Debt­watch gets a men­tion in Par­lia­ment

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It’s not yet the main topic of debate between Lib­eral and Labor, but some of the argu­ments in Debt­watch have at least made their way into Hansard cour­tesy of a speech by Lau­rie Fer­gu­son. The full extract from the speech is shown below.

This makes a mock­ery of the claim by the Prime Min­is­ter that we have never been bet­ter off. Whilst the Howard gov­ern­ment crows about the suc­cess in the econ­omy, which was largely inher­ited from Labor and fuelled by the raw mate­ri­als demands of India and China, there is an alter­na­tive real­ity of an out-of-con­trol per­sonal debt spi­ral. Steve Keen from the Uni­ver­sity of West­ern Syd­ney writes:

Australia’s house­hold debt to GDP ratio has risen from 57 per cent of GDP in 2001 to over 86 per cent in 2005 or five fold from the mid 1970s. With the excep­tion of a dip in 1985–87 period, when the Stock Mar­ket was the focus of a spec­u­la­tive frenzy in Aus­tralia, the hous­ing debt to GDP ratio has been ris­ing expo­nen­tially for at least 25 years. The focus of RBA con­cern today is there­fore on bor­row­ing by house­holds.

Aus­tralian house­hold debt was five and a half times higher in 2005 than it was in 1990. The Amer­i­can growth rate of eight per cent trans­lates into 3.2 times as much house­hold debt in 2005 as in 1990.

So we see that the sit­u­a­tion of Aus­tralia has markedly wors­ened as com­pared with the United States. Fur­ther­more, whereas in the US debt weighs heav­ily on house­holds and busi­nesses, in Aus­tralia the pres­sure of debt is being exerted pre­dom­i­nantly on house­holds. A potent indi­ca­tor of the level of finan­cial stress now being felt by Aus­tralian house­holds is a ratio to house­hold dis­pos­able after-tax income. This ratio has more than tripled since 1981. The expla­na­tion that this is due to falling inter­est rates ceased being viable about two years ago.

The rise in debt has eclipsed the impact of gen­er­ally lower inter­est rates since the early 1990s so that pay­ments by house­holds now con­sume more of house­hold dis­pos­able income than they did when stan­dard home loan rates peeked at 17 per cent in 1989, even though the aver­age vari­able rate is now 7.5 per cent.

Since its elec­tion, the Howard gov­ern­ment has presided over an almost three­fold increase in per­sonal house­hold debt. The total per­sonal debt in Aus­tralia has increased from about $46 bil­lion in Jan­u­ary 1996 to a stag­ger­ing $133 bil­lion in Novem­ber 2006. The Insol­vency and Trustee Ser­vice Aus­tralia reports that the Decem­ber 2006 quar­ter saw a blow-out in bank­ruptcy num­bers in all states except West­ern Aus­tralia.

This includes a 30 per cent increase on the cor­re­spond­ing 2005-06 period in New South Wales and almost 28 per cent in Vic­to­ria. Steve Keen’s analy­sis of ris­ing per­sonal house­hold debt is under­pinned by AFFCRA’s analy­sis show­ing that wide­spread use of credit cards for house­hold and dis­cre­tionary spend­ing, dri­ven by aggres­sive indus­try sell­ing prac­tices, has led to unhealthy finan­cial think­ing where card facil­i­ties are con­sid­ered in the con­text of avail­able credit rather than actual debt lia­bil­ity. Jan Pent­land writes:

In the cur­rent con­sumerist hege­mony and the increas­ing gap between the haves and have nots, where mate­r­ial goods can define self worth, eas­ily avail­able credit has been a trap for many clients of finan­cial coun­sel­lors. This bud­get clearly fails Aus­tralian con­sumers. The government’s pri­or­i­ties are twisted. The gov­ern­ment is pour­ing mil­lions of dol­lars into finan­cial lit­er­acy cam­paigns when it is clear indus­try is already doing so. Where money is scarce it should be directed where it is most urgently needed. Finan­cial coun­sel­lors are being increas­ingly called upon to deliver ser­vices to grad­u­ally more des­per­ate Aus­tralian con­sumers. These and many mil­lions of other Aus­tralian con­sumers need finan­cial coun­selling around keep­ing out of debt. They do not need coun­selling on how to get rich.”

