The Ripple Effect

1. The Ripple Effect 1694–2009: Finishing The Past By Lowell Manning

2. The Ripple Starts Here 1694–2009: Finishing The Past Hi, I’m Lowell Manning Please join me in this short trip inside our debt-based financial system • 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

3. Fisher’s Equation of Exchange Irving Fisher proposed his equation of exchange in 1911: • MV = PQ M = money supply V = speed of circulation of the money M P = price level Q = quantity of goods and services produced In Fisher’s day the terms were hard to quantify – that didn’t get any easier until now V is essentially a hoarding function

4. CPI 50,000 45,000 40,000 35,000 30,000 Fisher Equation 1911 MV=PQ 25,000 20,000 15,000 10,000 5,000 Base year 1300 = 100 0 1300 1350 1400 1450 1500 1550 1600 1650 1700 1750 1800 1850 1900 1950 2000 Year The Visual Challenge Consumer Price Index: England 1300–2000 Are we to blame Mor V?

5. Bank of England 1694 Perpetual Interest-Bearing Debt Perpetual debt is unproductive and permanent Unearnedinterest income

6. Unearned Interest The unearned interest must itself be borrowed, otherwise prices P must keep falling: Ms = unearned interest income Mp = productive money supply Vp = circulation speed ofproductive debt M = Mp + Ms MpVp = PQ = (M-Ms)* Vp Msapplies to all unproductive unearned income interest on deposits

7. Let: Mv = debt borrowed for purely speculative purposes Ddc = domestic credit Dca = the accumulated current account deficit R = Reserve Bank capital reserve M(d) = total debt = (Ddc + Dca - R) Q(d) = production created by the total debt M(d) Mp = PQ(d) = productive debt Debt-Based Economies For practical purposes, in modern developed economies all money now arises from bank debt, so: In a modern debt-based economy $1 debt = $1 deposit then M(d) = (Ddc+Dca-R)= PQ(d)/Vp + (Ms+Mv) Vp = 1 because debt can only be used once

8. Nominal GDP (PQ(d)) 500 450 Growth 400 350 300 Inflation 250 200 Ms 150 Mv 100 50 0 Year 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 The Debt Model Debt Model: New Zealand 1978–2009* DebtNZ$ billion Md Ms+Mv+Inflation on PQ(d) Ms+Mv Ms * Growth and inflation exclude changes arising from cash transactions

9. 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) … and when deposit rates are zero dGDP/dt = dM(d)/dt – dMv/dt Therefore in a cash-free, debt-based economy with zero deposit rates: The increase in GDP equals the increase in total debt M(d),less any changes in direct speculative investment Mv

10. Debt Management The economy is indeed about debt management as Irving Fisher surmiseda hundred years ago!

11. Deposit interest rate peak >14% Wage & price freeze 30 NZ$ floated 3/85 25 Deposit interest low <5% Asia ‘crisis’ 20 15 Deposit interest low 10 ‘Roger’s hole’ Dotcom Property 5 0 -5 Year 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 Speculative Bubbles Business Cycle Bubbles as % GDP: New Zealand 1978-2009 MV as% GDP (March year) Perhaps for the first time ever, the new debt model quantifies the speculative bubbles inherent in traditional business cycles

12. Business Cycle 1 Business Cycle 2 Business Cycle 3 45 40 Sharemarket crash from Oct ‘87 Bubble forming 35 30 Wage/price freeze June 82-Sep ‘84 Recession period Asia/dotcom crashes 98-02 25 20 15 Growth 10 5 Bubble dissipating Inflation Richardson budgets 0 -5 Year 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 Fisher Differential Equation Debt Model Differential Form: New Zealand 1979–2009 Annual change in variableNZ$ billion dMd/dt d/dt (Ms+Mv+inflation) dMs/dt d/dt(Ms+Mv) 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

13. The New Debt Model The new debt model reveals a raft of new economic concepts: • System liquidity (circulating debt) • Systemic inflation (inflation caused by interest rates) • Growth and trade (impact of current account) • The nature of (earned) savings • Sample application: why Japan stagnated for so long

14. 50 McdNZ$ billion y = 1.24x + 2.4 45 Linear(Circulating debt Mcd NZ$ billion) Earned savings decreasing 40 35 30 Circulating debt Mcd NZ$ billion 25 20 Earned savings increasing 15 10 5 0 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 Year System Liquidity (Circulating Debt) Circulating Debt Mcd: New Zealand 1978–2009 Mcd = (Mp–Dca) = Ddc – (Ms+Mv) – R

15. 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 8 7 6 5 4 3 2 1 0 -1 -2 Year Systemic Inflation Model Systemic Inflation vs. CPI Inflation: New Zealand 1989–2009 Systemic inflation = inflation caused by interest rates Systemic 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 SNA (CPI) inflation% GDP Systemic inflation% GDP Total inflation = systemic inflation + ‘PQ’ inflation + non-systemic price changes Systemic inflation rises when interest rates rise

16. 250 200 R2 = 0.977 150 100 50 0 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Year All nominal GDP has been borrowed Accumulated Current Account deficit Dca $100 billion higher Domestic Credit Ddc $100 billion lower System liquidity Mcd and domestic wealth $100 billion lower Growth & Trade (Impact of Current Account) Increase in GDP vs. Increase in Accumulated Current Account:New Zealand 1988–2009 Mcd = (Mp–Dca) = Ddc – (Ms+Mv) – R Accumulated current account deficit+ NZ$45 billion GDP/DcaNZ$ billion GDP NZ$ billion

17. The Nature of Earned Savings Original Fisher equation MV=PQ Mcd is the modern debt equivalent of money M in the Fisher equation… …and its speed of circulation Vcdis broadly comparable to Vin the original Fisher equation.

18. 7 6 5 4 3 2 1 0 Year 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 The Nature of Earned Savings Speed of Circulation Vcd of Circulating Debt Mcd:New Zealand 1979–2009 Speed of circulating debt (Vcd) Speed of circulation of circulating debt (Vcd) Linear The accumulated current account deficit Dca is the underlying source of New Zealand’s lack of savings and new investment The sharp upturn in Vcd shows system liquidity has fallen dangerously low by comparison with the long-term trend

19. Why Japan Stagnated for So Long Current Account Deficit: Japan 2004–2008 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]

20. Why Japan Stagnated for So Long Current Account Deficit: Japan 2004–2008 Dca(the deficit) is negative to the tune of US$-914b Therefore to maintain dPQ/dt, dDdc/dt must increase by US$914b The Japanese government has had to pumpUS$1 trillioninto the Japanese economy to keep it afloat

21. 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)

22. Fisher Revised – The New Debt Model This presentation has revised the Fisherequation MV=PQ to develop a new debt model… 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 In the current financial system based wholly on debt…

23. 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

24. 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

25. The Ripple Effect 1694–2009: Finishing The Past By Lowell Manning 19B Epiha Street, Paraparaumu, New Zealand. manning@kapiti.co.nz