Prior to the Global Financial Crisis (GFC 2007), many senior economists and policy makers expressed confidence that they had finally solved the problem of business cycles, booms and busts, that plagues capitalism. Because of this over-confidence, early warnings of a looming crisis by Nouriel Roubini, Ann Pettifor, Peter Schiff, Steven Keen, Dean Baker, and RaghuramRajan, were ridiculed and dismissed. Even after the crisis, many economists thought this was a minor glitch, which would soon be remedied. Now however, while conventional economists continue to search for reasons for the mysterious stagnation besetting capitalistic economies, the weak and jobless recovery from the GFC has been labeled as an illusion and a false dawn by Schiff. Like him, deeper analysts are converging on the idea that the problems run deep, and that radical changes in the global financial architecture are required to solve current problems and prevent future crises.
For instance, consider Lord Mervyn King, the Governor of the Bank of England from 2003 to 2013. His experience at the heart of the global financial system led him to the conclusion that “Of all the many ways of organising banking, the worst is the one we have today… (can we) think our way through to a better outcome before the next generation is damaged by a future and bigger crisis?” Similarly, Minneapolis Federal Reserve President, Narayana Kocherlakota, after viewing the stark conflicts between the empirical evidence and the macroeconomic theories over the past ten years, writes the economists use “Toy Models” which do not work in face of the complexities of real life
There are two central elements which lie at the core of the fragility of the financial system. The first problem is credit-creation by banks. This means that when banks give loans, they create credit out of thin air. This ability enables corporate raiders to buy multi-billion dollar corporations without any money in their pockets using financial gimmicks. The second problem, closely related to the first one, is the use of interest instead of equity in the lending process. This means that banks can lend for mega-projects designed to fail, because they are guaranteed a return of their money regardless of outcomes. Bankers have successfully created the illusion that they are necessary, so that when borrowers can’t pay back outrageously risky loans, the government reimburses the banks for their losses. Both of these problems at the heart of the financial system can be fixed, but the ability of high finance to create huge amounts of money at will gives the financiers ample resources to block any attempts at solving the problems. The one per cent who benefit from this financial system have created a robust and resilient multidimensional system of defence to protect, preserve, and sustain the current fragile and crisis-prone financial architecture. Using billions of dollars of funding, many different institutions, which include academia, media, think tanks, policy makers, regulators, politicians, and the military-corporate-industrial complex, have been co-opted by high finance. In an article entitled “It Takes a Village to Maintain a Dangerous Financial System,” Stanford professor Anat Admati describes how these different institutions work together to maintain and perpetuate the current financial system. In this article, I focus on how economic theory itself has been captured by the top one per cent and changed to serve their interests.
The role of economic theory should have been to clarify and expose the structure of the economic system, so that economists could understand it and make it work better for all. Instead, economic theory has been captured by the financiers and turned into a propaganda machine, which hides the realities of the system. Modern economics textbooks continue to teach myths which are overwhelmingly contradicted by empirical evidence. In particular, they teach that the quantity of money and the levels of debt do not have any long run effects on the economy. They teach that consumers and businesses can accurately foresee the path of future prices, and of government policy, and plan purchases and investments accordingly. They teach that levels of inequality do not matter because wealth will trickle down. The distinction between needs and wants has been erased from the textbooks. Economists used to be concerned about rentiers — people who earn money without doing any work to deserve it. Current economics textbooks no longer mention the concept. Instead they teach that markets efficiently recognise and reward participants: if you make money, it means that you deserve to make money. This leads to the idea that the more wealthy you are, the greater is your contribution to society. When this myth is combined with the trickle-down myth, it leads to tax cuts for the rich advocated by Trump, and a guiding policy principle in the USA since the Reagan era. Small wonder that IMF Chief Economist Olivier Blanchard wrote that modern models used for conduct of monetary policy are based on “assumptions profoundly at odds with what we know about consumers and firms”.
Like Blanchard, economists who have contact with reality have come to recognise the deep flaws in the economic theories used for the conduct of monetary and fiscal policy around the globe. Highly respected economist David Romer, recently appointed Chief Economist at the World Bank, has created shock waves among economists by a trenchant critique entitled “The Trouble with Macroeconomics.” He writes that for more than three decades, macroeconomics has gone backwards, losing knowledge instead of gaining it. Since banks, financiers, money, unemployment, debt, inequality, rentiers, and all other major drivers of the modern economy have been removed from the picture by economists, contemporary macroeconomic models “attribute fluctuations in aggregate variables to imaginary causal forces .” Romer notes that economists’ blatant disregard for facts in conflict with their imaginary theories is so extraordinary that it deserves its own label — he suggests “post-real”. Even though there are formidable obstacles in the path from this imaginary post-real world of economists to reality, humanity urgently needs to find a way, if the bottom 99 per cent, and the planet we live on, is to survive.
Published in The Express Tribune, December 5th, 2016.