The Omega Point of economic life (or how to end the Keynes vs. Hayek debate)

Read our article in the Cayman Financial Review Magazine, eversion 

When modern man looks back on the era of Christopher Columbus, there is a natural tendency to look upon their cherished belief that the world is flat as a ridiculous and mythical hallucination.

Immersed in an era of satellites and search engines, it goes without saying the idea that one could fall off the edge of the Earth by venturing beyond the known into new territory has long been proven to be a gross error on the physical plane of reality.  

However, there is an irony in our attitude towards our forebears’ belief systems, for we consistently fail to consider that such limits of perception may apply to ourselves. True, such limits may be at a different order of complexity than in the past and thus the old signposts often have very little to offer in terms of where to look.

Such problems are generally invisible to our eyes and in an era of materialism – an era that grossly discounts the inner world – that itself is a very big problem indeed.

Following the contributions of Thomas Kuhn, the revolutions in scientific paradigms are now well documented. We can point to the words of Lord Kelvin who stated “there is nothing new to be discovered in physics now, all that remains is more and more precise measurement” and know that they are only famous because Einstein et al exploded his words into subatomic particles by looking at the problem from a wholly new vantage point.

Although Kuhn also spent considerable time studying revolutions in economic and social paradigms, they are much less appreciated in our modern era and subject to far greater ego investment and resistance to change.

The assumption that we have reached an end state in economic theory is consequently more than alive today. It is the predominant belief system on the planet.
Embedded in the current economic paradigm, we are all Lord Kelvins.

Even as the global financial crises persists; as the Tea Party and Occupy Wall Street movements grow in numbers, the paradigm itself largely goes unchallenged. For the most part we see the usual suspects of alternatives: more government, less government, no government and absolute government with the appropriate corollaries for the marketplace.

The fact that Occupy Wall Street cannot express or articulate what it wants is not only a question of limited understandings of the financial complexities of our time; it is first and foremost a problem of paradigms. Therefore it is extraordinarily challenging to even contextualise and agree on the world and reality that we see and aspire to build.

The very fact that so many of us intuit that something is out of alignment on a very deep level – yet it is so difficult to articulate a reasoned response – is a very clear indication that our cultural syntaxes are not yet sufficiently expansive to frame the problem.

Kuhn observed that the predominant paradigm in any field tends to push paradoxes and intractable problems out onto the periphery (the field’s unconscious) until a crisis emerges. The crisis itself provides the painful catalyst to motivate the field as a whole to re-evaluate its deepest assumptions and philosophical underpinnings.

It is common for multiple explanations to emerge that seek optimal explanations for the phenomena in question. Yet, still based upon the old paradigm, these explanations are always partial and therefore competing, where each represents an essential part of the solution (and usually mistakenly claims to be the whole solution).

It is only through the lens of a new paradigm that these explanations and contending theories can be reconciled. And when they are, many of the old paradoxes and unsolved problems can be brought back into the light of day and answered from this new way of approaching the field.


Keynes vs. Hayek

In economic life, a dominant free market paradigm has assumed global proportions. Communism has been largely relegated to the dustbin of history and free-market ideology has emerged to such a degree that some had prematurely declared victory with the proclamation of the End of History.

These statements already reek of naivety and Kelvinesque hubris.

Within economics itself, free-market proponents, policy makers and theorists have largely divided into two camps. In one corner, we have the legendary John Maynard Keynes, who symbolises the wisdom of state intervention in times of crisis to ensure the liquidity and the continuance of aggregate demand.

In the other corner we have FA Hayek, a master of the Austrian School, who advocated minimal government intervention and championed the wisdom of markets to resolve our economic difficulties.

For most of us who lack investment in either one of these camps, it would appear as rather obvious that both are coming up short with respect to adequately confronting our economic crises. On the one hand, our economic system naturally tends to concentrate wealth, structurally guarantees unemployment and frequently rewards exploitative, myopic and unreasonable risk-taking – even if those actions virtually guarantee the planetary disruption or termination of the very system on which we all depend (think, for example, of derivatives in the multi-trillions of dollars and environmental degradation).

On the other hand, our efforts to offset the emergent systemic problems through government spending have rendered most of the developed world on the edge of bankruptcy. Keynes’ profound insight that government intervention during recessions can compensate for the failure of the private sector to maintain aggregate demand was a deep challenge to the status quo.

This approach can short-circuit the systemic propensity to slide into a downward deflationary spiral of lower production, lower liquidity, higher unemployment and lower government revenues, which in turn make it much harder and more expensive to recover.

Nevertheless, the difficulty in reigning in spending during recoveries, combined with a global trend towards exponential growth in public spending has rendered this policy approach undesirable and in many cases, simply untenable.

The world’s governments collectively only have so many bazookas to unleash on sceptical bond markets before the whole things collapses under its own weight.

This is why it is our moral responsibility to urgently follow Kuhn’s advice and search for a new paradigm that can provide a satisfactory answer to the real-world problems in policy and design of our global financial system. For that, there is no better place to start than with Hayek.

