0:00:00.128,0:00:05.573 The question was phrased very generally - why don't academics understand money 0:00:05.573,0:00:12.557 and I have chosen actually to look at it from the standpoint of academic economists because I am one 0:00:12.557,0:00:16.893 and that's what I know and there are some interesting things I think to say about that. 0:00:16.893,0:00:25.745 And the rest of the academics would look to us for answers claiming that it was our area of expertise 0:00:25.745,0:00:30.663 and we ought to be able to enlighten them. 0:00:30.663,0:00:39.345 And it is a very strange fact of fate that I have been in this business long enough 0:00:39.345,0:00:48.894 for the kind of understanding that you've been exposed to today and through where money comes from and this new book, 0:00:48.894,0:00:56.025 to constitute a return to what I was taught as an undergraduate. 0:00:56.025,0:01:03.307 Dennis Robertson, Cambridge economist used to say, "highbrow opinion is like a hunted hare. 0:01:03.307,0:01:07.903 If you stand in the same place long enough it will come around again". 0:01:07.903,0:01:19.064 Well, it has come around again and so the shocking thing to me is the amount of energy 0:01:19.064,0:01:24.186 that people in Positive Money and NEF and places like that have to expend 0:01:24.186,0:01:30.224 to get a point of view across which was taught to me as an undergraduate and then forgotten. 0:01:30.224,0:01:40.704 So there has been a regression from the understanding you are presented with today 0:01:40.704,0:01:50.103 and which pertained in the late fifties and early sixties and now we are fighting to restore that understanding. 0:01:50.103,0:01:54.947 [br]And that´s a very peculiar state of affairs and I hope, 0:01:54.947,0:02:01.624 just to give you a few ideas, no more than that, as to how it might have come about. 0:02:01.624,0:02:11.104 The question has to be treated in two parts, according to a very strange split 0:02:11.104,0:02:17.546 in the way that money is talked about in academic economics. 0:02:17.546,0:02:25.268 First of all, it has a role to play in what we call macroeconomics, and I think most of you have got a pretty good idea of what that is, 0:02:25.268,0:02:36.945 it is the theory of the economy as a whole, and the policies that you might use to change the economy in some way from time to time. 0:02:36.945,0:02:46.307 And then, quite separate from macroeconomics, there are always courses in money and banking, 0:02:46.307,0:02:57.225 the macroeconomics is sort of thought of as a core part of economics and money and banking are kind of an optional slightly frivolous thing 0:02:57.225,0:03:03.892 that some people spend a little time thinking about. 0:03:03.892,0:03:10.905 So, what I have to say will fall into those two parts. But they are, it turns out, connected. 0:03:10.905,0:03:23.344 In macroeconomics money in the mainstream of economics has a very limited sphere of influence. 0:03:23.344,0:03:31.664 And it doesn't connect at all well even with the kind of money and banking 0:03:31.664,0:03:37.641 which is taught as this frivolous option that I spoke of 0:03:37.641,0:03:48.904 Keynes, John Maynard Keynes, in his famous letter to George Bernard Shaw, said when he was writing the General Theory, 0:03:48.904,0:03:59.588 that he thought that what he was writing would revolutionise the way the world thought about economic problems. 0:03:59.588,0:04:05.808 And later on, in a small article, he spelt out what was different 0:04:05.808,0:04:11.185 about the kind of economics he was creating, from what had gone before. He said, 0:04:11.185,0:04:23.663 "I want to talk about a money production economy, and the kind of economics that we have been doing, is about a real exchange economy." 0:04:23.663,0:04:31.344 That was his basic contrast, that was what he thought would be his big revolution. 0:04:31.344,0:04:36.703 His was a theory in which money permeated the entire economy. 0:04:36.703,0:04:45.224 Labour bargains for money wages, saving and investment were analysed by him in money terms, the rate of interest 0:04:45.224,0:04:50.744 was a monetary phenomenon, and it was determined by exchanges of money assets. 