Below is the transcript for Transcript for: Steve Keen: Why 2012 is Shaping Up to be a Particularly Ugly Year
Chris Martenson Welcome to another PeakProsperity.com podcast. I am your host of course Chris Martenson and today we have the good fortune of speaking with Steve Keen, Professor of Economics and Finance at the University of Western Sydney, and author of the popular book Debunking Economics and website Steve Keen’s Debtwatch.
I have long been an avid reader and follower of Steve’s work over the years, because it is logical and starts with the data. Steve’s research focus is on the dynamics of debt and leads him to believe that debt deflation is the key issue that will continue to dictate what happens in the global economy. I am really looking forward to discussing deflation, his new book, maybe something of his recent debate with Paul Krugman, and whether the global markets are rolling over as we are speaking today. Steve it is a pleasure to have you as your guest.
Steve Keen: It is great to be back on again Chris.
Chris Martenson: Oh, fantastic. So, listen let us start right at the outset if you could give a summary for those who are not familiar with your work. You say debt deflation is the key issue. Can you give us a summary of your views?
Steve Keen: Yeah. Well, a capitalist economy necessarily has banks that is news to conventional economists, but as we use that as a risk to that and banks create spending power by creating debt. So, you can actually have a boom being driven by banks lending money at a faster rate than the economy itself is growing, which gives you an accumulation of debt that is getting to be a higher and higher ratio of debt to the GDP.
You get to the point where that can not continue any longer, where you cannot get new borrowers, and when you reach that point you go through a turning point then where people who have normally been enticed into debt to borrow money to gamble money on rising asset prices. Instead finance prices are falling and trying to liquidate, you then have a period where debt levels are reduced and rather than rising debt, adding the demand as a it does during the boom phase.
During the depression phase, it is not as slump its a depression, people are spending less than the earn and therefore the aggregate demand is less than income and you have a declining level of demand all the way through as asset prices collapse and debts gradually paid back down.
That is what gave us the 1930’s and we began the 1930’s process with an American debt to GDP ratio of roughly 175% and thanks to Greenspan and Co we began this particular downturn with a peak level of debt of 303% of GDP. So just as it took about 15 years to get out of the last Great Depression, this one which American’s are still calling a lesser depression now I noticed, it could last even longer than great depression 1 did.
Chris Martenson: This time with 50% more extra debt. In this story then, there is a math problem and the math problem is that you cannot borrow more than your income. If you debts are growing at a faster rate than your income, eventually you have a math problem. You are saying we reached that math problem in 2008 I guess, do you agree with that? In addition, secondarily, was there a trigger in events that precipitated that or did these things just somewhat happen randomly?
Steve Keen: It is an endogenous thing. It does not require an external event, because to continue having more and more debt being taken on, you have a ton of people who are willing to acquire that debt. Initially the level of debt the household had back in the 1990’s was relatively low, about 40% of GDP. They were then enticed by the subprime bubble and the debt levels for the household was about 100% of GDP. To keep the bubble going, you would need not just people to keep raising their debt, but accelerating debt.
This is why it always has to break down, because for debt to accelerate indefinitely you have to get to the stage where debt to income ratios were infinite. Now, of course that can happen. So, as soon as you start to exhaust the supply of people who are willing to go into debt, as we have more and more of society becoming indebted, a simple slow down of the rate of growth of that is enough to turn the acceleration negative. That is what drives the whole economy down.
So, we take a look at the data, I think you have to look at three factors of debt, the absolute level, the rate of growth of debt, and whether that rate of growth of debt is acceleration or decelerating. In fact, the process begins as soon as the rate of acceleration consistently decelerates and goes from getting faster to growing more slowly. That is what sets the process off.