The Road to Serfdom

In the midst of the Great Depression and the rise of cold-blooded nationalism, Friedrich Hayek, retreated from continental Europe to the safer shores of Albion. Alarmed by the naïve sympathy expressed by Britain’s intellectual class towards the socialistic movements across the channel, Hayek penned a brilliant work that has only gained in popularity to this day.

In The Road to Serfdom, Hayek laid out a powerful philosophical formula for economic success: the creativity and impulse of the individual knows best how to realise their self-interest and dreams.

Consequently, our objective should be to remove arbitrary power and centralised control from our economic and political domains. In other words, wherever possible, remove the bureaucrat or manager who thinks they can run your life better than you.

It is from this context that he made a brilliant argument that capitalism was morally and practically superior to the increasingly popular alternatives of socialism and communism.

Keynes himself, who of course disagreed with Hayek on many policy fronts, had an opportunity to read this book on his transatlantic voyage to Bretton Woods. He embraced his position in general yet it raised for him the question of how best to implement it in the real world. This question, he believed, was most critical and ultimately, left unanswered by the book.
Idolatry of the market

Keynes himself was a pragmatist and was willing to do what he perceived to be the most appropriate policy based on technical capacity and the actual life conditions on the ground. What he understood – and this remains underappreciated – is that capitalism was very much imperfect in practice, which is why government was so necessary. While free markets in theory might always produce optimal results, in practice this was never the case.

It is this understanding between the ideal and the reality that has us very much confused even to this day. The free market as we know it is not free in some idealised sense, but rather free relative to the alternatives of socialism, communism, tribalism and so on.

Our idolatry of the market may help us defend ourselves from the onslaught of competing (and regressive) ideologies, but it also precludes us from grasping its limitations and seizing opportunities to reach its as yet enormous unrealised potential.

If our system is indeed imperfect, to escape serfdom we must constantly commit ourselves to making it freer and more self-organising. This is not achieved by government cuts or laissez-faire neo-liberalism, but rather by qualitatively improving the dynamics of the system itself.

How can this be done? Hayek’s thoughts are often unwittingly deployed to block the evolution of free-market economics by those who assume or implicitly claim it is already free (not infrequently deployed as a rationale to protect very dubious practices embedded within the status quo).

Yet his advocacy to remove arbitrary power, centralised control and build an economy that optimises this aim is probably the wisest means we have to get there.

If we were to take this task with the utmost seriousness and courage, there would indeed be many stones to turn and uncomfortable realities to face with respect to money creation and monetary policy.

While difficult to do, the failure to confront arbitrary power in the economy while the financial system teeters on the brink would be to condemn ourselves to our own road to serfdom, where half-baked market economies and bloated and unsustainable government institutions continue to fail to address the challenges and paradoxes of our time.

The Organic Paradigm

In General Theory, Keynes endorsed an idea called demurrage, which is very seldom even discussed today in mainstream economics (although Harvard’s Greg Mankiw floated the idea in a New York Times piece a couple of years ago). It was also endorsed by Irving Fisher who believed that it was capable of helping the economy escape from the Great Depression within a matter of weeks.

Demurrage was considered by Keynes too impractical to implement beyond the local scale during the first half of the 20th Century. Ironically, with the advent of digital technologies, this tool is now eminently deployable yet there is so much contention and political partisanship that it is for all intents and purposes lost in the noise.

Just as Kuhn believed that in times of crises thinkers in a field would be forced to return to asking the deep philosophical questions, the concept of demurrage does just that by questioning the very nature of money itself.

Rather than seeing money as something that is static in nature, it is viewed as an organic process that mirrors the natural world. Because all goods are subject to the Second Law of Thermodynamics – iron rusts, tomatoes decay, milk turns sour – all commodities have an inherent cost to store and protect them.

This usually creates strong incentive to sell them as quickly as possible. This is not the case with money itself, for the costs of operating the monetary system and storing money are externalised to the general tax payer. Consequently, the money holder avoids a cost inherent to maintaining the financial system where the seller of goods must assume storage and maintenance costs.

This dynamic brings about the rather bizarre situation where the means of exchange is preferable to the ends (real goods and services). Today, money can be withheld indefinitely with the benefit of real interest rates compounded over time.

Thus, while the seller is bound to natural forces that incentivise selling, the buyer can benefit by holding out as long as possible before engaging in a transaction because the full cost of holding money is not currently internalised in this process (this process is not accounted for in Friedman’s quantitative analysis).

While this makes perfect sense to the individual acting in self-interest, it has profound effects of the resilience and quality of the system itself.

We must consider the implications of this dynamic in the attainment of price equilibriums and qualitative performance of free markets. With demurrage, a charge for holding money would incentivise a higher and, more importantly, stable velocity of money that helped to ensure that liquidity also remains stable, because money holders would be penalised for withholding money from circulation.

