Cause and Effect


The business cycle manifests itself in a wave-like pattern1 -- expansions are followed by contractions, and the cycle repeats itself with fabulous regularity. The empirical evidence is absolutely clear: expansions have been followed by speculative overinvestments, recessions, increases in the number of destabilized businesses, increases in the number of bankruptcies, job losses, increases in unemployment, increases in crime -- and absolute misery for many.

Were the expansions caused by Central Bankers? Milton Friedman, paraphrasing Clemenceau, stated that "money is much too serious a matter to be left to the Central Bankers."2 But, if Central Bankers are not to be allowed to control money matters, who ought to? -- Big Banks?

Central Bankers may control the supply of cash; but it is Bankers who effectively control how much loan money flows into specific sectors of the economy. Suppose the empirical evidence corroborated the following scheme:

  1. The average family income increases. The money stock increases. Bank deposits swell.
  2. Banks channel excessive amounts of depositors' money into a particular sector of the economy -- say commercial real estate loans, at the expense of industrialization or technology.
  3. Record business and consumer failures follow. Personal and government debt skyrocket. The economy is destabilized. The safety net is threatened. The country is threatened with a near-catastrophic breakup.

Who's policies would you blame? Central Banker policies for increasing the money stock? Banker policies for favoring highly collateralized commercial real estate loans? Borrower policies for engaging in speculative investments?

Overinvestments at Banks and the National Economy. Many Canadian Banks increased substantially their commercial real estate loan portfolio during 1986-1991. Canada's largest bank, for example, increased its domestic commercial real estate loans from $1,781 million in 1985 to $7,098 million in 19913 -- or, as a percentage of the bank's total domestic loans, from 3.95% to 9.04%. These increases were followed by substantial increases in the bank's total domestic non-accrual business loans. Net of allowance for credit losses, domestic non-accrual business loans swelled from $361 million in 1989 to $2,465 million in 1992. Other categories of net domestic non-accrual loans also swelled: (1) consumer instalment and other personal loans -- from $40 million in 1989 to $153 million in 1992; and (2) residential mortgages -- from $15 million in 1987 to $225 million in 1993. But Canada's money stock also increased. The year-over-year change in (M2-M1), for example, increased from $6,480 million in 1983 to $31,480 million in 1989, the largest increases occurring in 1986 and in 1989.4 Industry-wide increases in commercial real estate loans were followed by increases in:5

  1. The number of business bankruptcies -- from 7,659 in 1987 to 14,317 in 1992.
  2. Government deficits -- from $32,499 million in fiscal 1988/89 to about $66,137 million in fiscal 1992/93 (all government levels).
  3. The unemployment rate -- from 7.5% in 1989 to 11.3% in 1992.
  4. The total Canadian criminal code rate -- from 8,356 in 1984 to 10,309 in 1991, on a per 100,000 population basis (traffic infractions excluded), etc.

What caused these increases? The monetary policy of the Bank of Canada? The loan policies of banks? Real estate speculation? I will address some of the causality issues. But I do not believe, that causality is the only important question. As important is: Cui Bono -- who benefited from the policies?

Cui Bono. The Cui Bono method of investigation has been used with great effect by Hobbes, in Leviathan. Hobbes received his inspiration from a Roman Judge, who, when confronted with insufficient witness testimony in Criminal cases, had the custom to ask the Accusers: Cui bono. Hobbes favored this ingenious method because, he argued: No Presumption declares the Author of an Action more evidently than does the BENEFIT of the Action.6

The analysis of causation is no simple matter; that is why the above debate is "famous." The study of Causality has occupied many of the best minds -- Aristotle, Al-Gazzâli, Bacon, Descartes, Locke, Newton, Berkeley, Hume, Kant, Schopenhauer, Einstein, Heisenberg, Popper, etc. Why is Causality so important? Because it is most fundamental to human understanding.

Aristotle on "Primary Cause." To know anything, said Aristotle, one must grasp its "primary cause" -- one must understand "why it is as it is."7

Empirical Events. Consider the following events:

  • Event A = The average family income after tax in constant dollars increases
  • Event B = Commercial real estate investments increase
  • Event C = Non-accrual loans increase
  • Event D = The number of business bankruptcies increases
  • Event E = The unemployment rate increases
  • Event F = Government deficits increase
  • Event G = Personal debt increases
  • Event H = The national economy is destabilized

Are any of these events "causally linked"? What is their "primary cause"?

Causality According to Hume. Following Hume, two events are causally linked if, among other things:8

  1. The cause and the effect are contiguous -- in space and in time.
  2. The cause precedes the event.
  3. The cause and the effect are bound up by the relation of inference that unites them. The relation must be universal -- that is, the same cause, when repeated, always produces the same effect.