0:04:50.744,0:04:57.184 All these aspects are missing from today's mainstream economics as they were, 0:04:57.184,0:05:01.343 from the economics which surrounded Keynes when he was writing. 0:05:01.343,0:05:07.824 We have gone back in mainstream economics, to talking about a real exchange economy 0:05:07.824,0:05:13.726 which has an extremely limited role for money. 0:05:13.726,0:05:23.345 Classical economics, or pre-Keynesian economics, models everything in real terms. It's real wages, 0:05:23.345,0:05:30.643 that is to say, the amount of goods wages can buy, and so on down the line. 0:05:30.643,0:05:38.870 And money is only brought in at the very last minute to determine prices. So the role of money is separate 0:05:38.870,0:05:47.892 from this whole analysis of the real economy, has this little role to play, in determining the price level. 0:05:47.892,0:05:57.225 The term "pure economics" as used by Alfred Marshall and Walras, 0:05:57.225,0:06:04.064 meant the economics of this real economy, this barter economy. 0:06:04.064,0:06:08.557 So by implication, money is profoundly impure I suppose. 0:06:08.557,0:06:17.809 And the idea was that money was neutral. It didn't really affect these real relationships. 0:06:17.809,0:06:19.904 All it did was determine prices, 0:06:19.904,0:06:28.824 and prices could be anything; didn't really matter. The real relationships were set up by the system elsewhere, 0:06:28.824,0:06:33.984 without money, the pure economy, the barter economy, the exchange economy. 0:06:33.984,0:06:45.585 And this kind of system, dividing the economy between the real and the monetary, was known as the classical dichotomy, 0:06:45.585,0:06:52.142 and on the monetary side, you had the Quantity Theory of Money; 0:06:52.142,0:06:55.309 the quantity of money determined prices, full stop, end of story. 0:06:55.309,0:07:00.943 Not very interesting actually, for a role for money. 0:07:00.943,0:07:04.557 Now, Keynes showed that the Quantity Theory of Money was based on 0:07:04.557,0:07:10.141 enormously restrictive assumptions, which were very unlikely to pertain in practice. 0:07:10.141,0:07:19.307 But Milton Friedman, whose name I am sure you know too, was able to use the Quantity Theory of Money, 0:07:19.307,0:07:28.063 as the foundation of his monetarist revolution in the late sixties, early seventies. 0:07:28.063,0:07:40.583 And, as I am sure you know, the monetarist revolution touched the heart of Margaret Thatcher, and found its way into monetary policy. 0:07:40.583,0:07:49.664 Monetarism, you may not know, but you ought to, is also the basis of the construction of the Euro. 0:07:49.664,0:07:54.224 Can't have been very good then, can it? [laughter from audience] 0:07:54.224,0:08:02.141 And determines the way that the ECB is doomed to function, 0:08:02.141,0:08:07.664 and is responsible for inflation-targeting more generally in the Western world 0:08:07.664,0:08:14.863 and it could be said, to be the foundation also of Quantitative Easing, though that interpretation is open to some dispute. 0:08:14.863,0:08:18.063 So monetarism, and the Quantity Theory of Money and the classical dichotomy 0:08:18.063,0:08:28.225 are all over Western economies like a kind of skin disease, quite extraordinary. 0:08:28.225,0:08:36.224 And the Keynesian story, in which money influences everything that happens, has been forgotten, 0:08:36.224,0:08:40.141 which is I think, a tragedy. 0:08:40.141,0:08:51.624 Now, this simple, sequestered role of money, in an analysis which uses the classical dichotomy, 0:08:51.624,0:09:05.303 gives rise to some wonderful supporting rhetoric. After all it must be more interesting to study the real economy 0:09:05.303,0:09:12.201 than the monetary economy, the real economy as the pure economy. 0:09:12.201,0:09:19.824 Money is imagined to be only a veil thinly drawn across the real economy, and not affecting anything. 