Monthly Archive: May 2018

Switzerland: Folk Economics bottled into “Sovereign Money Initiative”

“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”
(Friedrich von Hayek, 1988)

Irrespective of the quote above, there is a further difference between what economists know and what non-economists know. This can be summarised under the heading “folk economics”. There is an interesting observation here: If you (as a non-physicist) were engaged in a conversation with a physicist who tells you about string theory, you are unlikely to interrupt him and disagree with what he was telling you. An economist engaged in a discussion about the economics of obesity, for example, with a non-economist would be far more likely to be questioned about the views being put forward. If the economist told the non-economist that obesity was caused by the rise in poverty levels in countries, it is likely that there would be some disagreement with this view.

Sovereign Money Communism

The Swiss popular initiative ‘For crisis-resistant money: end fractional-reserve banking’ (Vollgeld-Initiative) will be put to a vote in a national referendum on the 10 June 2018. The initiative calls for the introduction of a sovereign money system in Switzerland. However, a sovereign money system could not prevent credit cycles and asset bubbles in real estate and financial investments. While lending may reinforce such asset bubbles, it does not cause them. Asset bubbles and credit cycles are primarily caused by exaggerated price expectations and a propensity to underestimate risks. The principal causes of the recent financial crisis could not have been circumvented under a sovereign money system. Chief among these are:

  • the belief that asset prices can go on rising indefinitely;
  • complex financial instruments with opaque risk liability (e.g. CDOs);
  • the accumulation of excessive amounts of short-term debt via the money and interbank markets;
  • and instability at investment banks with no deposit business.

Omitting a variable in a theory can lead to deceptive conclusions. When a theory is being used to support an argument about cause and effect, it is important to ask whether the movement of an omitted variable could explain the result. A second problem is what economists call reverse causality – we might decide that A causes B when in fact B causes A. The omitted variable and reverse causality traps require caution when drawing conclusions about causes and effects. It might seem that an easy way to determine the direction of causality is to examine the which variable moves first. If we see crime increase and then the police force expand, we reach one conclusion. If we see the police force expand and then crime increase, we reach another. Yet there is a flaw with this approach: people change their behaviour also in response to a change in their expectations of future conditions. A city that expects a major crime wave in the future might as well hire more police now. Or people make demands on credits in expectation of low interest rates.

The Scottish philosopher David Hume argued that no ought claim could be correctly inferred from a set of purely factual premises. This result is sometimes referred to as Hume’s Law, or the Is – Ought Problem. Hume found that there seems to be a significant difference between positive statements and prescriptive or normative statements, and that it is not obvious how one can coherently move from descriptive statements to prescriptive ones. You can only derive should claims from premises that include should claims. Yet the initiative backers’ arguments are exactly drawn this way.

Without flexible money expansion and contraction, such a centralised system strongly resembles the communist idea of a command economy. For understandable reasons the initiative’s backers hold a distaste for banks creating money, but a much more democratic and disruptive concept is about to change the world: