Review and Summary of Quantum Economics by David Orrell

What is a price??? People use them every day, but they seldom think about what it is. It is, of course, a measurement. But a measurement of what? It is a measurement of value. But this just leads us to another question—what determines the value?

For a long time, the answer was thought to be the amount of labor, perhaps combined with materials. As Adam Smith put it, “The real price of every thing, what every thing costs to the man who wants to acquire it, is the toil and trouble of acquiring it.” (p. 101) Most classical economists followed suit. But it turned out that labor was not so easy to measure:

…unlike something like mass, labour isn’t easily measurable. For example, Smith equated the cost of gold with the labour required to extract it – but how did that square with the fact that most of the gold in circulation had been mined by slaves? for more sophisticated goods – say, an iPhone – it is even less clear how to add up the various sources of labour. Obviously there are the company’s employees, its suppliers, and so on, but where do you draw the line? Many of its technologies (such as internet capability, GPS, touchscreens, cryptography) were based on government-funded military technologies, so how do you factor that in? What about the basic science behind those technologies? What about the free websites such as Wikipedia, or open-source software, or digital information in general, which add value to the iPhone? And so on.

Labour is also subjective in other ways. How do you compare the labour value provided by a CEO who has just received a multi-million-dollar payoff in return for leaving a money-losing company (there is no shortage of examples) with the hard graft provided by an undocumented farm worker, or for that matter someone assembling iPhones?…Because labour is not directly measurable, one consequence is that the theory as a whole, including the invisible hand mechanism, is unfalsifiable in the sense that it can never be disproved by experiment. A broader point is that…there is no direct mapping between numbers and value…pp. 102-103

And so economists invented the concept of utility—how much use value someone derives from an item.

The concept of utility was first proposed in the late eighteenth century by Jeremy Bentham, the English philosopher and social reformer, who defined it as that which appears to ‘augment or diminish the happiness of the party whose interest is in question.’ Society’s purpose, Bentham argued, was to satisfy the ‘greatest happiness principle’ – i.e. provide the greatest happiness to the most people. The goodness of an action could be assessed by adding together its positive and negative effects on the people involved.

Bentham’s aim was to put social policy on a rational, enlightened basis. Neoclassical economics promised a way to do this, by expressing utility in terms of mathematical laws. Of course, utility was completely subjective, and even harder to measure than labour – but again that didn’t matter. The aim of utility theory was not to incorporate subjectivity; it was to replace it with numbers, which is not quite the same thing. p. 104

But even this did not explain everything. This was exemplified by the diamond/water paradox proposed by Adam Smith. Water is not only useful, but essential–we need it every single day or we will die. And yet it is relatively cheap, even free. Diamonds are utterly useless (except for things like industrial drills). Yet they sell for a fortune in jewelry stores.

We know prices to be connected to value, but how does it work? Why are the cookies made by your grandmother free, but the ones in the store cost money? Or put another way: if money is measuring something, what is it measuring?

So, exasperated economists threw up their hands and finally settled on the theory of marginal utility and called it a day. Marginal utility brings in the concept of the margin—a small increase in the quantity of something. The marginal utility of a the first slice of pizza is quite different from the tenth slice (the tenth slice being at the margin). If we just crawled out of a desert we would pay almost anything for a tall glass of water (assuming we had the misfortune to crawl into a libertarian compound), but probably nothing for a diamond ring at that moment. As Britannica summarizes, “[W]ater in total is much more valuable than diamonds in total because the first few units of water are necessary for life itself. But, because water is plentiful and diamonds are scarce, the marginal value of a pound of diamonds exceeds the marginal value of a pound of water.”

One of the founders of what was termed the “marginal revolution” was William Stanley Jevons (of Jevons’ Paradox fame).

As Jevons argued, if utility is equated with value, then it can be measured through price. He wrote: ‘I hesitate to say that men will ever have the means of measuring directly the feelings of the human heart. A unit of pleasure or of pain is difficult even to conceive; but it is the amount of these feelings which is continually prompting us to buying and selling, borrowing and lending, labouring and resting, producing and consuming; and it is from the quantitative effects of the feelings that we must estimate their comparative amounts. We can no more know nor measure gravity its own nature than we can measure a feeling; but, just as we measure gravity by its effects in the motion of a pendulum, so we may estimate the equality or inequality of feelings by the decisions of the human mind. The will is our pendulum, and its oscillations are minutely registered in the price lists of the markets.’

The economy could therefore be modeled using what Jevons called ‘a mechanics of utility and self-interest,’ similar to Newtonian mechanics. More precisely, exchange prices were determined by marginal utility, which took into account a person’s current state – you will pay less for a loaf of bread if you already have as much as you can eat. When the transaction is complete, both parties ‘rest in satisfaction and equilibrium, and the degrees of utility have come to their level, as it were.’…Today, economists often prefer to work instead with preferences, which simply rank things or desires in order, but utility is still seen as a mysterious, unmeasurable, subjective quantity which individuals aim to maximise (a word invented by Bentham) through economic exchange, subject only to budgetary constraints. Perhaps the most famous description of this process is supplied by what Jevons called ‘the ordinary laws of supply and demand.’pp. 104-105

The law (or laws, as it is sometimes called to distinguish the two components) of supply and demand is…a graphical representation of [Adam] Smith’s invisible hand. If the price of some commodity is too high for whatever reason, then more suppliers will enter the market, while at the same time demand will fall. The result will be a surplus of supply, which will bring the price down. Conversely, if prices are too low then the combined response of and demand will push them back up again.