0:09:19.824,0:09:31.584 And anybody who thinks that it does affect anything is subject to money illusion, which is a terrible mental illness. [laughter from audience] 0:09:31.584,0:09:40.824 Now how does this happen? What is the appeal of this way of analysing the economy, when we know actually, 0:09:40.824,0:09:45.546 if we keep our common sense about us, that money does affect everything? 0:09:45.546,0:09:52.023 Well, one reason as pertains to academic economics and not to common sense people like yourselves, 0:09:52.023,0:10:02.223 is that economics does not really understand its discipline to be historically-situated. It thinks of itself as covering universal truths, 0:10:02.223,0:10:09.224 and it, therefore, fails to recognise the institutional basis of its theories. 0:10:09.224,0:10:15.503 The Quantity Theory of Money was devised in the days of circulating gold coin, 0:10:15.503,0:10:24.063 not in the days when banks were overwhelmingly the suppliers of money. 0:10:24.063,0:10:35.783 And yet, the Quantity Theory of Money has been carried forward, and as I told you, has influenced major institutions to this day. 0:10:35.783,0:10:42.201 The idea that money should have something to do with the determination of prices has a certain intuitive appeal, 0:10:42.201,0:10:46.201 and of course it does have something to do with the determination of prices, 0:10:46.201,0:10:53.224 but the Quantity Theory of Money says that its only function is to determine prices, 0:10:53.224,0:11:01.385 and prices are determined solely by the quantity of money, and that is going far too far. 0:11:01.385,0:11:14.784 Another possibility of explaining how macroeconomics has come to this pass is sheer laziness. 0:11:14.784,0:11:21.623 Hayek, an unlikely source for what I am going to read to you, put it like this, 0:11:21.623,0:11:26.184 "The task of monetary theory is much wider than is commonly assumed. 0:11:26.184,0:11:32.624 Its task is nothing less than to cover a second time the whole field which is treated by pure theory" 0:11:32.624,0:11:45.451 - pure theory, real theory - "under the assumption of barter, and to investigate what changes in the conclusions of pure theory are made necessary". 0:11:45.451,0:11:50.618 So if you want to take money seriously, you have to do the whole thing again. 0:11:50.618,0:11:58.201 I think Keynes did do the whole thing again, and he's been wiped off the face of mainstream economics. 0:11:58.201,0:12:02.224 He's not taught, nobody knows what he said, nobody reads his book. 0:12:02.224,0:12:06.863 We have regressed to pre-Keynesian economics. 0:12:06.863,0:12:20.225 Now, let me return to this separation between macroeconomics and money and banking that's enshrined in the academic curriculum. 0:12:20.225,0:12:33.984 As I said, when I was a student in the late fifties and the early sixties, it was widely understood, absolutely taken for granted, 0:12:33.984,0:12:41.823 that the causality went from loans to deposits. Loans create deposits. 0:12:41.823,0:12:51.384 Now, students are all taught that banks lend on deposits, that deposits create the ability to lend, and banks respond to that. 0:12:51.384,0:13:05.451 This is a regression, which people like Ben are trying to redress, or reverse. 0:13:05.451,0:13:17.543 And again I try to think of reasons why this idea of deposits pre-existing and determining the volume of loans, has such a tremendous appeal, 0:13:17.543,0:13:25.464 and why the idea that loans create deposits is so difficult for people to grasp. 0:13:25.464,0:13:30.451 One factor is that there is a great fault in the language that we use, 0:13:30.451,0:13:35.984 or a great bias in the language that we use in relation to banking. 0:13:35.984,0:13:43.544 The word "deposit" is a hangover from the days of the goldsmiths, who took bags of gold for safekeeping, 0:13:43.544,0:13:54.600 and you will find if you look closely, that much of the neo-classical theory of banking, still regards these as kinds of glorified safes, 0:13:54.705,0:13:58.824 which they clearly are not. 0:13:58.824,0:14:03.787 Add to this the failure to understand banks as a system, as an interrelated system. 