|
|
Jeff Rubin, another economist who doesn't get economics
My critique of Mr Rubin's statement would begin with his labeling of my position as a form of monetarism. While I do regard the monetary supply as a critical factor, I define it very differently than do monetarists. In my opinion, monetarists disregard the elephant in the room in their dismissal of the vital role of credit in the effective money supply. In my opinion, they correctly identify the importance of the money supply, and specifically changes to it as a vital driver of prices, but then fail to recognize that the overwhelming percentage of the money supply is composed of credit. As it is the collapse of credit that defines the bursting of a financial bubble, neglecting this element means not understanding where we are going and why. As Ben Barnanke is a monetarist, the implications of this lack of understanding are significant. Essentially, there are two kinds of inflation. As inflation is defined as an increase in the supply of money and credit relative to available goods and services, one can achieve inflation either by increasing the money component (as in Weimar Germany or modern Zimbabwe) or the credit component. In the former case, one divides the underlying real wealth pie into smaller and smaller pieces. In the latter case, which represents our situation, one does not subdivide the real wealth pie, but instead creates multiple and mutually exclusive claims to the same pieces of pie. A credit expansion thus creates excess claims to underlying real wealth, and we have just lived through the largest credit expansion in human history. In other words, we are all playing a giant game of musical chairs, only there is perhaps one chair for every hundred people playing the game. You can imagine what will happen when the music stops. The free-for-all grab for an available chair represents the extinguishing of excess claims to underlying real wealth, and is deflation by definition. This will represent the end of extend-and-pretend, and the recognition that there is only so much to go around. In addition, Mr Rubin took exception to my discussion of the velocity of money as an important factor determining how financial crisis will play out in practice. The velocity of money is in fact a critical factor. It is an expression of how rapidly money circulates in an economy. If very little money is at rest, and most of the effective money supply is in circulation, many transactions will occur, it will be simple to connect buyers and sellers, and the economy will be healthy. The problem in a depression is that the small number of people who still have access to money (after the collapse of credit) will be hanging on to it for dear life, as they will have no idea when they will earn any more in an era of high unemployment and instability. This means that very little of the small amount of existing cash will be in circulation. Most of it will be at rest, being hoarded by people, and companies and banks. Money is the lubricant in the economy in the same way that motor oil is the lubricant in our cars. Without sufficient lubricant, the engine will seize up. This is exactly what happened in the 1930s - the economy had a seizure. When this happens, it is almost impossible to connect buyers and sellers for lack of a medium of exchange. In the 1930s we had plenty of everything - energy, resources, labour etc - except money. Perverse things happen under such circumstances. In the 1930s it was very difficult to connect farmers with a product to sell with the hungry people who wanted that product. Since demand is not what one wants, but what one can pay for, under conditions of little circulating money, there is very little demand. In the 1930s, farmers dumped milk in ditches while people were starving to death down the road. Perverse things happen during an economic seizure. This is where we are headed again, and we need to be aware of the implications in order to prepare for them. A dramatic fall in the velocity of money will greatly compound the collapse of the money supply due to the evaporation of credit. This is a dynamic that everyone needs to understand. Mr Rubin, unlike most economists, does understand that resource limitations are real, and hence writes about peak oil. This is an important element of understanding. However, it is equally important to understand that a credit expansion brings forward aggregate demand, borrowing it from the future. Because our access to cheap credit put so much extra purchasing power in our hands, we can purchase many things we could not otherwise have done. The debt created by this additional purchasing power must be repaid though, and when it is, it will be subtracted from future aggregate demand. This is a critical part of the dynamic leading to economic depression, yet it is a factor that modern economists cannot seem to understand. If we are to understand how the world works, we will have to discard the neo-classical model of economics that comprehensively fails to reflect reality, and has become a religion rather than the science it purports to be. |
 |
 |
In all the talks I have done, there has been only one person who has been critical to the point of dismissiveness, and that is Jeff Rubin, former chief economist of the CIBC Bank in Canada. When asked at the 2010 ASPO-USA conference in Washington DC about his opinion of my work, he called it (paraphrased) “a bastardized form of monetarism devised by a non-economist”. I did not have a chance to respond at the conference, although I have challenged Mr Rubin to a debate on monetary theory on Jim Puplava's Financial Sense Newshour programme.