In fact, the only real difference is that utility has been substituted for labour as the presumed source of value. Since neither can be measured directly – only inferred from prices – this has no effect on the equations. Money has no role, other than as a book-keeping device for things like prices or budgetary constraints, so has dropped out of the calculations altogether, with any increase in budget leading only to increased consumption,” Genuine subjectivity has also been removed; individuals are treated as a black box, in the sense that the reasons for their motivations are left alone, but at the same time their actions are reduced to the maximisation of an equation. p. 106

This, then, represents the mathematical foundations underpinning modern economic “science” (hence my oft-used scare quotes). It is (still) based on Newtonian classical physics. It assumes people are “particles”: highly rational actors constantly attempting to maximize their ‘utility’ (an invented phantom quantity). It argues that prices are fixed entities that are “naturally” headed towards equilibrium (a magic number where supply = demand), assuming no “interference,” of course. And it assumes money is just a neutral medium of exchange with no effects on the underlying economy.

To make people as regular and predictable as elementary particles in physics, economists invented the concept of Homo economicus—rational economic man. Rational economic man makes rational decisions based on perfect knowledge according to his or her utility—utility being defined as above. Rational economic man is also purely selfish, looking out for only his own satisfaction and no one else’s. The rational economic man consistently asks only one question: “What’s in it for me?”:

When neoclassical economics was first developed in the late nineteenth century, the idea was to literally translate concepts from Newtonian physics into economics, to produce what the French philosopher – and founder of sociology – Auguste Comte had called a social physics: A property of Newtonian dynamics is that it can be expressed mathematically as a kind of optimisation problem: objects moving in a field take the path of least action, where action represents a form of energy expenditure.

For example, the diffraction of light through a glass prism can be viewed as light waves (or individual photons) taking the most efficient path. Newton’s contemporary, Gottfried Wilhelm Leibniz, explained the idea by comparing God to an architect who ‘utilizes his location and the funds destined for the building in the most advantageous manner.’ Following the same script, neoclassical economists assumed that in the economy, individuals act to optimise their own utility by spending their limited resources. Economists could then make Newtonian calculations about how prices would be set in a market economy, to arrive at what William Stanley Jevons called a ‘mechanics of self-interest and utility’. p. 176

The equating of mechanics with economics was illustrated in the 1892 book Mathematical Investigations in the Theory of Value and Prices by Irving Fisher, which was based on his Yale thesis (he was awarded that university’s first PhD in economics)…Economic agents were viewed as particles, while the marginal utility or disutility for a particular commodity (defined as the satisfaction gained from consuming one more unit of it) was viewed as a force acting in a kind of commodity space...

But the idea of people acting rationally has been substantially undermined by modern psychology. People are hardly rational. They are full of various ‘cognitive biases’ and errors. They use rules of thumb and simplification. They do not have perfect knowledge or judgement. They are often highly irrational. They are sometimes selfish, and sometimes altruistic. They are social animals, and therefore vulnerable to social pressures and herd behavior. While there is a branch of economics that theoretically studies this (behavioral economics), none of its conclusions have been incorporated into fundamental economic concepts or models.

Now, if physicists’ fundamental model of the particle were to be somehow disproved, then how could the entire field not be called into question? Yet this never, ever happens in economics. Instead, it’s just swept under the rug as “necessary simplifications” with a few minor exceptions that can safely be ignored. This wouldn’t be a big deal, except for the fact that economics is supposedly the principal determinant of the social order according to politicians. We exist for the health of the economy, not the reverse.

Indeed, the libertarian’s entire philosophy and world view is dependent upon this idealized clockwork mechanism operating as smoothly as the orbit of planets around the sun or the falling of objects in a vacuum.

One big idea in the book is that prices are actually a quantum phenomenon. Prices have no objective, independent existence apart from our observations; prices can only decisively determined at the time of sale. Before said sale, it is an ‘indeterminate’ quantity—existing in theory, but impossible to be pinpointed with 100% accuracy. Only once the transaction is completed does the price becomes reified and measurable in various currencies.

Orrell makes an analogy with quantum physics, where a particle’s speed and position are unknown and indeterminate until it is observed and measured. We can, for example, assign a position or direction to a particle (but not both). It only exists in a range of potential; once a transaction is completed the potential ‘collapses’, into a fixed number we call ‘price’, but before that it’s properties are indeterminate, not fixed.

The diffuse nature of the wave equation meant that the true state of a particle could never be completely nailed down. The German physicist Werner Heisenberg argued that it therefore made no sense to speculate about what was going on inside the atom. The true state of a particle was unknowable, and all we had were observations, which were subject to inherent uncertainty because of the wave equation. He quantified this with his uncertainty principle, which stated that the more accurately a particles position was measured, the more uncertain was its momentum, and vice versa. p. 34

Think of items at a yard sale or an estate sale. Having conducted a number of these this past year, I can tell you that there is no set value—and hence no absolute price—for any item. An item is only “worth” what someone agrees to pay for it; before that it is just an indeterminate idea or concept, and one that is often quite wrong.

Of course, when we go to a store, we see prices on everything. This tricks us into thinking that prices are some sort of absolute value measurement like temperature or distance. But even these “set” numbers are only theoretical until someone actually purchases the item—that is, the money exchange takes place. Until that event takes place, prices are imaginary. Think of stores selling highly inflated prices for bottled water just before a hurricane, or slashing the prices of items like turkeys after Thanksgiving.

