The flawed assumptions that led economists astray
A book by Michael Reiss Ph.D.
Preface: Economics, It’s Not Rocket Science... Is It?
Michael Reiss has given us a fantastic short primer that makes sense of the economic disaster that has descended upon the world economy in the last few years. The simplicity with which he presents what appears to be a highly complex system of money is astounding. Every person who considers buying a stock, applying for a mortgage, or saving for retirement should read this book. Will it change your world? Perhaps!
But understanding how money is created and destroyed by banks, fractional reserve banking, and productive and non-productive loans. We can learn to manage our own futures in a very troublesome economy. Reiss introduces us to "Pseudo-investing" explains the pitfalls of this disastrous practice.
Finally he wraps up with a plan that seems so simple, but is unlikely to be implemented because of one factor he ignores - greed! I am hopeful that Reiss will rise as an honest truth-sayer in our economic maelstrom. Perhaps the highly paid economists at the Federal Reserve and our Secretary of Treasury should be given a gratis copy.
Brain surgery, higher mathematics, quantum mechanics; everyone knows they’re hard. If you ask someone in the street for their opinion on those disciplines, the most likely answer is: “I haven’t got a clue, leave it to the experts.” Very few people are embarrassed to admit that they know little of such things. Economics, however, does not appear to be in that category. Economics seems to have a characteristic it shares with driving skill. Surveys of drivers show that the majority of people think that they are more skilled than the average. On the surface, running an economy does not appear to be so difficult. If we all work hard, get the unions out of the way, have low taxes and invest in industry, the economy should get along just fine. It’s all just common sense, isn’t it?
The evidence would suggest that there is something wrong with this view. The economy appears to do crazy things. There are wild booms and busts, periods of seemingly out-of-control inflation and other periods of high unemployment. The busts are often not predicted, even by the most esteemed economists. Indeed a report produced by the International Monetary Fund concluded that the world economy was in great shape in April 2007 only for the biggest economic crash since the Great Depression to happen just months later.
A symptom of this “it’s all just common sense” attitude towards economics is that the most unlikely people are selected to run the economy in various countries around the world. People who have shown little sign of mathematical or scientific prowess are selected on the basis that they are good, honest people, or they are great orators, or they ran a successful business. Looking at the academic backgrounds of the past ten people placed in charge of the British economy in recent years, we find that only three of them had some degree level training in economics and the remaining seven had the following backgrounds:
| Chancellor | Main subject at degree level or higher |
| George Osborne | History |
| Alistair Darling | Law |
| Gordon Brown | History |
| Kenneth Clarke | Law |
| John Major | None (left school at 16) |
| Geoffrey Howe | Law |
| Denis Healey | Classics |
It should be noted that none of the ten had any degree level education in mathematics, physics, engineering or any other hard science.
Just at the time of writing a new politician, Alan Johnson, has just been selected by the leader of the main opposition party in the UK to be the shadow chancellor. It is interesting to note his credentials. He left school at 15 (even earlier than John Major), then stacked shelves in a supermarket before progressing to become a postman at age 18. If the position of “head of brain surgery” at a major hospital became vacant then there is no way Alan would even get an interview, let alone the job. But somehow, for the post of “head of economics”, Alan is deemed suitable.
So what is it within economics that trips people up? What features of it lead politicians and bankers to get things so badly wrong time and time again? The answer is that it’s not “common” sense at all. Economics is deceptively hard. There are several counter-intuitive aspects of our economic system that are either not widely known or are generally misunderstood. Most, if not all, university-level economics textbooks have inadequate, out-of-date or misleading information about a variety of critically important phenomena:
· fractional reserve banking (ill-understood/ignored)
· Keynesian beauty contests and their consequences (largely ignored)
· Ponzi dynamics in asset pricing (largely ignored)
· the paradox of thrift (ill-understood)
· inflation (ill-understood)
· the invisible hand (overestimated powers).
Hopefully by the end if this book you will have a good grasp of all of these things and will be in a position to understand our economic situation better than many professional economists.
A quick test: If you know someone that claims to know about economics and you are uncertain as to whether they really do or not, then try this test on them: Ask them to explain how money gets created and destroyed by the banks. If they cannot do so, then it is inconceivable that they could properly understand our current economic situation.
Contents
Preface: Economics, It’s Not Rocket Science... Is It?
1 Our Crazy Money System
Misconceptions about money
Fractional reserve banking (as told in the textbooks)
Fractional reserve banking, in reality
Capital adequacy
Characteristics of our banking system
But what about the interest?
How old is our monetary system?
Can you have a fixed money supply system?
Summary
2 How Do Banks Go Bust?
At times of crisis, normal bank regulation may not apply
In conclusion
3 Supply and Demand – in Practice
The special case of the supply not being in direct control of the producers
Supply and demand for investment products
4 Savings and Unavoidable Ponzi Dynamics
The nature of savings
Storing value?
Savings type 1: Simple warehouse
Savings type 2: Concentrated value storage
Savings type 3: Contract savings
Saving scenario thought experiments
Conclusion
5 Inflation Misconceptions
Rise in the prices of what?
The cost of living
Cost of living inflation is a political issue
The price of houses is not included!
Relation to the amount of money
Rises in the price of shares are often (incorrectly) applauded
Visualising money circulation
Conclusion
6 Booms and Busts – the Austrians Were on the Right Track
The boom
The bust
The faulty brakes on the positive feedback loop
Psychological effects of a boom–bust cycle
7 Monetary Illusions and Unemployment
Unemployment types
When do we have high unemployment?
Pessimism in a world without money
Pessimism in a world with money
The end of the spiral
Why major wars end depressive spirals
A mountain of debt is a constant source of pessimism
8 A Growing/Shrinking Money Supply: More Causes and Effects
A money supply thought experiment
Mortgages are particularly sensitive to money supply changes
An alternative solution to a post-housing-bubble depression
9 Interest Rates and Investing Against Our Will
Interest rates in a barter economy
Interest with money in a fractional reserve banking system
In conclusion
10 Investments and Pseudo-investments: Which do Banks Prefer?
True investments
Non-productive “investments” (pseudo-investments)
Investments v. pseudo-investments: which do banks prefer?
Productive v. non-productive loans in a fractional reserve system
11 Pseudo-investment 1: Private Tailgating
Financial tailgating
Private tailgating
Mortgages
12 Pseudo-investment 2: Government Tailgating
A choice of mechanisms for making up tax shortfalls
There was probably never any need for government borrowing in the first place!
The difference between a small company and a big one
13 Pseudo-investment 3: (Most) Share Dealing
Initial share sales (this is the good bit that works)
Unrestricted secondary share dealing and price accuracy
What is the benefit of unrestricted secondary share dealing?
The new wave paradox
Politicians and bankers don’t want stock market bubbles to burst
Conclusion
14 The Bloated Financial Sector
15 The Private Pensions Casino
Pensions throughout history
Mr Lucky and Mr Unlucky
A fairer pensions system
16 Land Ownership and Mortgages
Most of the cost of housing is in fact the cost of land
A thought experiment about land
Drawing lots
The committee
Free market renting
The free market with purchasing as an option
Income from owned land – another problem
Environmental consequences
Conclusion
17 Restless Bandits and Competition
The casino owner and the screwdriver
Restless bandits
Monopolies: okay at first – but then…
Conclusion
18 A Recipe for a More Stable Economy
Reduce unnecessary lending and borrowing
A less elastic monetary system
No money creation for non-productive purposes
Discourage short-term share ownership
Prevent governments from borrowing
The transition from our current state
Acknowledgements
About the Author
Index
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