It actually began pretty much at the beginning of 2008, but of course part of the other triggers as well was that a large part of the debt that was created was then put into ventures, which themselves were losing money. Therefore, you had the subprime crisis where we know people were borrowing amounts of money they could never pay. They were unnecessarily going bankrupt, there were losses being made by speculative ventures elsewhere as well, but those losses accumulate and have to be serviced or they have to go bankrupt and write the debts off. Therefore, those triggers were all sitting there, but they were truly internally. It does not take a meteor from mars to create this crisis.
Chris Martenson: So, I plant the seeds of this stretching back a long ways, I am the most familiar with US debt. At this point, I know that starting in the 1970’s through the next four decades, over those four decades total credit market debt, which includes financial and non-financial. That doubled five complete times in that period of time and of course the economy did not double anywhere close to five complete times.
So, that rolled over around in 2008, so just to get back on that trajectory, to get back to what people would call normal for budgets to operate like we expect them to, capital markets, and the whole shebang. I would estimate that we would have to double again, what is calling in a decade. Therefore, from 2008 to 2018, the US has to figure out how to accumulate fifty some-odd trillion dollars of new incremental debt. I do not know what we would even possibly lend it to ourselves for, the total housing bubble was still only a ten or eleven trillion dollar market. Do you see any opportunities out there for us to take on the kinds of debt that seem to be required to rescue this system?
Steve Keen: No. You cannot go back to business as usual. This is the real trap of the debt bubble, because the thing that actually entices people into that much debt is the expectation that asset markets are going to continue rising. If you look at the debt that people have with respect to their income, you know personal lines, and stuff like that. Despite all the enticements to charge up credit cards, would you like an increase in your credit limit with that like if you are going to McDonald’s and getting extra fries.
Banks are trying to pump out higher credit limits all the time. Deals on buying cars, you know buy now and pay later, etc. Despite all of that, the ratio of unsecured personal debt to income has not been flat lined, but it certainly has not gone on an exponential rise. The only form of debt that rises exponentially compared to income is debt, which is being used by an asset were you believe that the asset is going to increase in price and you can sell it for a higher amount of money that what you paid to buy it in the first place.
If you can get a capital gain, which really is a ponzi game. You do not do anything, but you get money for it. That is what drives that prices up, you have the biggest bubble in stock market history and the biggest bubble in housing market industry simultaneously, having reached that peak because you can longer have accelerating debt driving up those processes further they are now falling and that it is going encourage people out of debt. Therefore, far from saying in a way it will get people back in again, the asset market bubble being over that is going to drive people out of debt rather than getting enticed to take on more. So, what was usual over the last 40 years cannot be restored.
Chris Martenson: Very interesting in that. I note that, one of the places that I date sort of a recent stumble in all of this, yes it is a four decade long credit bubble, but in 1994 we had a real issue in the credit market particularly corporate bonds. Greenspan took that moment to implement something called the Sweeps Programs, which enabled banks to effectively dodge the reserve requirements as minimal as they were entirely.
That enabled a brand new gigantic round of liquidity to take off, so they had the stock bubble and of course, that met its fate, and then that led to another round of ultra cheap money. Ultimately that led to a housing bubble. Therefore, my view of this is that we started with a relatively small crisis, but with the application of more sugar, monetary heroin, or whatever metaphor we are using here, that beget an even larger problem that required an even larger stimulus.
Therefore, here we are now globally looking at coordinated central bank interventions where in the past six years the balance sheets of just the six largest central banks have expanded by ten trillion dollars. Do you think that they can realistically keep this game going much longer?
Steve Keen: Well, they can prevent people from going insolvent by giving somebody who is bankrupt cash. That is pretty much what they have been doing. They have been bailing out the banks and bailing out the bondholders. They can continue doing that indefinitely, because it costs. Just as banks can create money, the commercial banks can create money by double entry book keeping. So can central banks, so they do not face very many limits at all.
There is not a limit to their profitability of course. So, they can keep on doing this indefinitely, but what they are hoping to have happen and this is what is going to fail, is by doing it the system will suddenly kick start itself. It will be like a lawnmower in which you continue pulling on the cable to try to get it to start, pull it a few more times, put a bit more fuel in, and it will finally fire up and then it will go off of it’s own.
That is what is not going to happen. They are going to have to continue pumping money back in again and of course each time they stop it will spot into life itself, because the basic trainings for the public safety is reduced its debt levels. It will always fall back into a slump. Therefore, they can keep on doing it indefinitely, but I think we will continue indefinite succeeding and filing as soon as they hear that the system can take over on it’s own.
Chris Martenson: So, spell it out for me. Why exactly is it that this engine will not sputter back to life?
Steve Keen: Because too much debt is already in there and because people no longer see a way of rising debt. Meaning, a gain on the asset markets for themselves they are going to be trying to reduce their debt. Particularly if asset markets are in fact falling. They are going to be reducing their gearing, reducing their leverage, and every time you kick start to go the system with a lot of extra money and hope to get it started once more.
Once you stop injecting that government created into the system, the system will then go to this stage where it takes money out, because to pay your debt down you have to take money out of circulation. Therefore, the economy will fall again and rather than booming, it will go back to faltering once more.
Chris Martenson: So, perhaps in a micro causing, if we look at what is happening in Spain today where we note that they have an extraordinary debt to GDP ratio, they have really dismal economic prospects, they have a banking system that is really weak if not mortally wounded, and they have just nationalized Bankia. Is Spain a good metaphor here for what maybe the larger world is going to experience?
Steve Keen: I think American can still apply to this metaphor, because as a point I think metaphorically we are talking about the actual story. Because, Spain is part of the Euro and the Euro is another catastrophe on top of all the overall catastrophe of private banking funding ponzi schemes. Therefore, the real story is the commercial banks generating money and making profit for themselves by creating debt and persuading us to do far too much debt by the asset bubbles that actually caused the prices to rise.
In addition, of course, Greenspan’s rescue is making this process go on for far longer than it would have without that particular government intervention. But, Spain is caught up with the Euro where just as neoclassical economists are responsible for the scale of the crisis by making us turn a blind eye to rising debt. They also drafted the economic component of the treaty to bring about European Union.
That treaty embodied the neo-classical fantasy that a market economy works best if there is no government intervention and no government policy. Therefore, they set up a system in which the governments could not do an exchange rate policy, because they are all part of the one currency. Therefore, they cannot devalue against each other.
You cannot do a monetary policy, because the European Central Bank is in control of that and sets an interest rate for the entire continent of Europe. You cannot do a fiscal policy either, because the master treaty said the maximum deficit that you can run is 3% of GDP and the maximum accumulative deficit that you can have is 60% of GDP. They are talking about public debt there.
So, to push Europe together and said you can have neither the fiscal, monetary, nor exchange rate policy and we are going to have the most wonderful world. Well, look at what has happened. It is the greatest catastrophe on the planet. Therefore, Spain is an additional catastrophe. Like in some ways it is America squared.
Chris Martenson: America squared. However, America is maybe the better metaphor, because it is not a metaphor we can talk about it directly.
Steve Keen: Yeah, it is the real story. Yeah. America is big enough even though it is being industrialized masterly through the last 30 to 40 years to under the cover of this financialization of this economy and even though it has a much larger import bill than it used to have because of that, it is still pretty much a self contained economy. What is going on there is an entirely endogenous process of the banks creating too much debt, funding an asset market bubble, and now we are caught up in the deleveraging from that and we are back in another Great Depression.
Chris Martenson: So, start to spin over in the great debate that has brewing with the neoclassical economists, who by the way have been just spectacularly wrong. I have yet to hear a qualified reasonable mea copa from that crew. If I could summarize, they seem to be saying any failures in policy and traction that we are not seeing so far, is simply because we did not do enough. Enough of what?