For example, what is modern art really worth? Why are the paintings of Van Gogh, which were literally worth noting in his lifetime, now auctioned for millions of dollars? What some people see as random splotches on canvas, others are willing to pay top dollar for. While this may be an extreme example, even a casual glance at Craigslist or eBay will confirm that value is not so easily mapped to prices, even at the margin.

I would argue that value is inherently a subjective quality, and thus impossible to determine! In that sense, it is analogous to beauty, which is also inherently subjective. While some things can be classified as objectively beautiful with a high degree of certainty (say, Renaissance paintings or Classical sculpture); others are much more de gustibus (i.e. ‘in the eye of the beholder’). However, we do not profess to measure beauty by an absolute, numerical scale. Nor do we claim that it is regular and predictable, or that it can be modeled accurately.

But the key point is, if price is an indeterminate quantity, then the smooth supply and demand curves used by Neoclassical economists (which treat prices as stable and heading towards equilibrium) are not valid. Instead, prices are better described by the principles of quantum physics:

The transaction is rather like the measurement process in physics, where we measure – put a number on – the position of a particle, or record how far it moves in a certain time. Even there, we know from quantum physics that position and time are not simple, linear, external quantities. They warp and connect and break into small parts. In other words, they are not like number. Measurement is a far more complex procedure than appearances suggest – hence the uncertainty principle.

Money therefore acts in markets as a measurement device: a means to collapse the estimate of an assets value down to a single point, akin to the process of wave function collapse which occurs during quantum measurement. Rather than measuring labour, or utility, it is measuring money, which in quantum economics is treated as a fundamental quantity (it might be made-up, but so is the economy, and money at least has well-defined units). Like a photon, a money object is not an inert particle, but a quantum entity in its own right which affects what is being measured.

…The economy as a whole can be viewed as a giant market where producers’ asks are being reconciled with consumers’ offers. As individuals we may usually feel like pricetakers, paying whatever our budget can afford, but as a group we act so as price-makers. Our bids are constrained and channelled by price lists and conventions, but nothing is set in stone, and there is always an element of uncertainty…supply and demand cannot be neatly separated, but are two aspects of a coupled system. pp. 116-117

The invisible hand is invisible because it doesn’t exist.

This view of prices demolishes the whole idea of supply and demand curves which stand at the heart of Neoclassical economics. Rather than markets “naturally” heading towards equilibrium, Quantum Economics argues that the economy is inherently unstable, using examples from unorthodox thinkers like Frederick Soddy and Hyman Minsky. That’s why, he argues, “the most appropriate models for economics tend to be based on mathematical techniques such as complexity and network theory that have proved useful for the study of complex organic systems in general.” (p. 49)

[An economics] textbook…explains that ‘A good way to think about the market equilibrium is to imagine that the demand curve is blue, that the supply curve is yellow, and that the only color we can see in the real world is green.’ The market equilibrium comes at the point where the two curves intersect, and the punch line – yellow and blue makes green! – carries an important lesson: the green dot has no independent existence of its own, and it doesn’t move unless either the yellow line or the blue line moves.

…Even though textbooks routinely claim that these lines have been empirically measured, (and people have certainly tried) it is in fact impossible to properly measure a ‘supply curve’ or a ‘demand curve’ – all we can do is measure transactions at a particular price (the green dots) and the result we obtain will include the effects of both supply and demand, is. We are therefore trying to tease out the values of two variables – supply and demand- from a single number, which doesn’t work (in mathematics this is known as the identifiability problem). And in fact there are plenty of reasons to believe that it makes no sense to view supply and demand as stable (for a time) and separate entities, rather than as parts of a coupled dynamic system.
pp. 117-118

As Orrell sums up in an online article for Aeon:

To sum up, the key tenets of mainstream or neoclassical economics – including such things as ‘utility’ or ‘demand curves’ or ‘rational economic man’ – are just made-up inventions, no more real than the crystalline spheres that Medieval astronomers thought suspended the planets. But real things like money are to a remarkable extent ignored.

Economics is quantum (Aeon)

Indeed, real things like money are indeed ignored in economics, to the surprise of most laypeople (i.e. outside of the “priesthood”). Economic “science” considers money to be nothing more than a neutral medium of exchange—just a convenient item to facilitate transactions. The total amount of this intermediate item in existence may effect prices to some degree, but the fundamental nature of the item itself (precious metals, paper, cowrie shells, iron nails, Newfoundland cod)—and how it is brought into existence—does not matter; only the exchanges do.

This grows out of the orthodox origin story of money as merely an intermediate item that can exchanged for all other items in an economy to facilitate barter transactions. So economists study only the transactions and ignore the role of money; it is just a “veil” over what is essentially a barter economy at heart.

…what does money do?…Most economists, the answer has long been very simple – nothing special. Money is just an inert chip with no special properties of its own. To understand the economy, economists should not focus on money – in fact, they should do the opposite, and ignore its bewitching and distracting activities…This attitude was born in part from the Aristotelian creation myth that money evolved as a substitute for barter, so it was just another commodity that could be exchanged like any other. As Paul Samuelson wrote in Economics, ‘if we strip exchange down to its barest essentials and peel off the obscuring layer of money, we find that trade between individuals and nations largely boils down to barter.’ But it also reflected a Newtonian view of the economy as a mechanistic system, in which the two sides of money were collapsed down to a single point, and money became no more than another inert particle to be held or exchanged. pp. 99-100

Quantum Economics argues that money should be a fundamental element of economic analysis. Furthermore, it embodies multiple, simultaneous qualities, just like light can be described and modeled as both a wave and a particle—both/and as opposed to either/or. Both of these “mental models” can be used to understand light. Similarly, money embodies multiple qualities at the same time. We can choose which model or aspect to examine for our purposes—medium of exchange, store of value, or means of denominating debts, etc.

