Economic and Financial Crises

Confronted with the most serious economic and financial crises since the 1930s, economists should feel the need to question their approach to economic analysis as well as the conceptual background of mainstream economics. Their mathematically sophisticated models, whether neoclassical, new classical, Keynesian, or New Keynesian, have clearly proved to be incapable of avoiding, let alone explaining, the devastating crises that are hampering our economies both nationally and internationally. The reason for this failure lies in their poor understanding of the logical laws governing our economic systems based, as they are, on bank money.

In this chapter, we will show that, when referred to money and income, economic laws are no less rigorous than physical laws. Their validity is not influenced by economic agents’ behaviour, since they belong to the category of identities, and not to that of equilibrium conditions. Whatever decision may be taken by individuals or institutions, these laws remain unaltered. They set the logical rules at the roots of any economic system based on bank money. As such, they do not refer to any specific economic policy, but rather to the monetary structure on which our economic systems are founded. In other words, they pertain to the logical infrastructure making up for the conceptual and practical framework within which economic agents are free to take their decisions. Economists have argued for a long time about the primacy of identities over conditions of equilibrium, and vice versa. Following Walras’s (1874/1984) contribution, and despite Keynes’s (1930/1971) suggestions, it is today almost generally accepted that economic laws are mainly behavioural, and founded on microeconomics. Mathematics is widely used, and equations of various kinds and complexity are considered as one of the best tools available to represent the real world of economics. Identities are rarely referred to, and when they are it is to transform them almost immediately into conditions of equilibrium. Our aim is to re-establish the logical priority of identities and show that they are the very foundation of macroeconomic analysis. We will do so by starting from a reappraisal of Say’s law, and a reinterpretation of Keynes’s identity between global demand and global supply, to end with Schmitt’s law of the necessary equality between each agent’s sales and purchases.

At the beginning of our discipline, economic crises were considered as disconnected and random events caused by exceptional and disparate contingencies and occurrences such as wars, political and social unrest, food shortage, natural disasters, and so on. Economists as well as bankers and businessmen soon started to realize that crises were much less isolated than it was generally thought, and that their recurrence was not random. Juglar (1857) was one of the first researchers to attempt to account for the recurrence of crises starting from statistical observation. Initially trained as a physician, the French economist is considered by Schumpeter (1954/1994: 1123) ‘as to talent and command of scientific method, among the greatest economists of all times’. Starting from a series of statistical data about banknotes circulation, bank deposits, discount, and metallic reserves for France, England, and the United States — which he correlates to the volume of commercial transactions, the price of corn, rent, public revenue, and variations in population — Juglar (1857, 1889) asserts that monetary and commercial crises are strictly interrelated and are the unavoidable price to be paid for the evolution of capitalism.

The aim of this chapter is to show that both monetarism and the new classical synthesis fail to provide a satisfactory analysis of the working of our economies and of the way disorders may arise, disrupting the economic system taken as a whole.

Keynes is unanimously considered as the ‘father’ of modern macroeconomics, and his followers have endeavoured to emphasize the crucial role played by macroeconomic concepts in seeking a theory capable of explaining both the orderly working of our economies and the insurgence of pathological states leading to the burst of economic and financial crises. Their interpretation of Keynes’s analysis, however, is not univocal, and some important differences exist between their approaches and the models they advocate. A classification of their contributions in the different schools of thought that call themselves Keynesian is not always easy and is meaningful only to the extent that it helps one to better understand the alternatives offered by each school. In this chapter, we will analyse the contributions of Keynesian, New Keynesian, and post-Keynesian economics in order to verify if they succeed in reaching a better understanding of the origin of crises than their neoclassical counterpart. In particular, we will show that, despite their emphasis on the role played by monetary disturbances and market imperfections, Keynesian economists of all schools fail to reach this goal.

Does it make sense to analyse crises in terms of global supply and demand? Can they be explained consistently with the necessary equality between supply and demand required by modern macroeconomic analysis? These are the crucial questions we will address in this chapter. Starting from Say’s law and Keynes’s logical identity between Y and C + I, we will first investigate the problem of whether or not the insurgence of an economic crisis entails their rejection. Indeed, the possibility of reconciling a situation of disequilibrium with the identity of global supply and demand seems very remote if not altogether inexistent. On the other hand, however, quantum macroeconomics provides clear logical evidence that the identity between global supply and demand is at the heart of economics. This can only mean that, eventually, economic crises will have to be explained without denying this identity. This is not what the followers of mainstream economics claim. Both neoclassical economists (whether advocates of the New Classical or of the real business cycle approach) and Keynesian economists (whether members of the New Keynesian or the post-Keynesian school) believe in some kind of general equilibrium framework and ascribe the outbreak of economic crises to factors affecting either the supply side or the demand side of their models.

Interest and capital are two closely related topics that have been widely discussed by economists. Although in today’s economic literature interest is mostly identified with contract-interest on loans and its rate with the market rate of interest, the problem of its origin has still to be satisfactory solved. Economists of the past struggled to argue the existence of an original interest enabling that of the interest on loans, where the latter is essentially nothing but the effect of the former. They all agreed that capital is at the origin of interest, yet they disagreed about the kind of causal link that exists between these two concepts. Is capital a direct or an indirect cause of interest? The question whether or not capital is a macroeconomic factor of production is still open today and, despite appearances to the contrary, still a subject of controversy. Indeed it is only thanks to Schmitt’s quantum macroeconomic analysis that a final answer is possible, the payment of human labour being the only transaction capable of transforming money into income.

Is the present system of international payments an orderly one? And if not, why and what are the consequences? These are the questions asked in this chapter, which is devoted to the analysis of international transactions and their impact on financial crises. The inconsistency between the way money should be used in transnational payments and how payments are actually carried out between nations is not difficult to discern or detect: what should be a mere numerical means of payment becomes an asset that is exchanged against other assets. Yet money does not change its nature when it is used internationally, which is why transnational payments that do not comply with the vehicular nature of money are hopelessly pathological and the source of monetary disorder that feeds speculation and propels financial crises.

The global financial crisis that erupted in 2008 highlighted that banks do not make a clear distinction between the monetary and the financial intermediation they carry out, as explained in this volume. Indeed, in the early drafts of his Treatise on Money, Keynes (1973a: 91) noted that a bank is both a ‘money purveyor’ and a ‘credit purveyor’ within a monetary economy of production. This distinction has been lost in both economic theory and policy since then. It was, nevertheless, at the core of Ricardo’s (1824) Plan for the Establishment of a National Bank. As he observed, ‘[t]he Bank of England performs two operations of banking, which are quite distinct, and have no necessary connection with each other: it issues a paper currency as a substitute for a metallic one; and it advances money in the way of loan, to merchants and others’ (ibid.: 276). Since these two operations are conceptually distinct, Ricardo (1824: 276) explained that they can be carried out by two separate bodies, ‘without the slightest loss of advantage, either to the country, or to the merchants who receive accommodation from such loans’. In fact, as we will argue in this chapter, this functional separation is not only harmless but a structural factor of financial stability, because it allows to avoid that banks issue empty money in purely financial transactions that do not generate new income within the economic system as a whole.