You have mentioned that some of the strategy here was sort of delay and pray, so we just kick the can long enough and pray and maybe the economy sputters back to life all on it’s own. However, there have been a number of other dynamics driving this with taking what were private debts and pushing them over on to the public side of the balance sheet with direct monetization of government debt by central banks in particular the Federal Reserve, very large quantities. What exactly is the strategy here?
Steve Keen: Well this is the intriguing thing, because the strategy is panic. The neoclassical economists believe that the economy is self-equilibrating, that it will return to the equilibrium after the minor shock and they really regard the global financial process as just a big shock. However, for some reason they continue to remaining negative and they cannot work out why.
In fact, if they have had their drothers, they would have drovened on nothing back at the time of the 2007 crisis. Except that according to their theories that crisis should not have happened. So, what happened when the crisis hit? You had people who were neoclassical and vehemently anti government spending; suddenly became born again Keynesians. They threw as much money as they could at the system hoping that would get it over this temporary process.
Then, when they did that and they got a bit of a recovery for a while, the scale of the government spending was far greater than the Great Depression. Therefore, you had a boost of aggregate demand coming out of the government’s behavior. Then, they thought they could sit back and watch it start booming once more and rather than booming of course, we have had an economy, which splatters.
Normally after a standard post second World War recession where you know growth is negative for a couple of quarters, you normally get a rebound where it bounces up between five and six percent on an annual basis per quarter for a few quarters at least after the slump. The best they have managed so far is about three; of course we are falling back to the stage where one may even hit negative again.
Their response was to abandon their principals so called and go for government spending, and then pray that would be enough to get the system started again. They are basically flummoxed as to why it has not worked.
Chris Martenson: You know I am going to note that I think Keynes is getting a bad wrap in this.
Steve Keen: He is getting a bad wrap, yeah.
Chris Martenson: I have read some of his works and he is clearly a very intelligent person. I am going to go out on a fat limb and suggest that he would not ever support the idea of trying to exponentially grow and increase your debts faster than your income. He was clearly too smart for that.
Steve Keen: No, Keynes was aware of the dangers there. I often said people like Paul Krugman call themselves new Keynesian’s, him and Woodford and so forth.As I read Development of Economics, if they can call themselves Keynesian’s and I can call myself a duck, because I can say the word quack.
There is no way in which they reflect what Keynes actually wrote. Ironically you read them and they do not care what Keynes actually wrote. They call it research, I am sorry but knowing what somebody said is essential before you can use their name as a label of what you do. However, in fact they do not do that, they simply think oh this looks like what I think Keynes said according to a textbook I read a few years ago and I will call myself the Keynesian. I am sorry, but they are better off calling themselves ducks, because they really are quacks.
Chris Martenson: Way to bring it all together. If we could just for a minute here, there was a very public debate with a New York Times economist, I am putting your quotes up here on this. I guess he is an economist but Paul Krugman. I was reading his blog and he was defending the idea that banks cannot create money out of thin air. He may have backtracked a bit on that, but it was a very odd debate. I did not quite understand ultimately what was being argued there. Can you help us out?
Steve Keen: Yeah. Well, the basic neoclassical attitude is that banks do not matter. Banks are simply intermediaries between savers and borrowers. All the bank does is act as a conduit; it does not actually create money. Now you then argue of course, it does create money and the money multiples then. So, the government gives a unemployed person a check, they go bank the money at the bank, the bank holds onto a bit of it, and lends out a bit.
There is the money multiplier process that they ultimately get to the stage where they finally have a ratio between their deposits and their reserves, which is the maximum level they can get to and then they cannot lend anymore until the government creates more reserves. That is the sort of money creation model that Krugman believe, that neoclassical economists in general believe the banking sector is capable of. However, they argue that the bank cannot simply create money beyond what the reserve systems allow it to do. I think that is the conventional belief they have.
Now, the position that I come from is to say that banks are unconstrained by the reserve system. There are a number of reasons behind that. One of the simplest is and the European Central Bank actually states this, the way the reserves are calculated is as a lagged response to what has happened in the lending market. So, the reserves are based on the deposits that were credited two weeks earlier in some cases. In America’s case, it is 30 days earlier.