Throughout its history, money has alternated between these two sides, presenting either as a virtual system for accounting (clay cuneiforms in ancient Mesopotamia, wooden tally sticks in early Medieval England, electronic money today), or as a treasured thing (Ancient Greece and Rome, the gold standard), while retaining the essential characteristics of each. The dichotomy is also reflected in our two main theories of money: chartalism, which says that money represents a virtual debt to the state; and bullionism, which says it boils down to metal. Most economists ignore the debate and treat money as an inert medium of exchange with no special properties of its own. The situation therefore resembles the old debate about whether light was a virtual wave (Aristotle) or a real particle (Isaac Newton). Eventually, quantum physicists came to the conclusion that light isn’t a particle or a wave, it is both at the same time. Most people didn’t care, and just worried about keeping the lights on, and so it is with money.

Economics is quantum (Aeon)

There is a good section on the history of money. Quantum Economics examines what’s sometimes called the Endogenous Theory of Money. That is, banks do not lend money that’s already in existence that has been deposited with them. Rather, new money is brought into existence anytime the bank initiates a new loan.

Mainstream economists, remarkably, do not believe that this is true (despite the banks admitting to it). They instead argue that it is fractional reserve banking which increases the money supply. That is, banks can loan in excess of what they have on deposits (holding, say, only 10 percent of a loan amount on deposit). When that “new” money is subsequently deposited elsewhere, it can be used as a deposit for further loans.

But in reality, the banks are not constrained by the amount of money on deposit in their vaults and on their spreadsheets at any given point in time. Instead, they first make the loans, and then secure enough deposits to cover their reserve requirements. Where do these new deposits come from? From the central bank, of course! They simply ask for it.

So that means that the amount of money circulating in an economy is inherently connected to the amount of overall debt. As debts grow, so too does the amount of money in circulation. If there is too much money circulating for proper investment, it can lead to bubbles—particularly asset bubbles. People buy assets which are increasing in value not because they derive any utility from it at all (for example, an empty flat in London), but because they can use the appreciation of the asset’s value to get more money.

…Since money is created by private banks when they issue debts, a flip side is that when the debts are repaid, the money just disappears back into the void, like a particle annihilating with its anti-particle. As noted by the Bank of England, Just as taking out a new loan creates money, the repayment of bank loans destroys money… Banks making loans and consumers repaying them are the most significant ways in which bank deposits are created and destroyed in the modern economy. So unless new loans are constantly created to replace these funds, the money supply will shrink, further exacerbating a downturn. p. 133

The most obvious reason for omitting the pivotal role of banks…was because economists wanted to keep money out of the equation. Only by doing so could they maintain the pretense that the economy is some kind of barter system based on rational exchange. Just as subjectivity is considered taboo in sociology, so the emotion-laden topic of money creation is taboo in economics. More troubling, perhaps, are indications that attempts were made to obfuscate, as if authors were at times willfully trying to confuse their audience and lead them away from the important insight that each individual bank creates new money when it extends credit…p. 134

Consequently, a capitalist market economy is a highly complex, interconnected, dynamic, stochastic system. Thus, it cannot be modeled by the tools of classical physics with its Classical pretensions of exact measurements and deterministic, interacting particles. With this flawed conception of market economies, it’s no wonder economic models have failed to make accurate predictions. Having documented the problems with the concepts and worldview of orthodox economics, much of the latter half of the book is devoted to analyzing the failures of economists to predict recurrent financial panics and crashes.

Economics is often compared to meteorology, and even sometimes models itself after that field. William Stanley Jevons wrote in 1871 that economics would become ‘a science as exact as many of the physical sciences; as exact, for instance, as Meteorology is likely to be for a very long time to come.’… p. 229

The most obvious difference between the weather and the economy, from a forecasting perspective, is that we create, and have some direct control over, the latter. Recessions are not random storms that come out of nowhere, as economists like to portray them, but are things that we take part in and can take steps to actively prevent. Economists are also entangled financially with the system they are studying. Viewed this way, it is true that it is not completely fair to compare economics with weather forecasting. Economists’ responsibility is far greater, and is more like that of engineers or doctors – instead of predicting exactly when the system will crash, they should warn of risks, incorporate design features to help avoid failure, know how to address problems when they occur, and be alert for conflicts of interest, ethical violations, and other forms of professional negligence.

Its failings in these areas, rather than any particular forecast, are the real reason so many are calling for a genuinely new paradigm in economics, as opposed to a rehashed version of the old one. And the danger is not pluralism (doctors don’t always agree either), but a monoculture based on flawed ideas. Macroeconomic forecasting might be a relatively small part of economics, but its missed predictions and mis-analysis, with their dramatic real-world consequences, are just the most visible and concerning symptom of a deeper problem which starts with the basic assumptions, and affects other branches of mainstream economics. pp.257-258

What this means, Orrell ultimately concludes, is that the concepts derived from quantum physics have much to contribute in fixing the conceptual errors in the conventional Neoclassical economic framework. But while physics is actively incorporating quantum models into its framework, economics remains resistant to any change or development. Perhaps this is because the tenets of the current economic pseudo-science is so very amenable for protecting and promoting the interests of the already rich and powerful around the world.