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • foun­da­tion

    Con­grat­u­la­tions Steve, I guess a men­tion in Hansard has as good as immor­talised Debt­watch as it will remain until the col­lapse of civil­i­sa­tion!

    More seri­ously, it is good to see some­body finally mak­ing a well-struc­tured attack of the government’s claims of good eco­nomic man­age­ment. I’d be curi­ous to know what Mr. Fer­gu­son pro­poses should be done about the sit­u­a­tion. If Labor win the elec­tion, we’re still faced with the same two poten­tial future pos­si­bil­i­ties: (1) That house­hold debt con­tin­ues to climb unsus­tain­ably (for a time, then slows caus­ing (2)), (2) That house prices col­lapse in dra­matic fash­ion.

    It is too late now to turn back the clock and stop the house price boom from occur­ring. This boom turned $1 tril­lion worth of homes into $3 tril­lion worth of homes over just one decade. That $2 tril­lion increase is roughly dou­ble the entire value of the Aus­tralian share­mar­ket!* Up to this point it seems to have been accepted – that house prices were just ‘doing their thing’, ris­ing as they always have. That those who bought (myself included) earned this extra wealth although we didn’t raise a fin­ger to gain it. That it’s nor­mal for houses to ‘create wealth’.

    Unfor­tu­nately, now it’s finally sink­ing in that the hous­ing boom hasn’t cre­ated wealth at all. It’s merely trans­ferred wealth from future buy­ers to cur­rent own­ers. The future buy­ers have to (over time) pony up that $2 tril­lion dol­lars, or house prices will col­lapse. If they are to man­age to pay, it will only be through a con­tin­u­a­tion of the cur­rent trend in debt accu­mu­la­tion.

    If we look at Aus­tralia as a sin­gle entity, and as hous­ing as a sin­gle asset that has a sin­gle price it makes no sense to cel­e­brate a price boom. Where is the gain in adding $2 tril­lion in to the price of this hous­ing asset if this price can only be met with $2 tril­lion of extra debt? The net gain from a house price boom that is entirely funded by debt is zero, zip, zilch, while the cost to house­holds and the econ­omy is high, as the increased inter­est pay­ments reduce (post-mort­gage) dis­pos­able income and con­sump­tion.

    If Mr. Fer­gu­son thinks things are bad today, he needs to realise that we’ve only paid for a very small por­tion of the recent boom. In Decem­ber 1996, the value of all hous­ing assets in Aus­tralia was $1.07 tril­lion, and hous­ing debt was at $192 bil­lion. Ten years later, the value of all hous­ing assets was $3.14 tril­lion and hous­ing debt was at $827 bil­lion. Hous­ing debt rose by $103 bil­lion dur­ing 2006 alone enabling some 5% of houses to be bought and sold. And therein lies the rub.

    The fact that only a small pro­por­tion of houses are turned over each year means that after the boom, debt lev­els will con­tinue to rise each and every year for many years. The boom cre­ates noth­ing but pain, pain that is drip-fed to house­holds in increas­ing quan­ti­ties for ten or fif­teen years depend­ing on how quickly their wages man­age to coun­ter­bal­ance the ris­ing debt.

    Okay so I’m ram­bling, but the blog has been a bit quiet lately so I guess I can hog it! Here’s my point: House price booms are bad, okay? And if Labor want to do some­thing to help house­holds, the very best thing they can do is to encour­age run­away infla­tion which would reduce the real cost of debt. The sec­ond best thing would be to stop look­ing at ‘solutions’ that add to the demand side of the bal­ance (stamp duty cuts/exemption/FHOG/shared equity loans/etc). To solve the afford­abil­ity cri­sis and stop peo­ple from con­tin­u­ing to over-accu­mu­late debt you want LESS peo­ple who are able to buy at cur­rent prices, NOT MORE

    If less peo­ple are unable to afford stu­pidly high prices, prices will fall and afford­abil­ity will be rebal­anced. Peo­ple will take on less debt and the coun­try will be bet­ter off for it! Bet­ter still, force banks to stop lend­ing peo­ple stu­pid amounts of money. Limit total debts to 3x house­hold income. Would this stop peo­ple buy­ing houses? No, it would sim­ply pre­vent peo­ple buy­ing houses at stu­pidly high prices using stu­pidly high mort­gages. House prices would fall to a level where peo­ple could afford to buy with a mort­gage of just 3x house­hold income.

