Saturday, July 7, 2012

Steve Keen's Private Debt Jubilee?

David MacDonald of rabble.ca reports, Keen on economics and Canadian debt:

I was fortunate enough to be able to attend Steven Keen's talk "Canada's Debt Bubble" on June 28, 2012 (recorded in full here). The session was jointly sponsored by the new Ontario office of the CCPA, the Progressive Economics Forum and Ryerson University...and what a talk it was! I immediately purchased Steven's book, Debunking Economics, and read it all weekend.

Much of the book is a revelatory tour de force for those who've experienced pure neoclassical economics at university. As many readers of this blog are hopefully aware, what's taught as economics today in English-speaking universities is actually only one school of economics, the neoclassical school.

It teaches that for markets there is a demand and a supply curve and they tend towards the equilibrium point where the two curves meet. Neoclassicals argue that this is the case for individual products but also for the economy as a whole. All other things being equal the economy will lead to full employment, low inflation and strong economic growth. The reason we find ourselves empirically in other states is due to "external shocks" generally blamed on government interference.

Much of the book is spent delivering crushing blows to the basic tenants taught in university micro and macroeconomics. Keen shows again and again how each one has been critically undermined, usually by neoclassical economists themselves and usually decades ago. Upward sloping demand curve for the economy...wrong, downward slopping supply curve...wrong, monopoly control less efficient than competitive firms...wrong and on and on.

Anyone who has taken these courses, or is going to, will find the book riveting and deeply disturbing. Neoclassical economists are the ones running our central banks, figuring out how to drive economic growth, trying to solve the crisis in Europe (Well we at the CCPA are trying to figure these things out as well, but we have less sway). Essentially, economics as it is being taught in English-speaking universities hasn't been updated since the '30s. Imagine if this were the case with the sciences...we'd still be listening to music on records (They are those circular plastic things you find at garage sales)!

How could most major institutions and economist have completely missed the run up to the biggest crisis since the great depression? It is one of Keen's ongoing criticisms. That is if you want to build a theory of economics, it had better have predictive and explanatory power. As such, it had better have a state where it is in depression and it had better otherwise oscillate between growth and recession. Keen attempts to build such a model not on a neoclassical equilibrium basis which has no such states, but instead on an system that, not unlike population models in biology, can oscillate between various states (high unemployment, low unemployment etc).

In building this better model, Keen includes debt as an important part of the equation of aggregate demand. For neoclassicals, aggregate demand = GDP. For Keen, aggregate demand can be further influenced by how fast debt in the economy is accumulating. For neoclassicals, the aggregate level of debt in an economy is irrelevant. For Keen, one cannot understand what happened in 2007-8 without including debt in economic models. Over the past two decades, it has been debt that has been driving aggregate demand. This debt isn't the productive kind that fuels investment, it is rather the unproductive kind that merely drives up asset prices, in the 1990s of Internet stocks and in the 2000s of housing prices.

Keen's model even predicts widening income inequality as the interest being paid on ever larger debt is taken out of the wages bill.

For those of you who want a quick overview, I encourage you to watch the lecture that contains Canadian specific data. I hope to follow up on Keen's variables and track their Canadian versions in the future. For those who want to whole enchilada, and if you're interested in economics as an academic discipline, you should buy the book. It is definitely worth it.

For those of you who don't know Steve Keen, he's an Australian economist who recently took on heavyweight Paul Krugman on one of the biggest issues of all in economics:

During the last few weeks, economists Paul Krugman and Steve Keen have engaged in a lengthy (and ugly) blogger debate about the role of banks in expanding the monetary base.

But beyond the jargon, the nitpicking, and the insults (from both sides) the point they debated is a crucial one: Does the Fed have sufficient power to control the monetary system? Or are the Fed and other central banks given more credit than they are due?

The impetuses for this debate are the theories of Hyman Minsky, an American economist who wrote that markets are intrinsically in a state of disequilibrium.

According to Keen, Minsky thought that irrational market actors can exacerbate disequilibrium's when they perceive future stability in the markets. For example, banks in the early 2000s continued extending loans to home-buyers with poor credit because they did not foresee (or did not want to accept) that home prices could not continue rising. Even the initially conservative activity of extending loans to creditworthy homebuyers soon became speculative, as home prices skyrocketed out of control because of unsustainable demand in the market.