If quantum economics has a central principle, though, it is that it is not possible to take this kind of detached, impersonal view of the economy. We are entangled with each other and with the economy as a whole, and our subjective judgements about value both define the economy, and are shaped by the economy. The quantum T has an independent, localised, ‘particle aspect’, but also a diffuse and entangled ‘wave aspect’ – in a very real sense, we are not just influenced by, but are actually formed by our relationships, especially when money is involved. This quantum objectivism, if we call it that, might sound a bit mystical, but really it is a more realistic version of Randian objectivism: reality has a quantum nature that is dependent on consciousness; one cannot always attain knowledge about this reality through the use of inductive logic; the purpose of life is more than the pursuit of one’s own happiness; individuals are entangled. And as we have already seen, it has a number of practical implications for the field of economics… p.301

Quantum Economics Paper at Real World Economics Review (PDF)

On MMT and Venezuela

For those of you not members of the C-Realm Vault podcast, the latest episode features some correspondence from me, so because I’m feeling lazy this weekend, I’ll just feature that correspondence here.

The context was an older episode I listened to after finally getting around to watching Westworld. Getting even more meta, the relevant part was another letter from a listener called Gus. Gus was reacting to an interview with Charles High Smith, of the Of Two Minds blog.

Charles is not a fan of the Universal Basic Income idea, and he argued that it was ‘unaffordable.’ It would simply cost too much money to implment. This isn’t unique—it’s clearly the most common criticism of UBI (along with moral hazard). Charles also felt that people needed formal work in order to feel like a valuable, contributing member of society, and that not having a job was detrimental to one’s self-esteem—also a common argument.

Listener Gus took issue with that, using Modern Monetary Theory (MMT) as a takeoff. Here is some of his correspondence, read by KMO on CRV293:

“The piece of the puzzle missing is actually understanding money, debt, accounting. A lot of the stuff in the interview sounded like it came from 5-10 years ago, before people learned MMT, or Modern Monetary Theory. Charles [Hugh Smith] mentioned the old notion that money is anything that acts as a store of value, a medium of exchange, [or] a unit of account, which was the best people could come up with when they didn’t really understand money–just defining it by what it does, rather than what it *is*. It’s like saying that a tree is anything that is tall, provides shade, and that you can climb. So in prison, basketball hoops can be trees.”

“Money is transferable credit – an IOU – debt for the issuer; credit for the bearer. An emergent social phenomenon existing in accounting balance sheets, and there are loads of repercussions in your thinking once you really grasp the concept, plus learn a bit about how the plumbing of government finance works. So all the opinions, predictions, evidence, etc. about the psychological effect of jobs and work for humans–great. But having strong opinions about money, UBI, Steve Keen’s proposals, inflation, etc. without actually understanding debt and money? It’s like listening someone talk about orbits in the solar system before they learned basic Newtonian physics.”

“For example a ton of very smart people get sucked into the Right/Libertarian black hole when their staring assumption–that government spends our tax dollars–is faulty, even if they have sound, principled logic applied after that…”

KMO then reacts to this part of the letter:

“This is something I encounter a lot–A LOT. ‘If you didn’t mention my pet theory, then you’ve never heard of it.’…I can assure you that Charles Hugh Smith has encountered Modern Monetary Theory. It’s not a new discovery…”

KMO goes on to compare MMT advocates to the acolytes of Ayn Rand, in the sense that they believe that those who don’t share their point of view either must not have heard of it, or are just too dumb to understand it (i.e. either stupid or ignorant). This attitude is also shared, he says, by advocates of Peak Oil Doomerism, Techno-utopians, and many other topics.

Let me just break in for a moment here (I realize this is confusing as to who is saying what, but I don’t know how to make it any clearer—sorry!). I certainly hope that I don’t display the rigidity and fanaticism of a Randroid in my advocacy of Modern Monetary Theory. But I don’t think Gus’s assumptions were all that unreasonable.

First, there is no way from just hearing the interview to know whether or not CHS was familiar with MMT or not. Second, he may reject the premises, but we don’t know why. Is it for legitimate reasons, or is just for emotional reasons?

And this may be behind the “attitude” of some MMT advocates CHS criticizes. Here’s something I encounter a lot–A LOT–people don’t wish to logically refute the points raised by MMT, they simply refuse to accept it! I’ve literally heard people say that they simply “refuse to believe” that the national debt is not a horrible crisis, or that taxes are not required for the government to spend. It’s literally a “faith-based” argument. It’s like people saying “I experience the earth as a flat plane, thereby it is so,” and refusing even to look at a globe or a photo of the earth from space for emotional reasons.

So, if there’s a bit of arrogance and frustration on the part of MMT supporters, I would say it’s partly because people refuse to engage in legitimate, good faith debate, or even attempt to refute its logic, and just keep repeating the “conventional wisdom” as a kind of religious mantra.