    Mr Fer­gu­son, if you or other ALP peo­ple are read­ing this, you need to realise you’ve dropped the ball on this one. The government’s fail­ure to con­trol this debt bub­ble should be a huge issue for you. It’s not too late to start let­ting the pub­lic know that they’ve been duped over this, that debt is caus­ing harm and will con­tinue to cause fur­ther and worse harm in future. It’s in your inter­ests to get this infor­ma­tion out before the elec­tion, just in case you win. Oth­er­wise when the full force of LIB’s fail­ure is felt (ie when the next reces­sion inevitably occurs), you might end up get­ting all the blame… again!

    * Clearly, houses are the most pro­duc­tive things we have, moreso than busi­nesses, fac­to­ries, mines or work­ers. Sure they don’t appear to be pro­duc­tive; they don’t after­all make any prod­ucts, but they pro­duce money faster and with far less (in fact, with­out) effort than a busi­ness, fac­tory, mine or worker could. /sarcasm off

  • hired­goon

    When you think of it, we have all been fools, we’ve bought some pretty crazy sto­ries:

    If we all bor­row money from over­seas to bid up the price of domes­tic real estate we’ll all get rich.

    It makes per­fect sense that sit­ting inside a pile of bricks and being pro­vided with shel­ter should EARN you money. As foun­da­tion says, more than every­one going out and work­ing! This is rea­son­able and will con­tinue on for­ever!

    We’re fac­ing chal­lenges like global warm­ing, peak oil, an inverted social pyra­mid with the baby­boomers retir­ing — and before we’ve even started to face them, we’re start­ing out with the high­est ever debt bur­den in the coun­tries his­tory. Not only have we made, as a soci­ety, a ter­ri­ble mis allo­ca­tion of wealth, but we’ve put our­selves behind the 8 ball before we’ve even started.

  • Fred­Bloggs

    Well, I’m a lum­ber­jack and I’m OK.

    The great thing about Awstralyan house­holds get­ting up to the the teeth in debt has been catch­ing the money they blow and sock­ing it away.

  • foun­da­tion

    With­out mean­ing to pry, how do we catch it? Surely there’s only so many lum­ber­jacks required to cut down trees for con­struc­tion?

  • bear-foot econ­o­mist

    The source of the prob­lem has been the com­bi­na­tion of spec­u­la­tive opportunities/incentives and easy money (loose credit). Even if things improved such that hous­ing became afford­able again and debt lev­els reduced to safe lev­els, the whole cycle would likely repeat again with­out address­ing those two causes. 

    On the credit side, there is noth­ing wrong with obtain­ing credit to pur­chase now and pay over time if it is “worth it” (and the bor­rower can afford it), indeed the econ­omy would not func­tion with­out this facil­ity. So with­out restrict­ing credit, we need to address spec­u­la­tive incen­tives.

    I have men­tioned else­where on this blog the strong (tech­ni­cal) argu­ment for high ‘land tax’ to address this (as well at the eth­i­cal argu­ments foun­da­tion alludes to regard­ing the wind­fall gains cur­rently obtained by land­hold­ers from house price appre­ci­a­tion). A major advan­tage of land tax (in terms of avoid­ing asset bub­bles) would be its sys­temic effect on dis-incen­tivis­ing prop­erty spec­u­la­tion.

  • Brief com­ments because I’m at a con­fer­ence in Salt Lake City today and active in all 3 ses­sions (chair­ing one and pre­sent­ing papers in two).

    Foun­da­tion, I think your analy­sis of the house bubble/debt link is spot on, and some time this year I’ll attempt to include a sim­i­lar mech­a­nism to that into my Min­sky model–the rapid devel­op­ment of which is my main sab­bat­i­cal leave project (I may make the trip down to Mel­bourne to brain­storm with you on this one).

