Why Modern Economics Gets It Wrong

August 1, 2013 in Good Reads

Here’s some great wisdom from Alaisdar Macleod of Gold Money, via Casey Research.

There are four horsemen of the global economic apocalypse, all interlinked: the overburdened economy; broken banks; expensive interventionist governments; and a developing welfare and pension crisis. As a politician aptly described to me when I interviewed him a few months ago in Brussels, trying to squeeze out economic growth under these conditions is like trying to fly a plane with concrete wings. This simile applies best to the European Union, but it is also true in the US, Japan, and the UK.

The economic establishment will never understand the true causes of our economic problems by focusing on econometrics. For example, reliance on gross domestic product (GDP) is a major error. Faith in this money-total of all transactions is so ingrained that the fact it can only measure quantity, not quality, is never considered. GDP treats wasteful government bureaucracy and genuine production that satisfies consumer demand as one and the same. For that reason, GDP is not an accurate measure of progress.

As a result, the quality of economic transactions has deteriorated, and few seem to care or even notice. More government spending bolsters GDP, particularly when credit and money are issued out of thin air, which is why the Europeans so cherish their concrete wings. But it does not make us better off.

Monetarists also persist in their belief that the velocity of money is a predictive tool, either for changes in economic activity or the rate of inflation. This can be traced all the way back to David Ricardo at the time of the Napoleonic wars, who tried to link increases in gold quantity to increases in prices. Now, it is true that there is a very rough correlation between the two, but at the very best it was a summation of price effects when gold circulated as money, which it does not today. Today’s fiat currencies are devoid of all intrinsic value and depend on confidence for their purchasing power, which changes independently from supply factors, though supply can be an influence.

Ricardo suffered under the common delusion that prices were determined by costs, while any economist who truly understands prices knows that they are determined by the subjective opinions and desires of the consumer. Prices are not determined by a simple mathematical relationship, but rather people’s preferences for what they will buy and how much they will pay.

Monetarists unquestioningly rely on mathematics, which is only a valid method of study for the physical sciences. This leads them to ignore reality—like the reality that we earn our income once, and out of that we pay for our needs, pleasures, and savings—all on our own terms. Nor do we hoard our money, as they seem to think happens when velocity slows. There is no mathematical relationship to predict or illustrate these human dynamics.

It is no wonder that the greatest economist of the last century, Ludwig von Mises, wrote that “in the long run we are all dead” was the only correct declaration of the neo-British Cambridge school. He also concluded that Keynes merely wrote an apology for the prevailing policies of governments, a tradition followed by Keynesians and monetarists to this day.

You can read the full article here.

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