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Tuesday, January 25, 2011 1:41 PM


Exponential Credit Petri Dish; Steve Keen Responds to "World Economic Forum Endorses Fraud" Post


In response to World Economic Forum Endorses Fraud; Steve Keen Mocks the WEF Report, So Do I; The Purported "Need to Double Credit in 10 Years" I received a nice email from Steve Keen.

Hi Mish,

One key thing better in your critique than mine was that you focused on the naivety of neoclassical thinkers (it certainly wasn't any other type that put that together) when it comes to compound growth.

I was once sent a link to the work of a very good mathematician who claimed that humanity's greatest weakness was its inability to comprehend the exponential function.

Here is the link: Albert Bartlett on Sustainability
Bartlett has made two notable statements relating to sustainability:

"The greatest shortcoming of the human race is our inability to understand the exponential function."

and his Great Challenge:

"Can you think of any problem in any area of human endeavor on any scale, from microscopic to global, whose long-term solution is in any demonstrable way aided, assisted, or advanced by further increases in population, locally, nationally, or globally?"
It could be argued that neoclassical economics institutionalizes this failing, by using static analysis to consider what is really an exponentially growing system. It therefore doesn't see the problem with "small divergences" like credit growing 2% faster than GDP for a decade or so, when that means that every 36 years, two numbers that should stay within reach of each other diverge by a factor of two.

At some stage, those two factors will have to come crashing back towards each other, and that's what in our case has given us a financial crisis (it can also give you a population crisis, a resources crisis, etc., depending on the factors you're looking at of course!).

Moreover, you're spot on when you comment that it's not availability of credit that is the problem for the poor, but the lack of property rights, and I like your way of putting it too:

"It's easy to figure this out if you think in reverse. What do countries have in common where credit is generally available?"

Here's your answer.


• property rights
• rule of law
• civil rights

Fix problems in those areas and credit will likely be available.


I'd like to use that as a way of getting into the FRB thing. Seen from one perspective, FRB is the fraud: take in $10 in deposits, lend out 90% of them, and after a number of loans and re-deposits, you end up having $10 in cash backing $100 of money. Ipso facto, FRB is a fraud.

But what is going on is, I think, a very different process: double entry book-keeping. A bank makes a loan of $100 by double entry bookkeeping, having (I'm assuming for the sake of the argument) NO reserves to back its loan. The money circulates in the economy and a fraction is repaid. Over time, the bank ends up with 90% of its assets in loans and 10% in repayments. The appearance is exactly the same: $10 in "cash" backing $100 of money circulating in the economy.

I argue that this is the process that lay behind the Free Banking period in the 19th century, and to get past some confusions in non-neoclassical economics, that's the system I modeled in this technical paper on how money is created and monetary profits made in a sustainable capitalist system with credit finance: Steve Keen - Solving the Paradox of Monetary Profits

In some ways Fractional Reserve Lending might be viewed as an essential step in the development of capitalism. However, when applied to banking, it enables the creation of credit money and the crises we have seen emanate from it because the temptation to fund Ponzi Schemes that was is almost irresistible.

Bear in mind that this problem existed when the Fed wasn't backing private credit creation with its bailouts. What I see as dangerous in the current system is that the Fed's interventions have enabled a process that would have ended with a minor crisis in 1987 without its backing to continue for another 2 decades and lead to a far bigger crisis--the 2-4% rate of growth thing compounded over 25 years.

Attempts to tame this process using gold backing in effect try to make money a commodity when it's not one, but a creature of double entry book keeping. The problem is that the only way to guarantee this is to insist that gold is used in every transaction--literally. As soon as you allow certificates (or electronic database exchanges) to be used, even if they are ostensibly backed by gold, you allow double entry book keeping to work its magic once more and you're back in a credit system.

Interestingly, the section of my blog you took as a veiled critique of FRB is actually a critique of a system in which non-banks can't create money, but can create debt. When a non-bank lends, it debits its account at a bank and credits a borrower's account in its own institution. There is then no creation of money, but an additional debt to a non-bank is added to the debt created by the bank loan to create the non-bank in the first place.

There is a reform proposal out there to apply the same system to banks themselves, so that they can only lend out what they have in accounts with another institution: the Federal Government. Fundamentally, this proposal sees double-entry bookkeeping as the root problem, not FRB which it regards as a fiction, as I do--a case of seeing "SunRise" when in fact what is happening is "EarthRotate". So in effect it proposes banning double entry bookkeeping for banks to end their capacity to create money and hand that over to the government instead.

I know this is ideologically the opposing position to you, but in a fundamental way I think they're in agreement with you about the problems of the current system, and accurate about the mechanism by which money is created (as you are--I know you understand that the Money Multiplier is a myth of course!), but they reject the concept of money backed by a commodity like gold. Their alternative is to hand over money creation to the government--not your alternative! But their vision about the need to stop the banks exploiting and debasing double entry bookkeeping is the same.

The group is the American Monetary Institute.