    Effec­tively, my cur­rent model under­es­ti­mates debt accu­mu­la­tion because in it, all bor­row­ing for invest­ment leads to an expan­sion in pro­duc­tive assets. As you put it how­ever (minus the sar­casm!), bor­row­ing for “invest­ment” in hous­ing doesn’t add to pro­duc­tive capacity–it just adds to debt lev­els.

    I’d bet­ter go–I have two hours before I’m chair­ing a ses­sion!

  • Miner

    Foun­da­tion,

    Are you seri­ous about solv­ing the debt issue with infla­tion???

    Who would pay for this? Wouldn’t peo­ple with debt (myself included) be ben­e­fit­ting from the pur­chas­ing power lost by peo­ple who do not have debt?

    If we do increase infla­tion, is the ratio­nal response to just bor­row more?

    Be gen­tle with me I am only new to this…

  • Speak­ing for Foun­da­tion -:)), yes he is, and so am I. The root prob­lem is that, using debt, asset prices have been pushed far higher than can be sus­tained by the cash flows from real eco­nomic activ­ity. Pol­icy-gen­er­ated infla­tion would redress the bal­ance, by dri­ving goods prices up while keep­ing asset prices where they are.

    How­ever, this pol­icy is highly unlikely to be fol­lowed in prac­tice. We are there­fore likely to fol­low the alter­na­tive route–asset prices falling. How­ever, this nor­mally has the knock-on effect of depress­ing goods prices–deflation. In this world, you are chas­ing your own tail to the bot­tom.

    That is a lot more painful for every­one than the alter­na­tive.

    How­ever, because econ­o­mists are so para­noid about con­sumer price infla­tion, while being simul­ta­ne­ously san­guine about asset price infla­tion, they will fight tooth and nail to stop a pol­icy of delib­er­ate infla­tion. So if we fall into a debt trap, we are likely to repeat Japan’s expe­ri­ence of a long drawn out depres­sion.

  • Fred­Bloggs

    There is lit­tle or noth­ing a demo­c­ra­tic gov­ern­ment can do to stop deter­mined adult cit­i­zens from con­sign­ing their future income to mort-gage pay­ments.

    What are the cit­i­zens to do but play the mar­kets and sell ser­vices and imports to each other when man­u­fac­tur­ing can not com­pete with imports and export indus­tries of min­ing and agri­cul­ture are cap­i­tal inten­sive and labour non-inten­sive?

    Turn­ing a blind eye and keep­ing hush to the rapid cre­ation non-cash money by mon­e­tiz­ing assets, through cre­ation of debt and credit over those assets, the cre­ated money being used to mon­e­tize more assets, keeps the cit­i­zenry hap­pily employed in record num­bers.

  • Gen­er­ally, we agree with Steve Keen’s view on Australia’s pre­car­i­ous debt defla­tion posi­tion (see our view: Can Australia’s deflat­ing prop­erty bub­ble deflate even fur­ther?

    But now that our prop­erty prices is already inflated, how do we deflate the prop­erty bub­ble? We have an idea, but we don’t know whether it will work:

    1. First, remove all neg­a­tive gear­ing loop­hole.
    2. Next, for every prop­erty trans­ac­tion that involves a non-first home owner (i.e. investor) as a buyer, impose a pur­chase tax on the buyer which is a cer­tain per­cent­age of the price of the prop­erty being trans­acted. Also, increase the gov­ern­ment stamp duty, and fees for buy­ers who are investors.
    3. For all sell­ers of prop­erty, scrap all gov­ern­ment stamp duty, taxes and fees with regards to the prop­erty trans­ac­tion.

    But we dis­agree with Steve Keen on:

    Pol­icy-gen­er­ated infla­tion would redress the bal­ance, by dri­ving goods prices up while keep­ing asset prices where they are. 

    How is it pos­si­ble to engi­neer an infla­tion whereby only goods prices rises and asset price remain stag­nant? Any pol­icy of delib­er­ate infla­tion runs the risk of mis­fir­ing and thereby fur­ther inflat­ing asset prices.

  • Wel­come aboard Con­trar­ian.

    It would be pos­si­ble by increas­ing wages.

