Comment on Steve Keen on ‘Why China had to crash: Part 2’
Blog-Reference
Because Orthodoxy is a scientific failure it is, indeed, an intuitively promising approach to start from the exact opposite assumptions.
Roughly speaking, you have shown that leverage, or more precisely, debt acceleration, is the ultimate cause of the boom/crash of the Chinese stock market. This is equally true for the subprime meltdown in 2008 and for the crash in 1929.#1
The general conclusion is that markets do not work as the textbook story suggests and that the supply-demand-equilibrium paradigm is empirically refuted for the financial markets.
The pervasive boom/crash phenomenon tells us that the institutional framework and, in particular, the monetary order in the U.S. is fundamentally flawed. The conclusion for China and other countries is to identify the defect and to come up with a superior institutional framework.
Until now, China has mainly adopted the U.S. financial market blueprint. Therefore, it does not come as a surprise that she crashes against the wall just like the U.S. did on several occasions since 1929.
Rethinking the actual stock market crash, China, first of all, has to ask herself (i) whether she needs a stock market in the first place, and if so (ii), whether her stock market should institutionalize the possibility of leverage.
The U.S. is not very talented at institution-building. The Wall Street/Fed configuration is not a success story. If China wants to overtake the U.S., it has to create a superior institutional framework.
In a sense, Modigliani-Miller was right: ultimately, it is a matter of indifference whether a firm is financed by equity or debt. And if equity is not needed, the stock market is not needed.
What China urgently needs is the correct economic theory. Financial crashes and persistent unemployment are the empirical mirror images of false monetary and employment theories. Standard economics has scientifically crashed; that is, China needs a superior approach. Can Heterodoxy deliver?
Egmont Kakarot-Handtke
#1 Mathematical Proof of the Breakdown of Capitalism
Showing posts with label Bubble. Show all posts
Showing posts with label Bubble. Show all posts
September 16, 2015
August 26, 2015
Quick rethinking of the stock market
Comment on Dean Baker on ‘Quick thoughts on the stock market and the economy’
Blog-Reference
The monetary order, banking, and the stock market are institutions that evolved historically. Like in biological evolution, the outcome of this messy process is often suboptimal. Institutions can and must be designed, constructed, and maintained. The U.S. is particularly bad at institution-building.
Mortgage financing, for example, is a very old and rather simple business. In Germany, it was institutionalized in 1900 with the Mortgage Banking Act. This law was so well-crafted that it worked with minor modifications until 2005, when it was abolished in an act of institutional suicide. This was when deregulation was the hype of the day, which lasted until Wall Street's meltdown. This financial mega-crash, first of all, showed one thing: what happens when you do mortgage banking the American way.
Remember that the investment banks literally invented and pushed subprime lending and the derivatives superstructure. No classical mortgage banker, neither in Germany nor in France, would ever have touched this type of business. It is important to realize that after 1900, there has never been a real estate boom-bust cycle in Germany. That is quite remarkable when one considers that Japan, the U.S., Britain, Spain, and many other economies have been badly devastated by real estate busts.
Interim results: (i) financial crises are the result of a bad institutional design, (ii) the U.S. is particularly untalented at institution building, (iii) in the international arena, according to a variant of Gresham’s Law, bad institutions crowd good institutions out, (iv) without well-crafted counter-measures the financial superstructure quite naturally deteriorates and becomes a menace to the real economy.
Therefore, the question is not: Does the stock market have an effect on the real economy? But should the stock market be allowed to have such an effect in the first place? Or, even more fundamentally, is a stock market needed at all, or can its useful functions be taken over by a better-designed institution and its negative impacts thereby eliminated?
The stock market wrecked the U.S. economy in the 1930s and in 2008. This is sufficient proof of a dilettantish institutional design of the financial sector, including the central bank. For China, the fundamental question is whether it needs a stock market at all. It should not be impossible for Chinese economists to come up with a superior institutional design that shields the real economy from dysfunctional international shifts between liquidity, stocks, and bonds.
With a plan B in place, China could let equities crash, buy the rest cheap, close the stock market, regain its full financial sovereignty, and live happily thereafter.
Rethinking economic theory is indispensable because neither Walrasians nor Keynesians have found out to this day how the market system works.
