Need for a Change: Challenging Our Understanding of the Economic and Financial Systems

Aug 8, 2018 by

“Check the facts yourself. There is fake news. There is also fake science. There is even such a thing as fake economics. … Don’t take people’s word for it”. — Richard Werner, 31.07.2018

Students of the 5th Alternative Economic and Monetary Systems Summer Course trickled back into the lecture hall, returning from lunch in the park or discussions for the ongoing course project. Previous to lunch, students were lectured regarding money, banking, and financial markets. The afternoon’s discussion promised a critique on traditional economics and suggestions for monetary reform for sustainability.

The lecture was provided by Prof. Richard Werner of University of Southampton. To begin, he asked students to be critical of the information that is provided to them, priming students to be critical of traditional economics and their ‘conventional theories’. He introduced several anomalies that do not fit current economic thinking. He argues these anomalies justify re-examination of many of the past and current economic theories by asking what is the link between money and the real economy.

  • MV=PY

To illustrate this link, many of the economic theories over the last 200 years use the above simplified equation where M is money, V is velocity of money, P is price, and Y is nominal GDP.

Prof. Werner argued that there is no universal definition of money, complicating the above equation. Furthermore, there exists numerous axioms and assumptions. An axiom is a statement that is accepted as true without demonstration. For example, in economics, it is accepted that individuals are rational and self-interested, seeking to optimise their utility. Furthermore, many models assume perfect information, complete markets, perfect competitions, zero transaction costs, markets regulate themselves, among others. However, these axioms and assumptions require empirical evidence to demonstrate validity.

  • Scientific Approach to Economics

Prof. Werner demonstrated that there is less than 1% probability of all of the assumptions in economics being statistically valid. As such, he advocates a scientific approach to economics, one that relies on inductive reasoning (as opposed to deductive reasoning) and empirical data to illustrate the functioning economy and challenge the axioms as well as assumptions of economics.

“Why have we seen so little progress in Economics?”

Ultimately, Prof. Werner illustrated throughout his remarks the need for a new monetary and financial system reform. Contrary to common conception, central banks are not the primary creator of money; in fact, credit creation is predominantly carried out by banks, where the central banks are only responsible for 3% of money creation. And, much of the credit creation by banks is being used in asset markets, which lead to asset bubbles and patterns of boom and bust.

Therefore, in his proposal for monetary and financial reform, he distinguishes between asset markets and the real economy. He advocates a new system, in which the real economy dominates. This means that credit creation is leveraged for productive purposes (investments in the real economy that support development and protects the environment, which can lead to economic growth) as opposed to asset markets.

Prof. Werner used the examples of the Central Bank of England and the European Central Bank, although there are others, which advocate for the centralisation of power and decision making in fewer financial institutions. In order to avoid the concentration of power in the central banks, he argues for the support and development of local and community banks, creating a network of decentralised banks. This would allow for citizen and community involvement in banks, which create credit for local initiatives.

The last day of July 2018 proved to be hot, with temperatures in the mid 30s. This heat was also felt among the audience as our conceptions and perceptions were challenged by Prof. Werner. In keeping with his rally-cry for critical thinking, we advocate that fellow students and readers continue to research the current financial and monetary markets.

Written by: Steven Curtis and Riccardo Iudica

Based on the lectures by: Richard Werner (“The flaws of traditional economics and the use of scientific methods to analyse money and banking” and “Key issues for sustainable monetary reform”)