    Of course, in prac­tice, that is highly unlikely to hap­pen, given the atti­tude of con­ven­tional econ­o­mists to both infla­tion, and wages. I’d give the odds of this actu­ally being tried by pol­icy mak­ers as zero.

    How­ever, I flag it as a pos­si­ble rem­edy because what they are far more likely to pro­pose is some­thing that would make the sit­u­a­tion worse: reduc­ing wages. This was of course attempted as a “cure” dur­ing the Great Depression–a 10% across the board cut in wages. And Aus­tralia was even more mired in Depres­sion after­wards.

    From the point of view of neo­clas­si­cal eco­nom­ics, unemployment–one, but far from the only, symp­tom of a debt deflation–can be cured by cut­ting REAL wages. As Keynes argued against this pol­icy, cut­ting MONEY wages won’t nec­es­sar­ily cause real wages to fall, because the cut in wages will be passed on (in the envi­ron­ment of a Depres­sion) to a fall in prices, leav­ing real wages at much the same level.

    Though I dis­agree with Keynes about part of the fol­low­ing (caus­ing infla­tion by “increas­ing the quan­tity of money”), I think he puts the dan­gers in reduc­ing money wages well:

    “The method of increas­ing the quan­tity of money in terms of wage-units by decreas­ing the wage-unit increases pro­por­tion­ately the bur­den of debt;
    whereas the method of pro­duc­ing the same result by increas­ing the quan­tity of money whilst leav­ing the wage-unit unchanged has the oppo­site effect. Hav­ing regard to the exces­sive bur­den of many types of debt, it can only be an inex­pe­ri­enced per­son who would pre­fer the former.” (1936: 268–69)

    His com­ment about “inex­pe­ri­enced per­son” I read as a jibe at his con­ven­tional eco­nomic rivals.

    So partly, I’m propos­ing delib­er­ate wage infla­tion as a poten­tial cure, because I don’t want to see the descen­dants of Keynes’s rivals in the 1930s–who now dom­i­nate eco­nomic pol­icy once again–getting away with the same stu­pid­ity a sec­ond time.

    As for your sug­ges­tions, they would work to delay get­ting into a Depres­sion; once in one though, they would have lit­tle effect (very few peo­ple would be buy­ing assets at the time in any case).

    Ulti­mately, the only way to pre­vent what seems an inex­orable trend towards a debt cri­sis, is to make struc­tural changes that, as near as pos­si­ble, elim­i­nate the belief that the road to riches is via spec­u­la­tion in the sec­ondary mar­ket on assets. Your pro­pos­als are directed at that end,but they’re the sort of reform that mar­ket fun­da­men­tal­ists would aim to abol­ish when the cri­sis was over.

  • @ Steve Keen

    It would be pos­si­ble by increas­ing wages. 

    One ques­tion: how would that be done in prac­tice?

    Say, we increase wages by decree with­out a accom­pa­ny­ing mon­e­tary infla­tion (i.e. increase in the quan­tity of money). It will lead to mass unem­ploy­ment, which in turn will has­ten defla­tion that is led by mass debt defaults (see the 2nd last para­graph of our arti­cle: Can Australia’s deflat­ing prop­erty bub­ble deflate even fur­ther?).

    Say, we increase wages through mon­e­tary infla­tion. We would agree with you that the first round of impact will be on con­sumer prices. But this is highly risky. Firstly, with this mea­sure, busi­nesses will know in advance that their wage cost will increase. There­fore, they will respond by increas­ing prices per­haps even before­hand. Polit­i­cally, once you increase wages once that way, the mob will demand more increase in wages to ‘com­bat’ the increase in prices. This runs the risk of an upward spi­ral of gen­eral price level. In Mur­ray Rothbard’s (an Aus­trian econ­o­mist from the Mises Insti­tute) excel­lent book: What Has Gov­ern­ment Done to Our Money? (page 31–32), it men­tioned that