Egmont Kakarot-Handtke
Blog-Reference
The monetary order, banking, and the stock market are institutions that evolved historically. Like in biological evolution, the outcome of this messy process is often suboptimal. Institutions can and must be designed, constructed, and maintained. The U.S. is particularly bad at institution-building.
Mortgage financing, for example, is a very old and rather simple business. In Germany, it was institutionalized in 1900 with the Mortgage Banking Act. This law was so well-crafted that it worked with minor modifications until 2005, when it was abolished in an act of institutional suicide. This was when deregulation was the hype of the day, which lasted until Wall Street's meltdown. This financial mega-crash, first of all, showed one thing: what happens when you do mortgage banking the American way.
Remember that the investment banks literally invented and pushed subprime lending and the derivatives superstructure. No classical mortgage banker, neither in Germany nor in France, would ever have touched this type of business. It is important to realize that after 1900, there has never been a real estate boom-bust cycle in Germany. That is quite remarkable when one considers that Japan, the U.S., Britain, Spain, and many other economies have been badly devastated by real estate busts.
Interim results: (i) financial crises are the result of a bad institutional design, (ii) the U.S. is particularly untalented at institution building, (iii) in the international arena, according to a variant of Gresham’s Law, bad institutions crowd good institutions out, (iv) without well-crafted counter-measures the financial superstructure quite naturally deteriorates and becomes a menace to the real economy.
Therefore, the question is not: Does the stock market have an effect on the real economy? But should the stock market be allowed to have such an effect in the first place? Or, even more fundamentally, is a stock market needed at all, or can its useful functions be taken over by a better-designed institution and its negative impacts thereby eliminated?
The stock market wrecked the U.S. economy in the 1930s and in 2008. This is sufficient proof of a dilettantish institutional design of the financial sector, including the central bank. For China, the fundamental question is whether it needs a stock market at all. It should not be impossible for Chinese economists to come up with a superior institutional design that shields the real economy from dysfunctional international shifts between liquidity, stocks, and bonds.
With a plan B in place, China could let equities crash, buy the rest cheap, close the stock market, regain its full financial sovereignty, and live happily thereafter.
Rethinking economic theory is indispensable because neither Walrasians nor Keynesians have found out to this day how the market system works.
Egmont Kakarot-Handtke
June 3, 2015
Sitcom economics
Comment on Barkley Rosser on ‘On Missing Minsky’
Blog-Reference
Since Adam Smith economists have told rather enthralling stories about speculations, manias, follies, frauds, and breakdowns. The audience likes this kind of stuff. However, when it comes to how all this fits into economic theory things become a bit awkward. Of course, we have some 'modls' — Minsky, Diamond-Dybvig, Keynes come to mind — but we could also think of other 'modls' — more agent-based or equilibrium with friction perhaps. On closer inspection, though, economists have no clue at all.
Keynes messed up the basics of macro with this faulty syllogism: “Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (1973, p. 63)
From I=S all variants of IS-LM models are derived including Krugman's neo-IS-LM which allegedly explains the post-crash Keynes period. Let there be no ambiguity, all these models have always been conceptually and formally defective (2011).
Minsky built upon Keynes but not on I=S: “The simple equation ‘profit equals investment’ is the fundamental relation for a macroeconomics that aims to determine the behavior through time of a capitalist economy with a sophisticated, complex financial structure.” (Minsky, 2008, p. 161)
Here profit comes in but neither Minsky, Keynes, Krugman, nor Keen, nor the rest of the profession can tell the fundamental difference between income and profit (2014).
The fact of the matter is that the representative economist fails to capture the essence of the market economy. This does not matter much as long as he has models and stories about crashing Ponzi schemes and bank panics. Yes, eventually we will miss them all — these inimitable proto-scientific storytellers.
To have any number of incoherent models is not such a good thing as most economists tend to think. What is needed is the true theory: “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991, p. 30)
The true theory of financial crises presupposes the correct profit theory which is missing since Adam Smith. After this disqualifying performance, nobody should expect that some Walrasian or Keynesian bearer of hope will come up with the correct model anytime soon.
Egmont Kakarot-Handtke
References
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke: Macmillan.
Minsky, H. P. (2008). Stabilizing an Unstable Economy. New York, Chicago, San Francisco: McGraw Hill, 2nd edition.
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge: MIT Press.
Blog-Reference
Since Adam Smith economists have told rather enthralling stories about speculations, manias, follies, frauds, and breakdowns. The audience likes this kind of stuff. However, when it comes to how all this fits into economic theory things become a bit awkward. Of course, we have some 'modls' — Minsky, Diamond-Dybvig, Keynes come to mind — but we could also think of other 'modls' — more agent-based or equilibrium with friction perhaps. On closer inspection, though, economists have no clue at all.
Keynes messed up the basics of macro with this faulty syllogism: “Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (1973, p. 63)
From I=S all variants of IS-LM models are derived including Krugman's neo-IS-LM which allegedly explains the post-crash Keynes period. Let there be no ambiguity, all these models have always been conceptually and formally defective (2011).
Minsky built upon Keynes but not on I=S: “The simple equation ‘profit equals investment’ is the fundamental relation for a macroeconomics that aims to determine the behavior through time of a capitalist economy with a sophisticated, complex financial structure.” (Minsky, 2008, p. 161)
Here profit comes in but neither Minsky, Keynes, Krugman, nor Keen, nor the rest of the profession can tell the fundamental difference between income and profit (2014).
The fact of the matter is that the representative economist fails to capture the essence of the market economy. This does not matter much as long as he has models and stories about crashing Ponzi schemes and bank panics. Yes, eventually we will miss them all — these inimitable proto-scientific storytellers.
To have any number of incoherent models is not such a good thing as most economists tend to think. What is needed is the true theory: “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991, p. 30)
The true theory of financial crises presupposes the correct profit theory which is missing since Adam Smith. After this disqualifying performance, nobody should expect that some Walrasian or Keynesian bearer of hope will come up with the correct model anytime soon.
Egmont Kakarot-Handtke
References
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke: Macmillan.
Minsky, H. P. (2008). Stabilizing an Unstable Economy. New York, Chicago, San Francisco: McGraw Hill, 2nd edition.
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge: MIT Press.
October 27, 2012
Make a bubble, take a free lunch, break a bank {35}
Working paper at SSRN
Abstract Standard economics is known to be incapable of integrating the real and the monetary sphere. The ultimate reason is that the whole theoretical edifice is built upon a set of behavioral axioms. Therefore, the formal starting point is moved to structural axioms. This makes it possible to formally track the complete process of value creation and destruction in the asset market and its consequences for the household and business sector. From the set of structural axioms emerge the well-known phenomena of a bubble from free lunches through appreciation to defaults due to a lack of potential next buyers.
Abstract Standard economics is known to be incapable of integrating the real and the monetary sphere. The ultimate reason is that the whole theoretical edifice is built upon a set of behavioral axioms. Therefore, the formal starting point is moved to structural axioms. This makes it possible to formally track the complete process of value creation and destruction in the asset market and its consequences for the household and business sector. From the set of structural axioms emerge the well-known phenomena of a bubble from free lunches through appreciation to defaults due to a lack of potential next buyers.
July 12, 2012
General formal foundations of the virtuous deficit/profit symmetry and the vicious debt deflation {32}
Working paper at SSRN
Abstract A comprehensive dynamic model of the monetary economy that produces the key characteristics of debt deflation has been presented recently by Steve Keen as an alternative to conventional approaches. His model is based on a double-entry bookkeeping methodology but lacks an acceptable profit theory. In this respect, it is not different from familiar approaches. Clearly, a deficient profit theory prevents a proper understanding of how the real-world economy works. The present paper takes an entirely different route and places the core of Fisher's debt-deflation theory into the context of the consistent structural axiomatic approach.
Abstract A comprehensive dynamic model of the monetary economy that produces the key characteristics of debt deflation has been presented recently by Steve Keen as an alternative to conventional approaches. His model is based on a double-entry bookkeeping methodology but lacks an acceptable profit theory. In this respect, it is not different from familiar approaches. Clearly, a deficient profit theory prevents a proper understanding of how the real-world economy works. The present paper takes an entirely different route and places the core of Fisher's debt-deflation theory into the context of the consistent structural axiomatic approach.
Subscribe to:
Posts (Atom)