Phenomenalism. The Charts in Appendixes B through H summarize recent empirical economic data for Canada -- the "best" place in the world to live (apparently, ahead of the United States, Japan, Germany, etc.)9 A critical scan of this data for Canada shows two things: (1) Events A, B, C, etc., have been clearly contiguous, in space (Canada) and in time (1980-1994); and (2) the events followed a definite order. For example, the increase in the number of business failures (1988-1992) and the increase in the unemployment rate (1990-1992) have both been clearly preceded by increases in commercial real estate loans. Furthermore, decreases in commercial real estate loans have also been followed by decreases in the unemployment rate and in the number of business bankruptcies. In other words, the event pairs B and D, and B and E, both satisfy Hume's first two rules -- the rule of contiguity and the rule of priority. But, do they satisfy the third rule -- the rule of conjunction? Even if every occurrence of B is found to have been followed by an occurrence of E, can one conclude that the rule of conjunction holds universally? According to Hume, the answer is no! All we can say is that increases in commercial real estate investments have so far been followed by increases in the unemployment rate. All we are left with is the idea that increases in commercial real estate investments appear to cause increases in the unemployment rate.10

Pure Reason vs. Phenomenalism. Some people will probably delight in Hume's skeptical phenomenalism. An idea in the mind is not the same thing as the real world, they may declare. The real financial world (as manipulated by money managers) and how the financial world appears (especially to ordinary folks) are two different things, they may argue. But is this true? Is our knowledge exclusively limited to subjectively perceived appearances? Will the real financial world always elude us? Will the famous debate remain forever unsolved? Is objectivity irretrievably beyond our reach?

The reader need not worry. The assumption of a separation between reality and appearance is "mistaken."11 Kant refuted this phenomenalism.12 So did Plato, about 2000 years earlier. For both Plato and Kant, it is the same real substance that people perceive. We should therefore be able to use the Kantian method of pure reason to neutralize any Humean skepticism -- and, more importantly, to systematize the whole economic experience.

According to Consumer and Corporate Affairs Canada, there were 76,139 business and consumer bankruptcies in Canada in 1992.13 Surely, the losses experienced by bankrupts and by creditors were not just phenomenological ideas in their minds. For the bankrupt, the objectivity of the destruction he experienced is absolutely clear. The unity of the substance of the bankruptcy is not undermined by changes in perceptual properties of the bankrupt or of the creditor. Even sceptics have to contend with what Kant called the reality of the "faculty of judging."14

Where does this leave us? Well, we must begin with the empirical data -- the data that capture the economic experience. But, following Kant, nothing should stop us from using knowledge that is independent of experience: pure a priori knowledge -- the kind that belongs to thought and understanding. For Kant, "thought is knowledge by means of concepts."15 Therefore, we can first organize our knowledge around a diversity of concepts -- such as, family income, distribution of bank loans, the number of business and consumer bankruptcies, government deficits, personal saving and debt, the criminal code rate, the number of therapeutic abortions, the number of hospital discharges for heart attack, etc. Then we can attempt to connect these concepts into a system. In other words, we can achieve understanding by first delineating the concepts which form the whole economic experience, then by connecting them into one system. By connecting diverse concepts into one "common representation," we exhibit the "absolute unity" that underlies the system, and this unity gives rise to understanding -- to "unity in judgments."16 The "analytical unity"17 is what allows us to understand the relationship (if any) between bank policies and actions and economic prosperity (or misery), as a system. Thought is what unites "in one self-consciousness"18 the connections and linkages in this system. Without thought, the connections and linkages would remain hidden. The synthesis of the understanding by means of concepts or categories (family income, distribution of bank-money, number of bankruptcies, deficits, etc.) is what allows us to "fix [our] attention exclusively" on the "unity which is brought by the understanding."19 This is the essence and the genius of the Kantian method.

How do we know if our system is correct or genuine? Kant's answer is as follows: "the completeness and articulation of this system can at the same time serve as a test of the correctness and genuineness of all the parts of knowledge that belong to it."20

To understand causes from effects, it helps to know subjectively -- consciously in our skin or in the marrow of our bones -- the forms and effect of losses. Consider this partial list of possible losses:

  1. Loss of credit
  2. Loss of job
  3. Loss of income
  4. Loss of business (business bankruptcy)
  5. Loss of property (consumer bankruptcy)
  6. Loss of home or shelter (foreclosure or eviction)
  7. Other losses (crime, abortion, divorce, etc.).

What are their causes? Many losses can be traced to managerial incompetence, lack of knowledge or skills, lack of capital, agency problems, fraud, externalities, etc. But what is the role of flawed monetary policies or of flawed loan policies? What is the link (if any) between flawed policies and personal losses, such as the loss of a business, or the loss of a home? Can this link be uncovered? The philosopher Schopenhauer provides some clues.

