GUEST OPINION: Mainstream Money Myths

By on March 8, 2016

A small group of elite players continue to paint a false narrative of American economics.

160309GuestOpinionJACKSON HOLE, WY – When you advocate, as I do, for government to raise taxes and spend money on things like housing or schools or essential public services or better regulation, you get a lot of negative feedback from a very vocal minority.

These mostly take the form of arguments based on assumptions from mainstream economic theory; assumptions like “taxes are bad” or “the free market knows best.”

Mainstream economic theory has been dominant at all levels of government and academia for the past 30 to 40 years. Because there is very little dissent among elite opinion, many voters have been led to believe that it is a science. But it is not.

Real scientists use experiments to test provable theories based on hypotheses. Economists construct models based on grossly simplified imagined realities, and then try to pass off their results as science. Don’t believe me? Consider the Efficient Market Hypothesis (EMH).

EMH attempted to model the real economy, but because that was too hard, it’s creator, Eugene Fama, decided to simplify by making some assumptions. In his model, he assumes that all actors have perfect and complete information of the past, present and future, and assumes that they can process it perfectly—basically a God computer. All actors are also completely rational and have perfectly aligned incentives. Because of this, prices reflect all public and private information.

None of these assumptions are even remotely realistic of course, and EMH has taken a lot of the blame for the financial crisis of the late 2000s. Yet Fama not only won a Nobel prize for this theory, he is still employed by the University of Chicago as a respected economist.

How about the demand curve? The downward sloping demand curve is taught as gospel in every Econ 101 class ever offered, and the law of supply and and demand is fundamental to most mainstream economic theory.  Yet it literally falls apart when it models more than one individual. In order for it to work, its creators assume that all consumers are perfectly identical, or they assume that there is a “benevolent central authority that redistributes wealth in order to maximize social welfare.” (Mas-Colell, Microeconomic Theory)

Does this sound remotely realistic?

Yet theories of market equilibrium, which free market proponents rely on, are founded on these assumptions.

And these are the kinds of assumptions economists make in order to make their models work. They assume things that don’t exist, and ignore things that are inconvenient. Most macro-economic theory, for example, completely ignores the role of banks and money. That sounds unbelievable, yet it’s true. Does that sound like a science to you?

It isn’t. And it should call into question some other assumptions. Mainstream economists constantly talk about government debt and the deficit, as though the U.S. is in danger of going into bankruptcy. But a government like ours, with debt denominated in its own sovereign currency, can literally never default unless it chooses to. When pressed, economists will admit that is the case, but will then talk about hyperinflation, a ludicrous concept for a country in a deflationary period, and something that has only happened in countries experiencing large external shocks. (Germany in the 1920s, for example, or Russia after the collapse of the Soviet Union.)

The political establishment in the U.S. knows the severe limitations of mainstream economics, but ignores them when it’s useful. When a policy that helps average Americans is proposed (universal health care, for example), they are united in their demand that we listen to the economists who tell us we have to balance the budget first. Yet when a policy is good for them (the Iraq War, or $1.5 trillion for a useless fighter plane), you won’t hear a peep.

How bad is current economic theory? Economists completely missed the great financial crisis of 2008, and were still in denial even as it was happening. It didn’t fit their models, so they didn’t believe it was possible, even though their models were based on assumptions of reality that have never existed at any time or place in the history of the world.

This would be like the entire astronomy profession missing an asteroid the size of the sun entering the solar system and heading directly for Earth. The only difference is that the astronomers who failed to predict it would never work again, while economists who miss similar events—Alan Greenspan, for example—get to keep running the Federal Reserve.

Why is all of this important? Well, a lot of people base their opposition to policies, that would evidently help them, on their belief in economic theories that are demonstrably false. They’re acting against their own self-interest (something that, ironically, EMH considers impossible) because of it.

And getting people to vote against their own self-interest through beliefs in complex but discredited economic theories is a dream come true for elites, who are able to sell people on policies that hurt them terribly, like NAFTA and cutting taxes for the rich.

Locally, people who believe in these theories (I think of them more as a religion) are often morally opposed to things like taxes, minimum wages or regulations of any kind. They mean well, but they base their beliefs in theories that can’t withstand any real scientific scrutiny and have zero predictive power. That’s not science.

It’s important to note that this is not a conspiracy. Most economists probably believe they practice science with their intentionally complex models; models that leave the vast majority of voters few options but to trust them. The result? Economists find themselves in the role of high priests of the economy, and the rest of us at their mercy.

“It is well enough that people of the nation do not understand our banking and monetary system,” Henry Ford once said, “for if they did, I believe there would be a revolution before tomorrow morning.”

The same can be said for economics. PJH

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