Friday, August 16, 2013

Why Isn't There a Demonstrably Correct Economic Theory?

Although economics doesn't recognize it, the operative phrase here is systemic injustice.


Correspondent C.G.D. recently asked what I consider a very profound question: why isn't there demonstrably correct economic theory?
"My wife has asked me a 'simple' question that I can not answer. After 2000 years, why do we not know which economic theory is correct: Keynesian or Hayek-Friedman? Surely, there is a demonstrably, statistically correct answer."
Let's add Marxism to the short list of contenders, and then consider why we have cargo-cult faiths (Keynesianism) instead of demonstrably correct models of economic behavior.

Many others have noted the obvious, that economics is a pseudo-science rather than a real science: beneath the fancy quantification and math, economics is fundamentally the study of human behavior, and that complex mix of dynamics cannot be reduced to a tidy model that spits out accurate predictions.

One key element of science is that the results must be reproducible, that is, the same experiment/conditions should yield the same results time and again. I suspect that economic models are not applicable across all times and situations; a model might "work" in one era and in a very specific set of circumstances, but fail in another era or in a similar set of circumstances.

Since human behavior is based in culture as well as in naturally selected (genetically driven) behavior, then cultural milieus and values obviously play critical roles in shaping economic behaviors.

So presenting an economic model as "scientific" and quantifiable is in effect claiming that the bubbling stew of human culture can be reduced to quantifiable models that will yield predictions that are accurate in the real world. This is clearly false, as culture is not a static set of objects, it is a constantly shifting interplay of feedback loops.

This helps explain why human behavior is so unpredictable. Virtually no one successfully predicted World War I in 1909, and no one predicted the collapse of the U.S.S.R. in 1985.

Another reason all economic theories fail as scientifically verifiable models is that economics boils down to a very simple dynamic: those in power issue financial claims on resources as a "shortcut" way of gaining control of the resources without actually having to produce the resources or earn the wealth via labor and innovation.

I think this is the one fundamental dynamic of economics, and it does not lend itself to reductionist models.

We can understand this dynamic by stripping down the process of expropriation to its basics.

In the bad old days of rampaging hordes and empires, those in power simply took what resources and wealth they wanted after defeating the defending army: gold, women, wine, etc. were simply grabbed by the conquerors and hauled off.

The advent of finance enabled new and less overt forms of expropriation. Let's say that three traders enter a great trading fair seeking to buy goods to sell elsewhere for a fat profit. That is, after all, the purpose of the fair: to enable buyers and sellers to mutually profit.

One trader uses the time-honored method of letters of credit: he buys and sells during the fair by exchanging letters of credit which are settled at the end of the fair via payment of balances due with gold or silver.

Ultimately, the trader's purchases are limited by the amount of silver/gold (i.e. real money) he possesses.

Trader #2 has access to leveraged credit, meaning that he has borrowed 100 units of gold with a mere 10 units of gold and the promise of paying interest on the borrowed 90 units.

This trader can buy 10 times more goods than Trader #1, and thus reap 10 times more profit. After paying 10% in interest, Trader #2 reaps 9 times more profit based on the credit-based expansion of his claim on resources.

The issuance of paper money is an even more astonishing shortcut claim on real-world resources. Trader #3 brings a printing press to the fair and prints off "money" which is a claim on resources. The paper is intrinsically worthless, but if sellers at the fair accept its claimed value, then they exchange real resources for this claim of value.

Needless to say, those with access to leveraged credit and the issuance of fiat money have the power to make claims on resources without actually having produced anything of value or earned tangible forms of wealth.

Those with political power and wealth naturally have monopolies on the issuance of credit and paper money, as these enable the acquisition of real wealth without actually having to produce or earn the wealth.

This system is intrinsically unstable, as the financial claims of credit and fiat money on limited real-world resources and wealth eventually far exceed real-world resources, and the system of claims collapses in a heap. Though this end-state can easily be predicted, the actual moment of collapse is not predictable, as those holding power have a vast menu of ways to mask their expropriation and keep the game going.

To fill out the menu, just list every program and press release over the past five years of financial legerdemain from the Federal Reserve, the European Central Bank, the Bank of Japan and the Chinese state banks. They all boil down to enforcing the claims of unearned wealth, i.e. freshly issued credit and currency, on real-world resources.

Although economics doesn't recognize it, the operative phrase here is systemic injustice. 



Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

go to print edition1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

Kindle edition: $9.95       print edition: $24 on Amazon.com
To receive a 20% discount on the print edition: $19.20 (retail $24), follow the link, open a Createspace account and enter discount code SJRGPLAB. (This is the only way I can offer a discount.)



Thank you, Robert N. ($100), for your outrageously generous contribution to this site-- I am greatly honored by your support and readership.

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