Thursday, April 23, 2009

Gunnar Tomasson Interview by Tony Wikstrom

Questions and Answers

Tony Wikström and Gunnar Tómasson

Economist Gunnar Tómasson was born in Iceland but is currently living in Maryland,USA.After studies at Manchester University and Harvard he was employed for a long time by the International Monetary Fund.

He's a member of an international group of economists called "Gang8". The group emphasizes what they call "Creditary Economics". Gunnar Tómasson explains:

It is a fundamental mistake to view money as an undifferentiated unity. Money comprises credit used for both productive and non-productive purposes. That is, credit extended by the credit system to finance production, on the one hand, and the vast majority of credit extended in recent years for financial speculation, on the other hand.

Financial speculation doesn't produce real output, and the failure to distinguish between productive credit and what may be called parasitic credit - or credit that doesn't give rise to or facilitate productive employment - represents the single most important flaw in both mainstream monetary economics and the monetarist approach.

1. The financial crisis we're experiencing around the world right now has not come as a surprise to you. Why is that?

I have always looked at economics as a means of understanding developments in real-world economies. This is what attracted me to economics while still in high school in Iceland in the late 1950s. Later, after undergraduate work at Manchester University and graduate work at Harvard University , I joined the staff of the International Monetary Fund in 1966. During the next ten years, I worked on the economies of post-Sukarno Indonesia , and Cambodia and South Viet-Nam under war conditions, including service as resident IMF representative for five years in these countries between 1968 and 1975.

In 1976, I began work on a Ph.D. thesis at Harvard planning to transform my practical experience into useful theoretical work. But I soon realized that mainstream monetary theory was irrelevant for most of the financial policy issues with which I was familiar. Therefore, I discarded my initial thesis topic and turned my attention to what I felt certain was some still-to-be- identified flaw in Paul Samuelson's 1942 Harvard Ph.D. thesis, his so-called 'Foundations of Economic Analysis'.

I soon discovered the flaw - it resided in Samuelson's use of a certain conceptual scheme from 19th century Newtonian mechanics, the so-called general equilibrium model. When properly construed, this model is logically inadmissible in theoretical economics. Or, as Keynes wrote to a colleague in the 1930s, all general equilibrium economic models are "little better than nonsense". I wrote a letter to Samuelson, explaining the flaw. He replied that while there are few expert in both physics and economics, he was confident that any such would not agree that I had found an error in his work. In my own case, no expertise in physics was required while in that of Alan Greenspan, developments in real-world financial markets in 2007 drove home the presence of a fatal flaw in mainstream monetary theory. Or as Greenspan recently advised a U.S. congressional committee in this respect, "The whole intellectual edifice collapsed in the summer of [2007]."

That may have been so for Greenspan himself, but in December 1996 I advised his fellow Federal Reserve Governor Laurence Meyer as follows: "It is fair surmise that [Fed and IMF] macro-economic forecasting models predicated on mainstream monetary thought, which have detected no signs of a global crisis during the rapid rise in the ratio of paper wealth to real output during the past quarter century, are once again setting policy-makers up for a nasty "surprise"." This key ratio reached a tipping point in 2007, collapsing the pseudo-intellectual edifice which has informed the monetary policy views of the Federal Reserve and the IMF since the demise of the Bretton Woods system in the early 1970s.

2. You have called today's monetary system "systematic anarchy". What do you mean by that?

The phrase I used was "systemic anarchy" by which I mean that today's world monetary system has operated free of any internationally agreed rules or regulations since the early 1970s.

3. For years people have been fed the "truth" that the market is always right, that the market "demands" this and that, and that economic forces are pure mathematics, reliable as clockwork. Are those ideas dead now, and how will the economists of the future look at our beliefs of the last decades?

The brief answer is Yes - in fact, they were dead on arrival in 'Foundations of Economic Analysis' where Samuelson presented them in such inscrutable language that his Harvard professors must have ok'd them without knowing what they were doing.

For example, Samuelson asserted that "[A]ny sector of economic theory which cannot be cast into the mold of [a general equilibrium] system must be regarded with suspicion as suffering from haziness." If that were true, then it would be doubly true of any sector of economic theory which is actually cast into such a mold because money has no place in a market economy viewed as a system in general equilibrium.

Later, this fact was reflected in the mainstream notion that money does not matter - a truly absurd idea which vanished from mainstream orthodoxy after becoming a public embarrassment. Yet, it seems to be reappearing as the unspoken premise of the trillion dollar money creation by the Federal Reserve System which his economic advisors are recommending to President Barack Obama.

As for the clockwork aspect, it came into the picture through what Samuelson called "the Correspondence Principle between comparative statics and dynamics" and heralded as a key for arriving at "operationally meaningful theorems" (none of which has ever seen the light of day). Alas, there are simple technical reasons why the Correspondence Principle is nonsense. If that were not so, the late James Tobin, the foremost mainstream monetary scholar, should have been able to fit an economy's income and capital accounts within a unitary conceptual framework. After what may have been a quarter century's attempt to do so, Tobin apparently recognized that it cannot be done.

