The Ripple Effect1694–2009: Finishing The Past

By Lowell Manning

The Ripple Starts Here

Hi, I’m Lowell Manning

Please join me in this short trip inside our debt-based financial system

1694–2009: Finishing The Past

• Keynesianism and Monetarism have both failed because neither of them takes account of the mechanics of the debt system itself

• This work proposes to replace them with an economic debt model that takes into account the mechanics of interest-bearing debt

Fisher’s Equation of Exchange

Irving Fisher proposed his equation of exchange in 1911:

M = money supplyV = speed of circulation of the money MP = price level Q = quantity of goods and services produced

MV = PQ

In Fisher’s day the terms were hard to quantify – that didn’t get any easier until now

V is essentially a hoarding function

The Visual ChallengeConsumer Price Index: England 1300–2000

Are we to blame M or V?

Base year 1300 = 100

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

1300 1350 1400 1450 1500 1550 1600 1650 1700 1750 1800 1850 1900 1950 2000

Year

CPI

Fisher Equation 1911 MV=PQ

Unearnedinterest income

Bank of England 1694Perpetual Interest-Bearing Debt

Perpetual debt is unproductive and

permanent

M = Mp + Ms

MpVp = PQ = (M-Ms)* Vp

Ms = unearned interest income

Mp = productive money supply

Vp = circulation speed ofproductive debt

Unearned Interest

The unearned interest must itself be borrowed, otherwise prices P must keep falling:

Ms applies to all unproductive unearned income interest on deposits

M(d) = (Ddc+Dca-R)= PQ(d)/Vp + (Ms+Mv)

Vp = 1 because debt can only be used once

Debt-Based EconomiesFor practical purposes, in modern developed economies all money now arises from bank debt, so:

In a modern debt-based economy $1 debt = $1 deposit

Mv = debt borrowed for purely speculative purposesDdc = domestic creditDca = the accumulated current account deficitR = Reserve Bank capital reserveM(d) = total debt = (Ddc + Dca - R)Q(d) = production created by the total debt M(d)Mp = PQ(d) = productive debt

Let:

then

The Debt ModelDebt Model: New Zealand 1978–2009*

* Growth and inflation exclude changes arising from cash transactions

DebtNZ$ billion

MsMs+Mv

Ms+Mv+Inflation on PQ(d)

Md

Year

0

50

100

150

200

250

300

350

400

450

500

1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

Nominal GDP (PQ(d))

Growth

Inflation

Mv

Ms

Debt Management

Further reducing the new debt model using differential calculus we can say:

Over any short time span dt when deposit rates are not zero…

dGDP/dt = dM(d)/dt – (dMs/dt + dMv/dt)

The increase in GDP equals the increase in total debt M(d),less any changes in direct speculative investment Mv

Therefore in a cash-free, debt-based economy with zero deposit rates:

… and when deposit rates are zero

dGDP/dt = dM(d)/dt – dMv/dt

Debt Management

The economy is indeed about debt management as Irving Fisher surmised

a hundred years ago!

Speculative BubblesBusiness Cycle Bubbles as % GDP: New Zealand 1978-2009

Perhaps for the first time ever, the new debt model quantifies the speculative bubbles inherent in traditional business cycles

MV as% GDP (March year)

-5

0

5

10

15

20

25

30

1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

Year

Wage & price freeze

‘Roger’s hole’

NZ$ floated 3/85

Deposit interest rate peak >14%

Deposit interest low

Asia ‘crisis’

Dotcom Property

Deposit interest low <5%

Fisher Differential EquationDebt Model Differential Form: New Zealand 1979–2009

Using differential calculus the debt model can be expressed as:

dM(d)/dt = d/dt(Ddc+Dca–R) = d/dt[PQ(d) + (Ms+Mv)] Vp = 1

Annual change in variableNZ$ billion

dMs/dtd/dt(Ms+Mv)

d/dt (Ms+Mv+inflation)

dMd/dt

-5

0

5

10

15

20

25

30

35

40

45

1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

Year

Business Cycle 1 Business Cycle 3Business Cycle 2

Inflation

Wage/price freeze June 82-Sep ‘84

Recession period

Richardson budgets

Growth

Bubble dissipating

Sharemarket crash from Oct ‘87 Bubble forming

Asia/dotcom crashes 98-02

The New Debt Model

The new debt model reveals a raft of new economic concepts:

a) System liquidity (circulating debt)

b) Systemic inflation (inflation caused by interest rates)

c) Growth and trade (impact of current account)

d) The nature of (earned) savings

e) Sample application: why Japan stagnated for so long

System Liquidity (Circulating Debt)Circulating Debt Mcd: New Zealand 1978–2009

Mcd = (Mp–Dca) = Ddc – (Ms+Mv) – R

0

5

10

15

20

25

30

35

40

45

50

1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

Year

McdNZ$ billion y = 1.24x + 2.4

Earned savings decreasing

Earned savings increasing

Circulating debtMcd NZ$ billion

Linear(Circulating debtMcd NZ$ billion)