The chief guy behind them, Stephen Zarlanga, is an intelligent guy who has written a very detailed treatise on money "The Lost Science of Money", which argues that money has always been effectively credit, backed by the State's capacity to enforce contracts in money and acceptance of money as payment of taxes.

The difference that I see between your proposals and theirs thus boils down to whether credit money should be backed by a commodity (gold) or government money creation. I see problems with both proposals--which is why I am more directed at removing the capacity of banks to fund Ponzi schemes than at effectively abolishing double entry bookkeeping as applied to banking.

We should have a serious get together on this front at some stage: email is good but no substitute to a detailed working over of a topic like this over a few days face to face. I am flat out writing two books right now--a second edition of Debunking Economics, which I hope to complete by mid-February, and then a huge project to write up my overall economic analysis in "Finance and Economic Breakdown" for Edward Elgar Publishers.

I also have a large survey paper to write for a neoclassical journal on non-neoclassical approaches to economics!--but when I'm next in the States (god knows when--sometime this year for sure) I'll try to set aside a few days to spend with you.

Cheers, Steve
Sustainability of Exponentially Growing Systems

Steve Keen has still more on the sustainability of exponentially growing systems in an new post Mish Mashes the WEF.
My comrade-in-outrage Mish Shedlock has also taken a swipe at the World Economic Forum report More Credit with Fewer Crises, and pointed out a key weakness that I omitted reference to: their inability to understand exponential growth.

Mish attacks the report on many fronts, but the one that I’ll highlight here is [the WEF's statement]:

This means that the world’s stock of credit outpaced GDP growth by less than 2 percentage points a year – not a wide margin. In theory, there is nothing unsustainable about this picture: as long as credit grows broadly in line with economic growth, the credit is put to good use and borrowers can meet interest obligations and repay principal.

The American mathematician Andrew Bartlett claims that “The greatest shortcoming of the human race is our inability to understand the exponential function”, to which I’d add that that shortcoming almost defines neoclassical economics.

2 percent per annum doesn’t sound like a lot, but over 36 years that means the ratio doubles, over 72 it quadruples, over 144 it becomes 8 times what it was, and so on.

Mish provides some nice graphs to illustrate this process:



For the record, the actual rate of growth of the private US debt to GDP ratio was roughly 2.9% p.a. from 1945 till 2008. That means that the ratio doubled every 25 years, from 45% in 1945 to 90% in 1970, 180% in 1995, and if it had kept going, it would have been 360% in 2020.

Instead it fell over in 2008, and is now going backward at a rate of knots. Here’s an extrapolation of the trend that the WEF says is “nothing unsustainable about”, from the time period they should have started their analysis—not 2000 but 1945—and focusing on the key problem—private debt:



“Nothing unsustainable about” it, eh?

This naivety by neoclassical economists about growth and exponential processes in general is positively dangerous for the human race.
Exponential Credit Petri Dish

I view Steve Keen as one of the world's top economists. It is a pleasure and an honor to be in a position to exchange emails with him and get detailed answers back. As you can see, we agree on many critical things, but have differing opinions about other things.

This "sustainable" exponential credit growth theory of the WEF is much like the exponential growth of bacteria in a Petri dish. Bacteria keep expanding rapidly until the culture takes over the whole Petri dish and the system collapses.

In the case of credit, the lower the rate of exponential credit expansion, the longer the growth can last. However, to keep growth expanding at the target rates requires borrowers of decreasing marginal ability to pay back loans.

Eventually the pool of credit-worthy borrowers dries up just as the food in a Petri dish is consumed.

Think about the credit-expansion factors it took to get to this point starting from 1938.

Credit-Expansion Factors 1938 to Present

  • Destruction of the world's capacity in WWII
  • Baby boomer effect of increasing population after the war
  • Two wages earners replace one as women go to work in the late 60's, 70's, and 80's
  • The internet revolution fueled an amazing productivity advance
  • Greenspan stepped on the gas fueling the dot-com bubble
  • Greenspan stepped on the gas once again fueling the housing bubble in the wake of the dot-com crash
  • In a last gasp phase to keep the credit bubble alive, liar loans dominated

The WEF fails to see this is a gigantic Ponzi scheme. Indeed they purposely missed looking at those things via a piss poor starting date for their report, year 2000. Then they failed to consider the boomer bust, even though Japan provides a model.

"This naivety by neoclassical economists about growth and exponential processes in general is positively dangerous for the human race."

The above statement by Keen shows we both understand something about "sustainable credit" that a group of 50 economists, CEOs, and rating agency executives don't (or don't care to).

Interview Bias

Once again I point out that McKinsey interviewed all the people who benefited from the bubble.

CEOs, rating agency executives, central bankers, and regulators all were beneficiaries of the credit expansion. Of course they are going to agree on the need for more credit even if they cannot come up with a precise definition of "sustainable".

The result of this collective effort was a report extremely easy to systematically trash on numerous points (I listed 18). This is what happens when you purposely start with a bias then get someone like McKinsey to do a "study" with a predetermined outcome.

That report is a certifiable disgrace to McKinsey and every economist who remotely agrees with its conclusions.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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