Internalising these costs so that the money holder would be more accountable would simultaneously yield more efficient economic decision making while creating an organic currency that mirrored the natural properties of goods.

Whereas central banks at present generally try to control liquidity through the money supply, Paul Samuelson reminds us, “you can lead a horse to water, but you can’t make him drink. You can force money on the system in exchange for government bonds, its close money substitute; but you can’t make the money circulate against new goods and new jobs.” It is in this context that demurrage solves a real problem, for it incentivises strong circulation at all times.

This process will consequently yield stronger demand for productive saving and investment as their relative risk versus holding cash decreases markedly due to the demurrage fee.

As capital markets become increasingly saturated due to higher investment rates, interest rates will begin to fall towards zero, where long-term rates would presumably remain above zero for some time and shorter-term vehicles, such saving accounts, might actually fall below zero.

While it may be reasonably argued that it would take considerable time for long-term interest rates to decline below zero, what matters most is programming this general trend toward zero – what I call the Omega Point of economic life. An interest-free economy could have several benefits.

First, it could eliminate the compulsion for exponential growth in a globalising economy, bound by a finite planetary ecosystem.

While the economy would be free to grow, it would not be systemically compelled to do so due to interest. Secondly, it would create a systemic propensity for decentralising the flow of money.

Currently money is funnelled ad infinitum from the poorest 90 per cent primarily to the wealthiest 1 per cent in the form of compound interest payments. This clearly has an enormous role in the concentration of wealth effect.

Reversing this trend would yield immense dividends for empowering the lowest 90 per cent of income earners, both in terms of developing greater capacity to create income and consumption, and also in facilitating a more self-organising, creative and decentralised global economy.

In a real-world case where demurrage was adopted in the town of Wörgl, Austria, during the Great Depression, the town went from massive unemployment to full employment within weeks and even began repaying taxes early through the use of the currency. If it held true to form on a broader scale, its adoption in the global economy could yield a timely new tool in a time of severe economic uncertainty.

Beyond Keynes vs. Hayek

While the space here only allows for a brief introduction, demurrage offers the potentiality to function as a leverage point for a new economic paradigm based on an more dynamic currency that consciously integrates the Second Law of Thermodynamics into its theory and design by internalising the costs of maintaining national or, perhaps eventually, global monetary systems.

Because it has the potential to mitigate the systemic compulsion for compound growth (due to the gradual elimination of compound interest) and naturally enhance access to capital while stabilising liquidity, the system itself could become more stable and less subject to inequities and boom and bust cycles.

By decentralising the flow of money, we may safely predict that more people will become increasingly empowered in economic life and thereby will diminish the need for massive government expenditures for providing safety nets and arbitrary social justice (an albatross on Obama’s economic policy and re-election hopes).

Indeed, social justice is far more palatable in the form of a market economy that naturally provides real opportunity for full employment and self-development rather than simply assumes structural employment and the need for disbursing perpetual hand-outs.

The idea of a social justice that can be actualised by ensuring a percentage of the population remains dependent upon government help is unwittingly ensuring they remain in serfdom.

While it cannot be claimed to be a panacea for our current economic woes until we are able to experience the world that emerges, the potential is here to reconcile Keynes vs Hayek through a new economy that is simultaneously more self-organising and yet more stable because it has an intrinsic mechanism designed to ensure the continuance of aggregate demand without debt accumulation.

For this reason, it is not surprising that Keynes endorsed this tool and predicted a world that eventually “solved the economic problem.”

It is rather inconceivable that he expected the policies of government spending and hole digging for its own sake to enable us to solve the economic problem. Given his endorsement of demurrage, we might suspect he did not have Big Government in mind when he wrote:

“I see us free, therefore, to return to some of the most sure and certain principles of religion and traditional virtue – that avarice is a vice, that the exaction of usury is a misdemeanour, and the love of money is detestable, that those walk most truly in the paths of virtue and sane wisdom who take least thought for the morrow.

We shall once more value ends above means and prefer the good to the useful. We shall honour those who can teach us how to pluck the hour and the day virtuously as well, the delightful people who are capable of taking direct enjoyment in things, the lilies of the field who toil not, neither do they spin.”

When we realise that Keynes’ caricature as a Big Government enabler is not the whole Keynesian story but rather only a part that emerged out of his recognition that our markets as we know them sometimes require a secondary mechanism to stimulate aggregate demand.

Government can be understood as a crutch and compensation for inherent design flaws in our market economy, where demurrage was previously impractical to implement without the ubiquity of digital technology.

Whereas Hayek advocated for competition between different currencies and for removing arbitrary power from government bureaucrats and central bankers in favour of greater spontaneity, empowerment and self-organisation in our economic lives, Keynes endorsed demurrage as a means to dispense with the need for government intervention in managing systemic inefficiencies.

In this light, the core of Keynes’ and Hayek’s positions are wholly compatible through the lens of a new economic paradigm, where an Omega Point of economic abundance and mutual re-empowerment awaits.

This essay is an excerpt of MacLeod’s forthcoming book, Onement.