Therefore, in other words it is after the banks have created new money, then the reserve they need to match the new money they have created are determined. Therefore, rather reserves creating it first and deposits coming later, it is precisely the reverse way around. That is the big mistake; it means that banks can create money by double entry bookkeeping.
If you go to a bank and ask for a loan, the bank asks you what the money is for, I have this idea for this new hydrogen powered iPad, the bank says that is a great idea, here is one hundred million dollars, and by the way you own us one hundred million dollars. They simultaneously create a loan and a deposit without having to take the money out of the account of any other savers. Therefore, that means you get to spend one hundred million dollars building this new hydrogen powered iPad does not reduce the spending power of other people in society, it adds to it.
Therefore, banks play an essential role in the real economy and in the models that I build of it as well. They are actually adding to aggregate demand. What they add to aggregate demand generally goes on two things, investment, which would be a good thing if indeed a hydrogen powered iPad was a good idea which is not, but nonetheless that would be a good investment.
However, it also goes on speculation, which means buying existing assets and using the borrowed money to bit up the prices. That role of banks is an essential element of why we got into the crisis in the first place. But Krugman is quite amazing at having said this, his is all for putting in banks where they matter, but why do banks matter in a story about debt and leverage? To me that was a bit like saying I am for it with considering wings on birds, but why do I need to worry about wings and why birds fly?
Chris Martenson: It is mysterious. It is just mysterious to me that there can be such a disconnect between what appears to be obvious conclusions from lots of data. You do not have to dig hard; it is all right there. Help me understand something then, I do something very arcane, I look at the monetary aggregates, because I think that there is still some information in that. My prediction is that someday the velocity of money will turn around like it always does and that will be a moment to behold.
I am watching say M2 or MZM it does not matter; they are still trending up at an almost unbroken clip throughout this entire crisis. In fact, they even have some sharper up sloping periods during part of this crisis. On that basis, it looks like there are still plenty of money sort of entering the system by hook or by crook, even as credit is declining, mostly it is financial credit, that has declined. How do we explain that?
Steve Keen: I have to plead ignorance there but first I tend to look at the debt levels. To me the central act in creating new money is the creation of debt, because debt and money are created as a bonded pair when they begin and then after the creation process they are separated. So I am looking at the level of new debt being created and that is still declining. The level of debt in the economy is still falling very slowly; it was falling very rapidly when the crisis first began. That is the main metric I look at.
The monetary aggregates on the other hand, I tend to regard them as being caught up in the whole shadow banking sector and what is being done by the government in it’s rescue attempts. I think there are so many black ops going on there that I just do not find the data reliable enough to worry about too much.
Chris Martenson: Yeah, I understand that.
Steve Keen: It does puzzle me; I have to defer to you on that one.
Chris Martenson: All right, well back to your earlier point then, one of the other things about this double entry bookkeeping and credit expansion really does enable as well. If I am looking at the inflation adjusted expenditures of all the major OECD governments, they are all upwardly sloping lines for the past decade.
Therefore, the other enabling feature of creating all of this money is to allow governments to not really have to figure out how to balance their books all that carefully. So, everybody got to participate in this party I assume?
Steve Keen: Well, it is a bit different. There is a reason why debt should rise over time, but it should rise roughly at the same pace as income, faster sometimes and slower at other times. I was talking about private debt there, because when you have a growing economy because the growth is financed largely by the increasing debt financing investment, which then gives you technological improvements, new products and so on. That is a reason to continue borrowing money.
We should normally expect the banks to be creating new debt most of the time and only when the economy is actually in a recession is when we should see the level of debt falling. That would be a healthy economy if we did not have financing ponzi schemes and therefore rising exponentially faster than income.