Anyway, back to the show. KMO then presents a “steel manning” of the MMT point of view, using the analogy of running out of inches to build a house when all the labor and materials are present. He also brings up David Graeber’s book to dismiss the bullionist theory of money in favor of chartalism. He then backs up, apparently deleting some of his thoughts, and says the following:

[19:36] “…MMT gets presented to people nowadays as a coherent and new body of thought, and it is nothing of the sort. With reguard to the idea that a government can create as much money as it thinks is necessary with no underlying basis for that wealth; no physical correlate for that currency, well, let me just direct you to the example of Venezuela. Here’s a very short piece from Reuters:”

He the reads the following new story:

Venezuela annual inflation exceeds 6,000 percent in Feb – National Assembly (Reuters)

Followed by:

“So that short piece from Reuters brings in one very relevant piece of information which is that Venezuela is rich in oil. They should be able to convert that oil into monetary wealth and, if they are of a mind to, share it broadly with the people. Hugo Chavez managed this for some years, in spite of the fact that the U.S. administration was as opposed to the Chavez’s regime as they are to the current one. I’m definitely not discounting the portion of the narrative that says that Venezuela is struggling in this way in part because of economic warfare being waged against it by the United States and its allies.”

“But I would ask you, Gus, and anyone else who is enamored with MMT, how is the Venezuelan example not in line with the prescription of Modern Monetary Theorists? That is not a rhetorical question; I invite your feedback.”

“How is the Venezuelan example not in line with the prescription of Modern Monetary Theorists?” It’s a valid, and I think an important, question. Now, I didn’t think the example of Venezuela was a particularly valid demonstration of the core ideas of MMT , but I wanted to do a bit of research to verify that this was truly the case. Honestly, I wish MMT advocates would address this question a bit more heads-on; I had to dig to find good information.

But first, a few words about MMT. Is it, or is it not, a coherent body of thought? I would argue that various gaps in knowledge do not render it incoherent, otherwise we could dismiss the entirety of Neoclassical economics just as easily! We could also dismiss Marxism, Keynesianism, and a whole lot of other traditional economic and sociological concepts using the same logic. No one seems to be bothered by the many holes and inconsistencies in “traditional” economics which is taught in universities every single day—from the absurd fiction of Homo economicus to weaseling concepts like externalities and ceteris paribus. Yet, economics IS presented explicitly as a locally consistent and coherent body of thought to the public all the time! For example, just one idea—the Theory of the Second Best—seems to undermine much of Neoclassical economic thought:

In fact, it could be argued that Neoclassical economics—which eliminates money entirely from its analysis—is the more incoherent body of thought. It not only failed to predict the latest economic crisis, but may have even contributed to it with it’s ideas of rational expectations and markets tending towards equilibrium. By contrast, MMT does not have the same blind spot. This is pointed out in the introduction to the book Quantum Economics by David Orrell, author of Economyths:

What is economics?

How about this for an exciting definition: economics is the study of transactions involving money.

Obvious, right? Economists talk about money all the time. Everything gets expressed in terms of dollars or euros, yen or yuan. The health of a nation is reduced to how much they produce, as measured by Gross Domestic Product; a person’s value to society is expressed by how much they earn. Economics is about money! Everyone knows that.

And yet, if you look at an economics textbook, it turns out that the field is defined a little differently. Most follow the English economist Lionel Robbins, who wrote in 1932 that ‘Economics is a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.’ Gregory Mankiw’s widely-used Principles of Economics for example states that ‘Economics is the study of how society manages its scarce resources.’ Or as it is sometimes paraphrased, economics is the science of scarcity. No mention of money at all.

And if you read a little further in those same textbooks, you will find that economists do not talk about money all the time – in fact they steer clear of it. Money is used as a metric, but – apart perhaps from chapters to do with basic monetary plumbing – is not considered an important subject in itself. The textbooks are like physics books that use time throughout in equations but never pause to talk about what time is. And both money and the role of the financial sector are usually completely missing from economic models, or paid lip service to.

Economists, it seems, think about money less than most people do: as the former Bank of England Governor Mervyn King observed, ‘Most economists hold conversations in which the word money hardly appears at all.’ pp. 1-2

Second, is it something new or not? In fact, the term “Modern” in the name is a bit misleading. As KMO notes, many ideas date to the early twentieth century and earlier, including the work of Alfred Mitchell-Innes, G.F. Knapp, Frederick Soddy, Joseph Schumpeter, and Hyman Minsky, among many others.

But, I would argue that “Modern” does, in fact, make sense, in the sense that it analyzes our current monetary regime. If we were to analyze the operation of the monetary and economic systems for the Roman Empire, the Carolingian Empire, medieval England, Renaissance Venice, or Ancien Régime France, its analysis would not be valid. Instead, iIt analyzes our MODERN monetary system, which was established after 1688 when a consortium of wealthy merchants and bankers formed a joint-stock corporation called the Bank of England in order to manage King William of Orange’s war debt. The king’s debts now circulated as negotiable currency, with taxes now going to fund the debt to the bank which managed the state’s finances. As David Orrell notes in Quantum Economics:

In medieval England the stock half of a tally stick became a money object representing a credit, made up by the king, that could be collected. With the founding of the Bank of England, the direction reversed, so that money is now based on the state’s debt to the private sector. With modern fiat currencies that are backed only by the word of the state, the central bank goes a step further and creates money not by loaning real assets to the state, but by loaning made-up funds, produced magically at the press of a button. p.92

In some other ways, Modern Monetary Theory IS new. The modern renaissance in this subject began with a bond trader named Warren Mosler. Later, economists such as Randall Wray and Stephanie Kelton, among others, began to flesh out the paradigm, using economic history as a guide. Numerous other economists have also contributed to this field—Steve Keen, Bill Mitchell, Michael Hudson, Pavlina Tcherneva, et. al. So, a good part of the formal development and propagation of MMT ideas has, indeed, taken place in the last thirty years or so.