And how will the economists of the future look at our beliefs in the last decades? Briefly, I think they will marvel at their intellectual vacuity.

4. We are seeing how governments around the world, especially the US , are pumping huge amounts of money into the system in order to, as they say, help the patient recover. Will this work?

In my view, the patient is the structure of monetary and economic arrangements at both national and international levels. Thus, the medicine needed for the patient to recover is likely to be complex both in design and execution before sustainable recovery is attained.

5. So are the doctors willing and able to use the needed medicine, or will they jumpstart the heart and send the patient home with a jar of powerful painkillers?

The doctors have yet to come to terms with the causes of the illness. They assume it was not caused by the diet which the patient was fed by mainstream academics and the IMF over the years, and are now testing the hypothesis that more of the same will make the patient feel better. For the time being, therefore, the recommended cure, especially here in the United States but also in Europe , is for central banks to administer massive amounts of credit to the patient. This may bring temporary relief but it does not address the problem which got the patient sick in the first place: mainstream orthodoxy and the financial policy prescriptions of the socalled Washington Consensus.

6. Last summer people where shocked to learn that USA had a debt of more than 7 trillion dollars, which has increased since then, dramatically - how long can the world's only superpower stick it out? Is this a modern version of the fairy tale "the emperor's new clothes"?

After the collapse of the Bretton Woods system in the early 1970s, the United States has enjoyed the dubious privilege of a seemingly unlimited overdraft on its account with the rest of the world. This must now change one way or another.

7. But in your opinon, is it realistic to assume that the US will be able to repay its debt without seriously compromising basic social services?

It is clear that the United States cannot repay its debts. I think Adam Smith made the point in ‘Wealth of Nations' that no sovereign state has ever repaid its debts. Instead, states have resolved their debt problems through monetary inflation which erodes the burden of debts designated in their currencies. And inflation is the likely result of the massive money creation which is now being undertaken by the Obama administration.

8. There have been warnings of a future hyperinflation. Do you think that may happen?

Well, this is a very speculative issue. There are so many unknowns. We just don't know all relevant parameters of the world economy on which to base predictions in this respect. My guess is that world monetary arrangements will continue to unravel and that global economic conditions will not improve any time soon.

9. You have said that for a real change to occur everything must go to hell in a handbasket. Otherwise the experts set to reconstruct the system will come up with the same ideas. Can the system be salvaged?

No, the system cannot be salvaged. But established financial and economic arrangements generate powerful vested interests which will resist fundamental changes which threaten their privileged status. Mainstream orthodoxy would certainly not be the first ideology which vested interests will defend to the bitter end.

10. So how would you define "the bitter end"?

I don't want to put that thought into words but it will be ... very, very messy.

11. What do you think will happen in the next few years? Is there something to hope for?

There is much to hope for once the world community draws appropriate lessons from its ongoing financial and economic trials and tribulations. I have long been of the view that the International Monetary Fund can and must become a forum where the nations of the world join forces and cooperate in the task of reconstructing the international monetary system. There is much work to be done before the essential elements of a future system can be specified, but clearly the U.S. dollar era is coming to an end.

12. So what is coming instead? A new global currency?

In my view that would be the ideal solution. For the past forty years we have had such a global currency in embryonic form in the IMF's special drawing rights. At the planning stage for what became the IMF, John Maynard Keynes envisaged an organization where individual member countries would have access to agreed overdraft facilities. Thus, their economic and monetary policies would be tailored to suit the means available including, if necessary, overdrafts from the IMF. Such overdrafts would be substantively different from those which the US has been using to finance its external transactions in that they would be mutually agreed between all IMF members.
In short, I envisage the International Monetary Fund as an ideal forum for a collaborative effort by its members to reconstruct future world monetary arrangements, and I consider an appropriate international currency administered by the world community through the IMF to be the only workable means of restoring the world economy to monetary health.

13. The Aaland islands are an autonomous part of Finland and unfortunately the fall decrease of the economy has cut our contribution by about 10%. Do you have any opinions or ideas of how microstates should manage their economy in times like these?
These are technical issues which my home country Iceland must address urgently in the period ahead. I do not know much about the economy of the Aaland islands , but I would expect that they face some of the same problems. Open lines of communication between them might therefore be in the interest of both countries.

14. As more and more people are losing their jobs, and see their funds and holding reach new lows the anger builds up... and there's this collective hunch that was is being done to energize the economy right now isn't in the best interest of the average Joe, but for a rich elite. How would you comment on that?

I must say that I agree, because the anger is certainly justified. But there is no question that those who give advice to policy makers, for example President Obama's economic team, provide what they view as sound policy advice. If it proves wrong-headed, then that is because they were taught, and have worked for decades with, nonsense economic ideas dressed up in mathematics and econometrics. Misguided education leaves its mark on mainstream policy advisers because orthodox economics is ... nonsense.

Source : Gang of 8

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