The same thing applies for the government, if you have a mixed economy you have a combination of private sector spending and government spending, private sector created money, and government created money, you have to have the government creating additional money over time as well. The major way it does that is by running a deficit. Therefore, the normal situation for a growing economy should be a deficit that means the level government money in the system remains roughly comparable to the level of private money.
Instead what we have with this fixation on balancing of the books, which would be the right thing to do if you had a static economy. That has actually led to the level of government money plunging over time. If you go back to the 1960’s and I have some memory of the levels of aggregates back then, back in the 1960’s M Zero was about 15% of the total money supply. If you fast-forward to just before the crisis, we were down to about three percent.
That was the government, actually because of the obsession with running surpluses during the boom times and even during some slump times. Reducing the amount of government money in circulation, letting the credit system go crazy, and then when the crisis hit what does Bernanke do? He doubles the base money supply in four months from the previous doubling took 13 years. We got back to pretty much the same ratios as 1960 by the time we finished the pumping into the system, but it actually helped stabilize it in the period before that.
Chris Martenson: Interesting. So, let us imagine then when you see what is going on right now, you say credit is slowly falling and it is not growing at all. If credit is falling slowly at this point, would you say then the pressures on the global financial system, on markets and the larger economy, are those pressures still growing at this point.
Steve Keen: Yeah, the reason that we have this trauma for the asset markets is because of this whole relationship that rising debt has to the level of asset markets. If you think about the best example is the demand for housing, where does it come from? It comes from new mortgages. If you want to sustain the current price level of houses, you have to have a constant flow of new mortgages. If you want the price level to rise, you need the flow of mortgages to also be rising.
Therefore, there is a correlation between accelerating and rising asset markets. That correlation applies very directly to housing. You look at the 20-year period of the market relationship from 1990 to now; the correlation of accelerating mortgage debt with changing house prices is .8. It is a very high correlation.
The boom and bust is obviously too. It is not quite so clear for the stock market, but it is about .35. And then given how volatile the stock market is, I find that to be a remarkably high correlation anyway of aggregate debt to the change in the stock market.
Now, that means that when there is a period where private debt is accelerating you are generally going to see rising asset markets, which of course what we had right up to 2000 for the stock market and of course through 2006 for the housing market. Now that we have deceleration debts, debt is slowing down more rapidly over time rather than accelerating. That is going to mean falling asset markets.
Because, we have such a huge overhang of debt, that process of debt acceleration downwards and decelerating, negative, is more likely to rule most of the time rather than going positive. We will therefore find the asset markets traumatizing on the way down, which of course encourages people to get out of debt. It is a positive feedback process on the way up and it is a positive feedback process on the way down.
Chris Martenson: Do we also have something else contributing here where any market, whether it is an asset market or a fish market, if you have more buyers than sellers prices tend to go up in the reverse more sellers than buyers and prices tend to go down. When I look at the demographics of the United States and of Europe, people enter their peak earning years between the ages of 30 and 50 and then when you have more retirees that people behind them. If you have some sort of a demographic bulge you generally will find, well whom are they going to sell their assets to, as they want to fund their retirement?
Japan in many respects is almost exactly 10 may be 11 years ahead of the United States in terms of it’s population demographics. They have been experiencing just horrible asset markets for a very sustained period. Bernanke certainly studied that and promised we would not turn Japanese. Have we just turned Japanese?
Steve Keen: Oh well I am sure. That sort of work is the sort of stuff that Harry Dingey entertained of course. It is a genuine product of the whole dynamic that I tend not to include in my modeling. If I include the demographics, it would pretty much swamp everything else. I want to focus on the contribution the financial sectors made to it is own suicide.
But, yes when you have a demographic bulge, such as the baby boom and so on, passing through the system and they are trying to liquidate their assets they get and get their retirement funded. Of course all doing it at once and then having finding asset markets driven up through high levels of debt, now they are trying to capitalize that and come out with an income for the future. They are going down again.
Now of course, when you have a declining population, you do not need to have more houses being built and you can therefore have houses becoming empty. That of