Comment on

http://ineteconomics.org/question/financial-crisis-blinders#comment-512

The question was asked

“Why did so many economist fail to predict the global financial crisis, and so many policy makers mishandle it – while some saw it coming?”

Here  is my response.

It was impossible to predict when the GFC would happen. It was only possible to predict that it would happen.

The economic system is chaotic because of the way we introduce new money tokens into the system.

Chaotic systems arise when we have positive feedback within the system. In the money system we have a positive feedback because banks are permitted to increase the number of money tokens in the system by monetizing assets through loans. The positive feedback occurs because banks can monetize loans as well as productive assets.  This inevitably leads to unpredictable behaviour in the system.  This system behaviour was explained first in Maxwell’s “On Governors” paper in Proceedings of the Royal Society Volume 16 – 1867-1868.

The monetary system cannot be predicted precisely while-ever we allow the creation of more money tokens by monetizing money tokens or loans.  We can predict that a GFC will occur but we do not know when it will occur.

The simple solution is to only allow existing assets to be monetized with existing money tokens – that is eliminate fractional reserve banking. However, that throws out the ability to monetize existing productive assets which does not necessarily cause chaotic behaviour.

The slightly more complex solution is to make the monetizing of loans unprofitable.  Monetizing loans is profitable if an asset bubble is permitted to continue. We can make asset bubbles unlikely by creating new money tokens to construct new assets in the area of the economy where the bubble is occurring.  So when a housing bubble starts to occur we increase the stock of houses by giving interest free credit to people who will build a new dwelling and attach the credit to the title of the house. This increases supply of houses and stops the bubble occurring.

The systematic method which will increase money tokens in a controlled manner so that inflation will not occur is to distribute new money tokens through interest free credit to the general population but require the new tokens to be invested in new productive assets.  There are many ways this can be done.  The one the world needs at the moment is to create productive assets that through their operation will reduce green house gases in the atmosphere.

This can be done by Rewarding people with interest free credit in inverse proportion to the amount of electricity they currently consume in their dwellings.  The interest free credit MUST be invested to build new productive assets that when they generate income also reduce the level of green house gases.  This creates a negative feedback loop that will reduce green house gas concentrations, increase the wealth of the people, and stabilise the monetary system.  It increases wealth because without interest costs almost all forms of renewable energy are profitable investments and almost all ways of saving energy are profitable investments.

Once we have a system where we can control the money supply through increasing supply when the price (interest rate) of existing money increases we have a controllable and hence, as Maxwell showed, a predictable system.

Such a system of Rewards can be applied to any area of the economy. We can stop the inflation of medical costs, increase the availability of fresh water, stop the concentration of industries, increase innovation etc.   The judicious use of interest free credit to create productive assets changes our economy from being driven by consumption to one which is driven by doing more with less.

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