needing to write a text book and not really having the practical experience, the real-life experience to know how an actual loan works, so they make something up.
And where they converge towards with this notion that, well, a bank loan is no different from any other loan, the bank just transfers the purchasing power between Chris and Dan and it’s really no different, and that notion kind of went back and forth. There were quite a few economists over the years who understood how wrong that was. Schumpeter understood how wrong that was, and he recounts how they were fixing it in the 1920s until John Maynard Keynes wrote his book.
And then as soon as the Keynesians came along, they went back to the wrong way of thinking about banks. And you mentioned Steve Keen. It’s interesting, because he had an interesting blog, a little kerfuffle back in 2012 that got a lot of attention, where he explained to Paul Krugman that Krugman’s ideas about banking were wrong. That no, actually, banks don’t need to have the money on hand before they make a loan.
And Krugman said, “Yes, they do.” And then two years after that, the Bank of England, clearly having been influenced by that blog kerfuffle and perhaps a few others, came out with a report and said basically, “The textbooks have it wrong. The textbooks have money and banking wrong. They’ve got this notion of a money multiplier, all these concepts you hear about from mainstream monetary economics. They have all of that wrong.”
Chris Martenson: Thanks for putting that in context because I was going to bring that up. That was such—that was so humorous. 2014, the Bank of England puts out a research paper, it’s like, wow, hey, here’s how money’s created in the banking system. Who knew? Right?
Daniel Nevins: Yeah.
Chris Martenson: It’s like, well, people have known that since the ‘30s and ‘40s, and I included it in the crash course. It’s not—I’ve been challenged by economists who said I have the whole idea of money creation exactly wrong. And it’s just—it’s completely provably obvious how it’s done. And all you have to do is understand the system.
And so, we get back to that original quote you had, which was like only 33 percent of students said having a thorough knowledge of the economy would be important to them to get on the fast track. But I would include in that not just the economy, but banking. If you don’t understand the system you’re modeling, good luck with your models. Right?
Daniel Nevins: Yes. Exactly. And really, the choice the economists face is basically you have to buy into these false assumptions if you want to be a mainstream economist. That’s your choice. You can either join one of these heterodox schools. You can follow the Keynes and the—Most people call him a post-Keynesian, which is a field of study that’s not considered in the mainstream.
Or you can look at Austrian economics. The Austrian business cycle theory’s built upon real-life views of how banks actually operate. And economists really have that choice. They can read the textbooks and say, “Okay. It’s in my best interest to just commit this to memory and not question it, and continue to research in that tradition.”
Or they can say, “Well, I know it’s in my best interest not to question it, but it really doesn’t sound right. So, maybe I should read what Hyman Minsky had to say or what Ludwig von Mises or Steve Keen had to say.” And then you’re kind of changing your whole path and shutting yourself off from most of your profession.
Chris Martenson: Well, Daniel, one of my chief criticisms—and this extends across a variety of other economic disciplines as well—is this idea that to the extent they support the idea that you can have infinite growth and a finite plan, that I think they’re flawed in that long-term macro, grown-up adult sort of way, that at some point you would have to have the economics profession understand and wrap into this the biophysical side of things which is, Well, we’re still organisms. Energy flows matter. Resources are actually not just an assumable input, that, in fact, we have all the data that says that all the key resources we depend on are getting more dilute, more distant, more, you know, deeper in all of that, just more expensive if we want to quantify it economically.
But really this idea that we’re going to be just growing, growing, growing forever, to the extent any economics profession has that assumption of growth baked into it, automatically causes me to question it. Did you get into that level in this book talking—looking at really the big sweep of economics?
Daniel Nevins: You did a great job on that in the crash course, Chris.
Chris Martenson: Thank you. Thank you.
Daniel Nevins: I didn’t talk as much about very, very long-term growth. I was focused more on the risks of recessions, depressions, and crises; and proposing methods that are different to mainstream economics as to how me might think about and go about evaluating the risks of recessions, depressions, and crises. But I also included, because I think it’s—you just can’t—the elephant in the room today is government debt, the federal level in particular.
But states and municipalities are very likely to incur a lot more crises before the U.S. Government has to restructure its debt. So, really across the board fiscal policies and the public debt trajectory suggest that—I can’t tell you what the horizon is. I don’t know if it’s 20 years, 30 years, 40 years, but there’s going to be some serious payback for all of the fiscal stimulus we’ve been pumping into the economy for the last 40, 50, 60 years.
And that’s—as far as long-term views, I did discuss that quite a bit and contributed my little pieces of research. That’s—it’s a very difficult question, I think, in terms of how that plays out, because it will depend on how policies evolve between now and the ultimate, what I would say is a Ponzi point, a point at which investors are no longer willing to hold government debt at low interest rates.
So, I contributed a few of the research studies that I’ve done that are looking at, for example, historical instances of countries that ran similar debt levels to where America is today is one of the pieces. And then another piece is the work that I’ve done re-projecting the debt, starting with a base of how the Congressional Budget Office sees debt progressing and then correcting for all of the restrictions that they face as to the assumptions they need to feed into their projections.
Those are really rigged projections. They have to make extremely optimistic assumptions about how legislation evolves going forward. And by choice, I think they make overly optimistic assumptions about economic growth, which I think is an area that gets to what you’ve just discussed, Chris, as far as the notion, the assumption that you do get this perpetual growth of two, three percent that I think is unrealistic and—especially in that they make very, very meager allowances for any kind of growth setbacks.
Chris Martenson: Meager. I think it’s zero. I’ve seen those CBO projections, 3.5 percent economic growth forever, which, by the way, by the year 2050 or ’60—I forget. I don’t have the chart in my brain here, so this is from memory. They say that the United States economy is as large as the current world economy, which implies that the United States economy alone is consuming a hundred percent of everything that the world is currently consuming.
That’s clearly—just give me one minute with those CBO economists. We’ll have a quick discussion, and I’m pretty sure they will agree that’s probably a nonstarter. So, it’s just all these unrealistic assumptions. But what we’re really talking about, you’ve got—this is a great book.
We’ve been talking with Daniel Nevins, the author of Economics for Independent Thinkers. It includes a lot of wonderful historical background. And, by the way, it’s not that the economics profession is struggling towards figuring something out; it’s already forgotten more than it knows at this point in time. And so, if you want to understand the economy and where’s it’s going and how we might think about it or rethink it and why it’s so important, I would highly recommend that you check out this book.
And, of course, it’s for our tribe especially because it’s for independent thinkers. Daniel, thank you so much for your time today. And please tell people about where to find your book and your website, please.
Daniel Nevins: Sure. I have a website called NevinsResearch.com that describes the book in some detail and actually gives some sample chapters you can have a look at. And the book is for sale either on that website or on Amazon. Economics for Independent Thinkers. So, those are the websites. And, Chris, big thanks to you. I really appreciate the opportunity. Again, I think you guys do great work and really happy to have the chance to talk to you.
Chris Martenson: All right. Well, Daniel, thank you so much for your time today. And I appreciate the work you’re doing.
Daniel Nevins: Great. Thanks, Chris.
Article by Adam Taggart, Peak Prosperity