Schopenhauer's World as Will and Idea. The link between flawed economic policies and economic losses may not be obvious, clear, or directly intelligible. Many attribute other people's personal losses to "chance," "fate," or "bad luck."21 What caused somebody's bankruptcy may not be directly linked to this government policy or that bank policy. The chain of events leading to the destruction of a small business, to the destruction of a job, to an abortion, or to the increase in personal or national debt, is not necessarily obvious. However, the meaning of the destruction can be deciphered. Schopenhauer's philosophy provides some clues, which I use in the following.22

Most people do not experience directly, subjectively -- in their own body --, the immediate and destructive effects of a loss, such as the loss of a job, the loss from a business bankruptcy, or the loss from a home foreclosure. All people experience fear and anxiety; but unless they have experienced directly the objectified losses23 from flawed policies, their awareness of the causes of the losses remain fuzzy and veiled.24 Only when losses are objectified, can they know the intractable. Only then can they feel and understand the whole reality of the causes -- from the personal losses.25 The direct experience from the loss of one's job, of one's business, or of one's home, is an immediate experience in our "animal body."26 This experience -- which can include the destabilization of a credit line by a banker, harassment or defilement by creditors, the pain from the loss, etc. -- converts, in one full sweep, "dull" economic data into an understanding of the causality of the loss.27 The order (in space and in time) of the events surrounding the loss are normally not manifest until you experience directly and immediately the loss. The motives of your banker, of your creditors, of the government, etc., may remain a secret. But their "will" cannot be hidden. The a posteriori knowledge from the experience of the loss reveals your will, the will of your banker, the will of your creditor, the will of the government, etc. In other words, "causal connection merely gives us the rule and the relative order . . . "28 of events, but the direct experience from the loss process reveals much much more. It reveals, Schopenhauer held, the "meaning . . . the inner working"29 of each individual party involved, of their motives, of their behavior, and of their actions. The whole subjective reality of the loss allows you to uncover, to explain, and to understand what Schopenhauer called the "unité de plan"30 (unity of plan). What the body experiences directly is not just the intentions of the employer, of the banker, of the creditor, etc., but the objectification of their will. The pain from the loss is caused by your opposition to the objectified will of the manager who fires you, of the banker who chokes off your credit line, of the banker's agent who subsequently threatens to bankrupt you, etc. To quote from David Berman's introduction to Schopenhauer's The World as Will and Idea, " . . . our bodily feelings offer us the key or Rosetta Stone for deciphering the hitherto unknown language of reality."31 And what could that reality entail? Here's a partial list derived from Schopenhauer:32

  1. The wrongful or improper taking of property.
  2. The compelling of a person to submit to his exploiter's will. Lying and "fictitious motives" are often used to deceive the subjugated person into believing that he is "following his own" will, when in fact he is being manipulated to serve the exploiter's will and interests.
  3. he "broken contract," which Schopenhauer called "the most complete lie."

Benjamin Franklin admonished: "He that goes a-borrowing goes a-sorrowing."33 What did Franklin mean? Did he mean that there is a causal connection between "borrowing" and "sorrowing"? Did he mean that the act of "borrowing" is the primary condition of an ordered sequence of events which includes ultimately, or inevitably, "sorrowing." If Franklin's law of causality holds, what can this causal connection reveal about the lenders' motives and behavior? about the inner working of the lending process? and about the effects of loan policies on the economic well-being of the individual citizen?

For answers, we must look at the empirical evidence and extract the intelligible causality of the borrower's "sorrowing" (if any). Here's a strategy that is consistent with the scientific method (and with Kant):

  1. Identify, organize, arrange, and connect the elements of the whole economic experience.
  2. Order the sequence of events and probe for possible causal links or correlations between changes in the money stock, changes in bank loans, and changes in a variety of hypothesized possible effects -- recessions, increases in non-accrual loans, surges in business bankruptcies, increases in unemployment or underemployment, increases in governmental deficits, increases in the criminal code rate, increases in government transfer payments to families, decreases in personal savings, increases in personal and unincorporated business debts, increases in the number of therapeutic abortions, increases in acute myocardial infarction cases (heart attacks), etc. -- as if these were potential links in a chain of economic and social events.
  3. Follow the links in the chain, one link at a time, until a complete picture of the creative destruction process (if any) emerges.

