Science with little proving evidence?

Aug 5, 2019 by

Richard Werner started their lecture with anomalies that monetary economics and macroeconomics live with and looked at the link between “money” and “economy”. Although lay people would connect the economy with money and banks, neo-classical and other orthodox economics do not cover these topics. The relationship of quantitative theory  MV=PY between money (M), the velocity of circulation (V), price level (P) and the sum of goods and services (Y) suggests a link, but the problem to define money is bypassed by making “M” the demand for money and focussing on prices. Werner showed statistical proof of decreasing value of transactional velocity, so the textbook-link should be considered broken.

Although the widespread inductive approach of science exists, economists prefer the deductive approach following initially set axioms and assumptions. Werner considers this to be problematic, because, in their view, economists make conclusions without evidence, without a study that shows if the theory works in practice. Hence economists come to conclusions, such as “Lower interest rates stimulate economic growth and vice versa” on the assumption of equilibrium, which again is based on eight unprovable assumptions on markets. Werner showed the results of studies which indicate that the above stated negative correlation does not hold and – on the contrary – a positive one is supported. Causation also can be extracted from the data, although the question of a third factor engaged is still open. This is cognitive dissonance.The dominant state is pervasive disequilibrium.

Richard Werner distinguishes three theories of banking on how credit is generated

  1. banks as financial intermediaries (deposits are lent to creditors)
  2. fractional reserve theory (banks give out more credit than deposits are in the vault)
  3. credit creation (credit is created by the bank’s ex nihilo, no deposits needed)

and mentioned their empirical test, showing point 3 is effective nowadays.

Two cases in creating money have to be distinguished, of which Werner only elaborated on the second:

  1. Banks do not take so-called deposits. They take the money of the customers and use it for their own purposes. To compensate for this so-called depositor, they make themselves a debtor/borrower to them, promising to deliver cash and/or execute payments for them.
  2. Banks do not lend out money. When granting credit to somebody, they purchase the promise to pay back from him and pay that by making themselves a debtor/borrower by writing a number on the creditors running account.

This is, what makes banks unique.

Werner also asserted that the abolition of cash, as an increase of central bank power, should be avoided. They stated that any new cryptocurrencies are not outside the system, as they are presented, but rather a continuation of the same system.

Werner concluded that credit creation should be guided to productive purposes. Credit guidance, in the sense of common good, is necessary to justify the power of banks to create money ex nihilo. With this power, banks shape the world. They determine where the money goes.

In order to change this, the power to create money should be nearer to the people than to the central banks. This involves small regional non-profit oriented banks lending to regional small and medium enterprises. This would change things from the bottom to the top.

In their lecture, Richard Werner questioned the concepts of the velocity of money, the equilibrium of an economy and the inverse correlation of interest rates and economic growth by showing evidence. Their arguments are concise. Their description of money creation by banks is in accordance with publications of major central banks.

Written by: Leidy Rodriguez & Hans-Florian Hoyer

Based on the lecture “What is wrong with the current financial system?” by Richard Werner held during AEMS 2019.