Finally, about the theory part. As MMT advocates never tire of pointing out, MMT is descriptive of how the monetary system of a sovereign nation works. I have not yet seen its description of how money works in modern economies actually refuted. The worst you could say is that it’s irrelevant, which is what mainstream economics usually does.

I compare it to the hydrological cycle. The hydrological cycle describes the movement of water on planet earth. The ramification of this to the ecosystem, expressed by things like monsoons or droughts, would be the theory derived from it.

Similarly, there is a theoretical aspect to MMT in the sense that it’s proscriptions–how we should run an economy based on this information–are theoretical. It’s fair to discuss and criticize them. But in that sense, all of economics is a theory, described by Wikipedia as, “a contemplative and rational type of abstract or generalizing thinking, or the results of such thinking.” MMT is at least based on the reality of how money works, unlike “traditional” economics. And, like any theory, it will be developed, refined, and extended over time based on new data and research.

My letter is below. If you’ve listened to CRV319 then you’ve already heard it.


Re: Venezuela: The most common factor I’ve seen cited for Venezuela’s economic crisis is the fall in the price of oil. Being a major oil producer, paradoxically, is a cause of, rather than a palliative, for Venezuela’s economic woes. The reasons stem from the Resource Curse phenomena, or something called the “Dutch Disease” (for reasons too obscure to go into here.)

We all remember the spike in oil prices around 2008, when many believed that the Peak Oil “reckoning” was upon us. Basically, the Chavez administration used the windfall from the years of high oil prices to implement a suite of generous social policies—his “Bolivarian Revolution.” And, in those years, it really did reduce poverty and increase the living standards of poorer Venezuelans quite substantially based on economic metrics. This led to support for Socialist policies, which is still ongoing in a significant portion of the electorate.

The Dutch Disease is when a nation’s entire economy is centered around one particular commodity (such as oil). Thus, the country’s national budget is tied to the price of that commodity, which fluctuates. When the price is high, the government’s budget is flush. But a reversal in the price of that commodity causes the entire national budget to go into the red, and the overall economy takes a significant hit, affecting the currency and interest rates. This tends to not happen in more diversified economies, although it’s worth noting that even in the United States, the state budgets of places like Texas and Oklahoma also take a hit during periods of low oil prices (less so California in recent times). Texas is, however, not a sovereign currency issuer.

The problem is, that because the Venezuelan government’s revenues were so tightly bound to the price of oil, when the price of oil plummeted after 2013 or so, it took the government’s budget down along with it. The socialist government, however, chose not adjust the social spending it put in place during the era of high oil prices. As this economic blogger put it:

“…growth has been tied to terms of trade and the price of oil. Also, not only the economy collapses when the price of oil collapses, but exchange rate depreciation, in the black market now, leads to high inflation, which goes often with shortages. Anybody that has lived through high inflation in Latin America in the 1980s knows this. It has nothing to do with fiscal policy, or with the central bank printing money. The fiscal situation worsened as a result of lack of growth and the external problems.”

A brief note on Venezuela and the turn to the right in Latin America (Naked Keynesianism)

The above blogger points out that this is not a new or unique phenomena for Venezuela. Long before the Maduro or Chavez administrations, a very similar thing happened in the late 1980’s. Falling oil prices caused a budget crisis, and the implementation of Neoliberal economic “reforms.” This, in turn, led to urban rioting in the capital of Caracas, called the Caracazo. Wikipedia has this to say about the Caracazo:

“A fall in oil prices in the mid-1980s caused an economic crisis to take hold in Venezuela, and the country had accrued significant levels of debt. Nevertheless, the administration of the left-leaning President Jaime Lusinchi was able to restructure the country’s debt repayments and offset an economic crisis but allow for the continuation of the government’s policies of social spending and state-sponsored subsidies. Lusinchi’s political party, the Democratic Action, was able to remain in power following the 1988 election of Carlos Andrés Pérez as president.”

“Pérez then proposed a major shift in policy by implementing neoliberal economic reforms recommended by the International Monetary Fund (IMF)…Measures taken by Pérez included privatizing state companies, tax reform, reducing customs duties, and diminishing the role of the state in the economy…The most controversial part of the economic reform package was the elimination of the gasoline subsidies, which had long maintained domestic gasoline prices far beneath international levels and even the production costs. When the subsidy was eliminated, gasoline prices rose by as much as 100% and so the costs of public transportation rose by 30%.”

Caracazo (Wikipedia)

SO I don’t think that analogies between the Venezuelan economy and our own can tell us very much. They are fundamentally different creatures. After all, the United States is the world’s largest economy, and issues the world’s reserve currency. Those facts alone make any analogy difficult, if not impossible. There is always a demand for dollars. There has never been a single case of hyperinflation in the postwar period in any major industrialized G-7 economy. I’m sorry, comparing the U.S. to Zimbabwe, which I often hear, is absolutely ridiculous. No one who does that should be taken seriously.

