Published July 31, 2013

The Blindness of Modern Economists

Supposedly one of the top ten reasons to become an academic economist is that it gives you a chance to talk about money without ever having to make any. Also, you get to say "trickle down" with a straight face.

The contrast between mainstream academic economics and "real world economics" has always been stark, but today the disconnect is so enormous that it seems the two have nothing at all in common. If you were to ask Paul Krugman and Doug Casey how to fix what ails our economy, you'd get two diametrically opposed answers.

Here are some educated guesses why that may be the case:

  1. Mainstream economics relies heavily on mathematics, whereas real-world economics shuns it. In the hard sciences like physics or chemistry, fields based on immutable natural laws, focusing on math produces the best results. Economics, on the other hand, is a social science and attempts to explain human behavior—arguably the most fickle of actions, and no more mathematically quantifiable than the exact degree of mortification when throwing up on the dress of your 12th-grade crush at a high school reunion.  Which, of course, has never happened to anyone we know.
  1. In the hallowed halls of academia, you need not be correct to be useful. In the world of business, if you're wrong more often than you're right, you won't stay in business for long. In contrast, academic economists can and have made very successful careers out of being apologists for the regime. No matter that they've been dead wrong in virtually every forecast they've ever made: as long as their forecasts align with their peers', they can collectively claim, for example, that no one could have ever seen the financial crisis coming.
  1. Most academics believe that their work is worth more than the free market gives them credit for. That's not to say that academics' work is not important—it is. But there's a huge difference between thinking and doing, and those who are paid only to think rarely become wealthy. My guess is that academics are bitter about this fact, and believe that because the free market doesn't adequately reward them, there must be something wrong with it. They correctly understand that oftentimes, the only way for them to obtain a lot of money is to steal it via the government; and because that principle applies to their line of work, it must apply to all others too.
  1. The misguided belief that aggregate demand drives the economy creates a vicious cycle. Mainstream economists believe that aggregate demand—the total demand for goods and services in the economy at a given time and price level—is the wellspring from which all prosperity emerges, and so anything that increases aggregate demand must be positive, even otherwise wasteful government spending. Economists also use these as an excuse to make laughably rosy forecasts. After all, consumers spend more when they think the economy is growing like Jack's beanstalk, so why not add some more beans while we're at it? It's all for the greater good. We initiates, of course, know what awaits us at the other end of that lofty stalk.

Contrast that with real-world economists who are loyal to their investors, clients, or subscribers. If our Chief Economist Bud Conrad constantly made incorrect forecasts in order to help the economy recover, we wouldn't have any subscribers. That's why Bud tells it like it is—as he will in the upcoming issue of The Casey Report, in which he evaluates whether tepid GDP growth or soaring stock prices more accurately describe what's really happening in the economy.

I'm sure I've overlooked many other compelling reasons. But regardless of why economists differ, it's important to understand on exactly which issues they differ, and which understanding is correct.

This week's contributor is real-world economist Alasdair Macleod, head of research at GoldMoney. In a scathing article, Alasdair explains a few of the common errors mainstream economists make, the origins of those errors, and why they're wrong.

Enjoy, and see you next week.

Dan Steinhart
Managing Editor of The Casey Report

The Blindness of Modern Economists

By Alasdair Macleod, Head of Research, GoldMoney

The economic establishment failed to foresee the banking crisis five years ago. They then assured us that monetary stimulus was all that was needed to get economic growth back on track. Despite their abysmal track record, they continue with the same flawed Keynesian and monetarist beliefs, refusing to even consider they might be wrong. They are a collective of wise monkeys, seeing no evil, hearing no evil, and saying no evil.

The economic establishment blames today's evils on free markets, a lack of government intervention, and banks for being reluctant to lend. It blames government deficits on cheats who don't pay their taxes. I could go on; instead, I will attempt to identify the mounting dangers that face us all.

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.

Our collective of wise monkeys has no interest in the truth, because the truth earns them no nuts. For that reason, we must make up our own minds. We must understand that from the days of Keynes, the economic establishment has been egging on governments to progressively destroy individual wealth and liberty. The ownership of wealth has been replaced by debt, and savings replaced by bank credit. The financial crisis of 2008 was merely the end of this unsustainable road. It represented a systemic refusal to continue down this route.

Since then, central banks have sought to blow more air into the deflating credit bubble by creating more raw money. Central bankers are acutely aware that if they did not do so, many banks would go bankrupt. By subscribing to the GDP fallacy, they justify printing money to maintain government spending. Their naïve belief in the quantity theory of money persuades them that they need to print money to make prices rise by a targeted 2% per annum, and moreover that the relationship between the quantity of money and prices can be managed.

These combined errors lead central bankers to print too much money, a grave mistake illustrated by the chart below, which shows that growth rate of the US money supply is now at hyperinflationary levels.

True money supply is the sum of cash, checking and savings accounts, plus a few other minor deposit categories. This measure of the money supply quantifies deposits that can be withdrawn at short notice, making it superior to other measures. The black dotted line represents an exponential rate of growth—the fastest rate at which this measure of money can grow without eventually tipping into hyperinflation. Today, the actual money supply is about $3 trillion above the hyperinflationary level. Thus to avoid monetary hyperinflation, $3 trillion must be withdrawn from the Fed and bank balance sheets. Ain't gonna happen.

We are already seeing early signs of price inflation, closest to where the money enters the economy. The wonkish name for this is the "Cantillon effect." Asset prices are rising, and the cities that are major financial centers are thriving, with prices significantly above those in rural areas. Next, expect raw materials and commodities prices to rise as foreign exchanges try to recycle excess currency.

I find the complete blindness to monetary hyperinflation in the economic and financial establishment remarkable, even in my most cynical moments. But there is no consolation in this knowledge—only the drive to prepare for what I consider inevitable nasty inflation.

Alasdair Macleod first became a stockbroker in 1970 and a Member of the London Stock Exchange in 1974. His experience encompasses equity and bond markets, fund management, corporate finance and investment strategy.

After 27 years in the City he moved to Guernsey, where he advised a variety of offshore institutions as a consultant, becoming an executive director for an offshore bank in Guernsey and Jersey. 

He is currently head of research for