0:14:04.018,0:14:12.951 You heard much in the breaking of the crisis about a lack of systemic understanding; of risks that the banks were running. 0:14:12.951,0:14:23.700 If one did think systemically, one would realise easily, that the cheque you deposit in your bank, came from somebody else's deposit. 0:14:23.700,0:14:30.344 It's not new money at all. It's just moving around. 0:14:30.344,0:14:38.868 And then if you think systemically or macroeconomically about banks, there are very few sources of new money to the system, 0:14:38.868,0:14:46.784 except when banks are all expanding their balance sheets together, and that's what you've seen in the graphs, 0:14:46.784,0:14:52.784 those such powerful graphs, that have been shown to you. 0:14:52.784,0:15:00.343 So the language is bad. And we also speak of banks "lending money". 0:15:00.343,0:15:08.344 Banks do not lend money. It may feel like that when you get a loan, but that's not what they are doing. 0:15:08.344,0:15:15.426 They don't have a pot of money which they are passing on. What they are doing is accepting your IOU, 0:15:15.426,0:15:21.385 and agreeing to pay your outgoings while you don't have any money in your own account; 0:15:21.385,0:15:29.201 in an overdraft system. In a loan system they simply write-up your account. 0:15:29.201,0:15:37.026 Now, we've spent the whole morning talking about that, and you know that, but this leads us to another point which is very powerful, 0:15:37.026,0:15:48.201 which illustrates that it's in the bankers' interest not to let you know what they are doing because you really wouldn't like it. 0:15:48.201,0:15:52.623 They have too much power. 0:15:52.623,0:16:00.907 And others, including academic economists, might not like the power of bankers to be recognised either, 0:16:00.907,0:16:10.823 they know that if they expose the bankers they will be in deep trouble and their funding will be cut and all kinds of terrible things will happen to them 0:16:10.823,0:16:20.143 so they go along with it. You've all seen, "Inside Job", I take it. It's a kind of "inside job" problem. 0:16:20.143,0:16:24.664 Furthermore, there's a long history of wanting to believe that money is something real. 0:16:24.664,0:16:31.143 The idea that bankers can manufacture money with the flick of a pen is just too unpalatable. 0:16:31.143,0:16:46.033 And that leads to rejecting it. The idea that it should depend for its moneyness only on the fact that we all accept it is just too freaky for words. 0:16:46.033,0:16:51.344 So it doesn't come into the textbooks. 0:16:51.344,0:16:59.034 It would also make it very clear that money is very fragile. Once that trust is breached, the whole thing could collapse. 0:16:59.034,0:17:11.117 But then, finally, there is a connection between that macroeconomic separation of money from the rest of the economy, 0:17:11.117,0:17:21.384 and the difficulty of making people understand that banks create money out of nothing, 0:17:21.384,0:17:31.064 and that loans are the engine of the creation of money. 0:17:31.064,0:17:38.702 A deep-seated and longstanding idea in macroeconomics is that saving is necessary before you can have investment. 0:17:38.702,0:17:44.583 Read the reports of the World Bank and they all talk about insufficient saving for development. 0:17:44.583,0:17:49.904 It's absolute nonsense, if the banks can create money. 0:17:49.904,0:17:58.904 And it was the ability of banks to create money out of nothing, that led Keynes to say, "No, saving is not the engine of growth in the economy, investment is. 0:17:58.904,0:18:07.103 Investment comes before saving. And it's the banks that permit that to happen." 0:18:07.103,0:18:18.284 So that brings me full circle to tie those two strands together, they are related, and if macroeconomics is going to regress to a pre-Keynesian form, 0:18:18.284,0:18:27.871 so also did the understanding of banking have to regress, and that is what has happened, and what our brave heroes are trying to reverse. 0:18:27.871,0:18:31.296 Thank you. [applause]