Furthermore, despite popular belief, most of U.S. debt is held domestically and denominated in U.S. dollars. As MMT economists will tell you, this makes a huge difference. It effects the level of allowable domestic spending by governments. This is not the case with Venezuela. This is the best one-paragraph summary I’ve seen of the situation from a poster on Reddit:

“Venezuela gave up being monetary sovereign when they borrowed US Dollars, Euros, and gold. They borrowed these, in part, to finance trade with foreign powers. The idea was to repay these loans with dollars earned by the sale of oil — but the oil market dropped and they were unable to obtain enough dollars from the sale of oil, so they printed more of their own currency to trade in exchange for dollars. When that happened, prices began to increase, due to there being more and more bolivar in the system. To keep prices down, the government enacted price caps. This backfired, causing producers to stop producing, effectively destroying the productive capacity of the country. So now they owe a lot of foreign debt, their currency is crap, their productive capacity is trashed, and people are mad.”

So the debate is not whether any sovereign state does, or does not, have the money to accomplish any particular social goal it sets for itself–whether that be poverty alleviation or infrastructure improvement. The question is, rather, “What the macroeconomic effects will be?” To say, “We don’t have the money,” is not a valid argument for a sovereign currency issuer (although it might be valid for a currency user, such as a corporation or a municipality). To say, “we don’t have the resources,” or “it will be inflationary” IS a valid argument, however. Furthermore, the amount of debt is immaterial. The amount of debt is only significant if it affects the costs to borrow. Confidence in the currency is also tied to confidence in the institutions of any particular government, including its levels of corruption and its ability to reliably collect the taxes it is owed by its citizens. Many so-called “banana republics” struggle with this, as do even some Mediterranean states like Greece and Italy.

For a smaller economy like that of Venezuela, it needs to borrow, and it needs to import. It is not an autarky. Just because it has lots of oil does not mean it can be self-sufficient, or make all the resources it needs to run its economy. Thus, issuing more money without the ability of the economy to supply more goods and services WILL be inflationary according to MMT. It’s worth noting that Venezuela is under an economic embargo, which is not, of course, true of the United States. I’ve also heard credible stories of right-wing business leaders deliberately hoarding goods and refusing to distribute them specifically to undermine the socialist government. I can’t reliably confirm this, but if true, this would also factor into Venezuela’s hyperinflation problem. That’s also very different than the case in the U.S.

SO, in conclusion, there are significant differences between the situation in Venezuela and that of the United States. Having said all that, however, many economists working in the MMT paradigm DO, in fact, believe that a Universal Basic Income would be inflationary. If you increase the supply of money faster than the economy can absorb it, inflation is a likely outcome according to MMT. No contradiction there. Also, if you increase government spending without adjusting the level of taxation, you increase the supply of the currency floating around. This will “dilute” the value of that currency, causing inflation. If a UBI scheme is to be truly Universal, its quite likely that the economy would not be able to accommodate the sudden increase in spending power in the short run, leading to inflation. Such inflation would eat into the real monetary value of any UBI scheme we wish to implement.

That’s why most of the MMT economists I read and follow advocate something called the “Job Guarantee” rather than a Universal Basic Income. This would simply be the hiring by the government of people who cannot currently find remunerative work in either the public or private sector. Essentially, this is simply the government acting as the employer of last resort. Such workers could then be deployed to accomplish important social tasks that the private sector currently finds unprofitable. AS MMT economists point out, the U.S. can purchase any commodity for sale in U.S. dollars, including the labor of its own citizens, in whatever quantity is able to be supplied.

The debate over the Job Guarantee usually does not center around whether or not we have the money to accomplish it. Governments already employ millions of people, after all. Rather, the debate centers around whether there is enough useful work to give these people to do, or whether such jobs would end up being merely useless busywork; in David Graeber’s phrasing—”Bullshit Jobs.” That is open to debate. In my experience, people who believe that such jobs would be useless are the ones who gravitate towards UBI, as do people who already have non-remunerative creative gigs (we might include ourselves here).

In parts of Europe, in the age before Neoliberalism, the government was often commonly used this way. Aspiring politicians would promise–and then create–all sort of new government positions for their supporters and patrons in the cause of “job creation.” That’s why, back in the day, visitors to Southern Europe would be struck by the numerous government employees appeared to do little ease besides eat lunch and watch football while smoking. This, in turn, plays into the European stereotype of “lazy Southerners” that effects the debate over things like Greece’s economic problems to this day.

I would put forward the argument that the United States already has a similar program in place: The U.S. military. In my opinion, the U.S. military acts as an employer of last result and an economic stimulus package for the private sector. Surely, the level of military spending is far in excess of any practical need. And it keeps going up. Furthermore, no one EVER questions whether or not we have the money to pay for military spending. Here are some statistics I ran across:

“The U.S. Department of Defense is the nation’s largest employer, with over 1.4 million active duty personnel and 1.1 million reservists. It also employs 861,000 civilians. There are 450,000 employees stationed overseas in 163 countries. An additional 3 million Americans receive income from DoD.”

“There are also 1.1 million people serving in the National Guard and Reserve forces, and two million veterans and their families who rely on this income from their past service. Because of the enormous number of past and present personnel, the DoD is also the nation’s largest healthcare provider, serving 9.5 million military members, retirees, and their families.”

Department of Defense, What It Does, and Its Impact (The Balance)

So, although your correspondent was technically correct about us having the money, the actual picture is more complicated. But I don’t think that Venezuela or Zimbabwe tell us much about the case in the U.S.


Interestingly, it appears that something like the Caracazo is taking place in Paris right now. It’s even caused in part by rising gasoline prices (in this case by new taxes rather than the elimination of subsidies).