The modern scientific method. The modern scientific method consists of two steps:34 first "scientific" laws are hypothesized or postulated, then the laws are tested extensively to eliminate the false ones. It is not enough for a hypothesized law to pass one test, it must pass all tests -- direct as well as indirect. The law is assumed to be true so long as: (1) it continues to be corroborated by direct tests; and (2) it continues to be confirmed by indirect tests. New empirical evidence has one of two effects: (1) it can demonstrate conclusively that the law is false; or (2) it can demonstrate that the law is not as universal as originally thought (in which case, the law's domain of adequacy must be restricted). The laws of Newtonian mechanics, for example, are restricted in this sense -- to macroscopic bodies and to speeds that are relatively small compared to the speed of light. Both the theory of quantum mechanics and the theory of relativity extend the scope of Newtonian mechanics. In light of these remarks, we can, following Popper, say: "we shall be inclined to find the specific hypothesis that A is the cause of B the more acceptable the better we have tested and confirmed the corresponding universal hypothesis."35


1 See John K. Galbraith, Money, 1975 and 1995, at 105-107; and Joseph A. Schumpeter, Business Cycles (1939), abridged, with an Introduction by Rendigs Fels, 1964, at 114.

2 Milton Friedman, Capitalism and Freedom, 1962 and 1982, at 50-51.

3 See Royal Bank annual reports (loans by industry, as at September 30; non-accrual loans, net of allowance for credit losses, as at October 31).

4 Statistics Canada, Canadian Economic Observer, Historical Statistical Supplement, 1994/95, Catalogue 11-210, June 1995 (Bank of Canada: monetary aggregates -- M1, M2, and M3).

5 For general trends and data sources, see Appendixes A through H.

6 Thomas Hobbes, Leviathan, edited by C.B. Macpherson, 1968, at 704.

7 Aristotle, Physics, translated by Robin Waterfield, with an introduction by David Bostock, 1996, at 38-39 (194b16).

8 See David Hume, A Treatise of Human Nature, edited with an Introduction by Ernest C. Mossner, 1969, at 17, 126-130 (Why a Cause is Always Necessary), 130-131 (Of the Component Parts of Our Reasonings Concerning Cause and Effect), and 223-225 (Rules by which to Judge of Causes and Effects).

9 See UN Human Development Report 1996; ranking based on the UN Human Development Index.

10 Hume's theory of causation is discussed in Karl Popper, The Open Society and Its Enemies, Vol. II, 1962 and 1966, at 362-363 (Note 7 to Chapter 25).

11 See Immanuel Kant, Critique of Pure Reason (1781), a revised and expanded translation based on Meiklejohn, edited by Vasilis Politis, with an Introduction and Chronology by J.M. Dent, 1993, at xxxi.

12 Ibid., at xxxii-xxxiii, 96-97, and 493-499. Kant was inspired by Hume, but he rejected Hume's analysis of causality, calling it "destructive metaphysics." See Immanuel Kant, Prolegomena to Any Future Metaphysics, translated by James W. Ellington, 1977, at 258; and Immanuel Kant, Perpetual Peace and Other Essays, translated with an Introduction by Ted Humphrey, 1983, at 4-5, 15, and 20.

13 Consumer and Corporate Affairs Canada, Bankruptcy Branch (number of business and consumer bankruptcies in Canada).

14 See Immanuel Kant, Critique of Pure Reason (1781), a revised and expanded translation based on Meiklejohn, edited by Vasilis Politis, with an Introduction and Chronology by J.M. Dent, 1993, at 76-77 (concepts, thought, and understanding), and 78-79 (faculty of judging).

15 Ibid., at 78-79 ("understanding as an absolute unity" and "common representation").

16 Ibid., at 79.

17 Kant's expression; Ibid., at 100.

18 Ibid., at 100.

19 Ibid., at 85 (categories), and 106 (understanding).

20 Ibid., at 77 (completeness and correctness of a system).

21 See, for example, Ecclesiastes 9:11.

22 Arthur Schopenhaur, The World as Will and Idea, edited by David Berman, translated by Jill Berman, 1995.

23 Ibid., at 33 (" . . . act of the will objectified, i.e., passed into perception.").

24 Ibid., at 8 (Mâyâ, the veil of deception).

25 Ibid., at 9 (" . . . perception is not merely of the senses, but is intellectual: that is; pure knowledge through the understanding of the cause from the effect.").

26 Ibid., at 8.

27 Ibid., at 9 (" . . . the understanding . . . converts dull, meaningless sensation into perception.").

28 Ibid., at 31.

29 Ibid., at 32, and 58-59 (understanding causality by means of the law of motivation).

30 Ibid., at 28 (Morphology, the study of form, and Etiology, the study of change and of cause and effect, can be used to unconceal the "unité de plan").

31 Arthur Schopenhaur, The World as Will and Idea, 1995, at xxiv and 29.

32 Ibid., at 213-215.

33 James C. Humes, The Wit and Wisdom of Benjamin Franklin, with a foreword by David Eisenhower, 1995, at 9.

34 See Karl R. Popper, The Open Society and its Enemies, Vol. II, 1962 and 1966, at 362-363; and The Logic of Scientific Discovery, 1959.

35 Karl R. Popper, The Open Society and its Enemies, Vol. II, 1962 and 1966, at 363.



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