While it is quite conceivable that bank behavior did indeed exacerbate the housing bubble in this manner, Keen argues that this behavior demonstrates a deeper ideology: Fiscal and central bank policy have far less power in controlling credit conditions than we would like to believe. He writes:

We cannot rely upon laws or regulators to permanently prevent the follies of finance. After every great economic crisis come great new institutions like the Federal Reserve, and new regulations like those embodied in the Glass-Steagall Act. Then there comes great stability, due largely to the decline in debt, but also due to these new institutions and regulations; and from that stability arises a new hubris that “this time is different”—as the debt that causes crises rises once more. Regulatory institutions become captured by the financial system they are supposed to regulate, while laws are abolished because they are seen to represent a bygone age. Then a new crisis erupts, and the process repeats. Minsky’s aphorism that “stability is destabilizing” applies not just to corporate behaviour, but to legislators and regulators as well.

Banks, Keen insisted, form the crux of the problem since they are in control of the monetary base. Banks' assessments of the risks and rewards to lending grows virtually without reference to the deposits they receive, so banks—and not the government—ultimately determine credit standards.

He wrote in a blog post:

Why does it matter that “once you include banks, lending increases the money supply”? Simply, because the endogenous increase in the stock of money caused by the banking sector creating new money is a far larger determinant of changes in aggregate demand than changes in the velocity of an unchanging stock of money. And in reverse, the reduction in demand caused by borrowers repaying debt rather than spending is the cause of the downturn we are now in—and of the Great Depression too.

This is where Krugman took issue. A convoluted tit-for-tat sting of blog posts about whether lending or deposits expand the money supply followed, with the conversation devolving into bickering on the money multiplier, IS-LM models, dynamic stochastic general equilibrium, etc.

I'm quite sympathetic to some of the criticisms Keen discusses in the role of banks expanding the money supply but I also understand why Krugman took issue with them.

My reading of the 2008 crisis is a little simpler. Last November, I wrote a comment, banksters take it all. Even the normally bank-friendly Economist is calling them Banksters in an article discussing the LIBOR-fixing scandal (been around for years and people are now shocked!).

But to understand the crisis and the policy response post-crisis, you have to understand, and more importantly accept, that we are living in a world where banksters call the shots. You might not like this, and rightfully so, but this is the reality and barring a major social calamity, this 'capitalistic hierarchy' will define our era for better or for worse.

Back to the financial crisis. What exactly happened? Nothing new, banksters and mortgage fraudsters working together to push the envelope to the nth degree all in the name of profits until the entire system caved in because shady loans, and the shady paper underlying those loans, were eventually exposed and it all came crumbling down.

Then came the 'too big to fail' bailouts where banksters got a gift to basically keep their operations going. They also got massive free loans from the Fed to keep on doing what they love doing, namely, getting money for nothing and risk for free, speculating on risk assets hoping to make a killing in markets.

This is where I'm sympathetic to Steve Keen's criticism of Fed policy. Quantitative easing has been a boon to banksters, exacerbating income inequality in the United States and elsewhere. It has allowed the financial elite, including hedge fund titans, to prosper beyond their wildest dreams during a time when far too many Americans and Europeans are struggling with unemployment and under-employment.

The biggest problem is the money goes in the hands of a the financial oligarchs and trickles to the rest of the economy. Banks are not interested in lending money to businesses and consumers because they prefer the liquidity and yields that come with speculating on risk assets.

This creates huge distortions in our debt laden society and there are reasons to believe this model of capitalism has run its course. With interest rates at historic lows, and deflation knocking on our door, there are signs we are approaching a zombie economy.

This is why Steve Keen thinks it's time for a "radically new" policy, what he calls a private debt jubilee. It basically works like this: instead of lending money to banks, the Fed directly deposits money into bank accounts. This money is used to help those in debt pay off debts, while those without debts will have more money to save and invest with.

Steve Keen's debt jubilee idea has been heavily criticized by many (read this comment, for example). I have my own concerns but also realize that unless something is done to break the cycle of debt which permeates every facet of our lives, and threatens our democracy, we are in for a protracted period of debt deflation.

The power elite know this and are publicly warning of a long deleveraging cycle. In this environment, banksters will keep asking for QE, focusing on their capital markets operations, trading risk assets to bolster their profits, but it won't be enough. All this will do is create wild gyrations in equity and other markets. Some prop traders and hedge funds will profit, most will perish in these rigged markets governed by dark pools and high-frequency trading algos.

Whether you like it or not, this is the world we live in folks. Learn to accept it, embrace it, or else you too will feel the stinging crush of what lies ahead.

Below, Steve Keen’s recent interview on Capital Account with Lauren Lyster, discussing Minsky's Moment and the Debt Black Hole impacting economies around the world. Also embedded Keen's recent talk at the Canadian Centre for Policy Alternatives on the Debt Bubble and its implications for Canada. You can also listen to this BBC Radio 4 interview and follow Steve Keen's Debtwatch for his latest insights.

No comments:

Post a Comment