Systemic InflationModel Systemic Inflation vs. CPI Inflation: New Zealand 1989–2009

Total inflation = systemic inflation + ‘PQ’ inflation + non-systemic price changesSystemic inflation rises when interest rates rise

Systemic inflation = inflation caused by interest ratesSystemic inflation is the rate of change of dMs/dt, the speed at which the increase in the pool of unearned income Ms changes

Inflation% GDP

-2-1012345678

1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009Year

SNA (CPI) inflation% GDP

Systemic inflation% GDP

Growth & Trade (Impact of Current Account)Increase in GDP vs. Increase in Accumulated Current Account:New Zealand 1988–2009

System liquidity Mcd and domestic wealth

$100 billion lower

Domestic Credit Ddc $100 billion lower

Accumulated Current Account deficit Dca $100 billion higher

All nominal GDP has been borrowed

Mcd = (Mp–Dca) = Ddc – (Ms+Mv) – R

GDP/DcaNZ$ billion

GDP NZ$ billion

Accumulated current account deficit+ NZ$45 billion

0

50

100

150

200

250

1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Year

R2 = 0.977

The Nature of Earned Savings

Mcd is the modern debt equivalent of money M in the Fisher equation…

Original Fisher equation

MV=PQ

…and its speed of circulation Vcd is broadly comparable to V in the original Fisher equation.

The Nature of Earned SavingsSpeed of Circulation Vcd of Circulating Debt Mcd:New Zealand 1979–2009

The accumulated current account deficit Dca is the underlying source of New Zealand’s lack of savings and new investmentThe sharp upturn in Vcd shows system liquidity has fallen dangerously low by comparison with the long-term trend

Speed of circulating debt (Vcd)

0

1

2

3

4

5

6

7

1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009Year

Speed of circulation of circulating debt (Vcd)

Linear

Why Japan Stagnated for So LongCurrent Account Deficit: Japan 2004–2008

2004 2005 2006 2007 2008 Total

Current account deficit (US$b) -172 -166 -170 -213 -193 -914

Nominal GDP change (%) 2.7 1.9 2.4 2.1 1.4

CPI (%) 0 -0.3 0.3 0 0.6

Growth (%) 2.7 2.2 2.1 2.1 0.8

Nominal GDP change (US$b) 114 100 96 92 35 437

In the revised Fisher equation: dMd/dt = d/dt (Ddc+Dca-R) = d/dt[PQ(d)/Vp + (Ms+Mv)]

Take: dMv/dt = 0 (no bubbles since 1990)dMs/dt = 0 (deposit rates practically zero)dR/dt = 0 (R small compared to Ddc and Dca)Vp = 1

The equation reduces to: dPQ(d)/dt [Japan] = d/dt(Ddc+Dca) [Japan]

Why Japan Stagnated for So LongCurrent Account Deficit: Japan 2004–2008

The Japanese government has had to pump

US$1 trillioninto the Japanese economy to keep it afloat

Dca (the deficit) is negative to the tune of US$-914b

Therefore to maintain dPQ/dt, dDdc/dt must increase by US$914b

Back to Fisher

A general economic model aligned to the original Fisher equation of exchange is:

PQ = (Md – (Ms+Mv))Vp + MoVo +EoVeo

Where: PQ, Md, Ms, Vp, Mv, and Vp are as already described

And: Mo = circulating currency contributing to output

Vo = speed of circulation of Mo

Eo = circulating electronic debt-free currency

Veo= speed of circulation of Eo (and must be equal to Vcd)

Fisher Revised – The New Debt Model

This presentation has revised the Fisherequation MV=PQ to develop a new debt model…

In the current financial system based wholly on debt…

M(d) = (Ddc+Dca-R) = PQ(d)/Vp + (Ms+Mv)In which Vp = 1

GDP = PQ(d) = M(d) – (Ms+Mv)Ms results solely from interest rates (on deposits)

Mv results solely from loose bank lending for speculation

Fisher Revised – The New Debt Model

Bank profit is predominantly a function of M(d)

Recent world events show how derivatives have been developed and used to irresponsibly increase M(d)

to create extra bank profit

Fisher Revised – The New Debt Model

The debt model shows that management of both the quantity of debt and interest rates are crucial for financial stability, and that:

• The quantity M(d) must be increased in line with the productive capacity and resources of the economy for maximum production and very low or zero inflation

• Interest rates on deposits need to be zero or close to zero to avoid creating investment inflation that is out of line with the productive economy

• The present system based on interest-bearing bank debt produces a fundamental conflict between the interests of the financial sector and those of the productive economy

The Ripple Effect1694–2009: Finishing The Past

By Lowell Manning

19B Epiha Street,

Paraparaumu, New Zealand.

manning@kapiti.co.nz