    At first, when prices rise, peo­ple say: “Well, this is abnor­mal, the prod­uct of some emer­gency. I will post­pone my pur­chases and wait until prices go back down.” This is the [59] com­mon atti­tude dur­ing the first phase of an infla­tion. This notion mod­er­ates the price rise itself, and con­ceals the infla­tion fur­ther, since the demand for money is thereby increased. But, as infla­tion pro­ceeds, peo­ple begin to real­ize that prices are going up per­pet­u­ally as a result of per­pet­ual infla­tion. Now peo­ple will say: “I will buy now, though prices are ‘high,’ because if I wait, prices will go up still fur­ther.” As a result, the demand for money now falls and prices go up more, pro­por­tion­ately, than the increase in the money sup­ply. At this point, the gov­ern­ment is often called upon to “relieve the money short­age” caused by the accel­er­ated price rise, and it inflates even faster. Soon, the coun­try reaches the stage of the “crack-up boom,” when peo­ple say: “I must buy any­thing now—anything to get rid of money which depre­ci­ates on my hands.” The sup­ply of money sky­rock­ets, the demand plum­mets, and prices rise astro­nom­i­cally. Pro­duc­tion falls sharply, as peo­ple spend more and more of their time find­ing ways to get rid of their money. The mon­e­tary sys­tem has, in effect, bro­ken down com­pletely, and the econ­omy reverts to other mon­eys, if they are attainable—other metal, for­eign cur­ren­cies if this is a one-coun­try infla­tion, or even a return to barter con­di­tions. The mon­e­tary sys­tem has bro­ken down under the impact of infla­tion.

    In my hum­ble opin­ion, I believe your opin­ion (that is if I under­stand it cor­rectly as increas­ing wages by decree with mon­e­tary infla­tion) may run the risk of los­ing con­trol, result­ing in hyper-infla­tion.

  • Dear Con­trar­ian,

    Here we part com­pany on our analy­sis of mon­e­tary dynam­ics and the causes of infla­tion. We could debate from one the­o­ret­i­cal per­spec­tive (Aus­trian) to another (Post Key­ne­sian, Cir­cuitist), but my expe­ri­ence of such debates is that they con­vince nei­ther side. There­fore I sug­gest you take a look at the fol­low­ing paper, writ­ten by two econ­o­mists with impec­ca­ble con­ser­v­a­tive neo­clas­si­cal cre­den­tials (ie, a Nobel Prize) on the actual dynam­ics of mon­e­tary cre­ation in the USA. They con­clude that credit money cre­ation pre­cedes fiat money cre­ation:

    http://www.minneapolisfed.org/research/common/pub_detail.cfm?pb_autonum_id=225

    Hyper-infla­tion is indeed an eco­nomic dis­ease in its own right–I’d never deny that–but in the con­text of defla­tion, infla­tion can be desir­able. That was Japan’s posi­tion for the 15 years it was in a debt defla­tion recently, and con­ven­tional means to cause infla­tion (“print­ing money”) failed abjectly–which indi­cates amongst other things that the con­ven­tional the­o­ries, like the one you pro­pose above, are not cor­rect.

    Please remem­ber that I think a wage-increase-by-decree pol­icy has zero chance of being implemented–whether I think it might work or not. But I sim­ply want to pro­pose it because I expect the oppo­site pol­icy will be pushed if a debt defla­tion actu­ally ensues–and that would be an unmit­i­gated dis­as­ter.

    I’m sorry that this is a rather tan­gen­tial reply to your post, but I’m busy with other work at the moment, and the dif­fer­ence in our philoso­phies on this point is rather too extreme to make sen­si­ble debate on a blog fea­si­ble. How­ever I sug­gest that if you’d like to know where I’m com­ing from on some of my analy­sis on this point, you search out arti­cles on Hyman Minsky’s “Finan­cial Insta­bil­ity Hypothesis”–some of which I have linked from this blog, and from my web­site http://www.debunkingeconomics.com.

  • Hi Steve!

    I agree that the philo­soph­i­cal base of our schools of eco­nomic thoughts (mine is Aus­trian School) are dif­fer­ent. So, there is no point in fur­ther­ing the debate.

    Just a clar­i­fi­ca­tion on my view regard­ing the Japan exam­ple that you gave. My belief is that (and I’m aware you may not share my belief) Japan’s defla­tion was caused by credit con­trac­tion that was caused by the col­lapse of asset prices. There­fore, I would not advo­cate mon­e­tary infla­tion as a cure because all that would do was to inflate the base money sup­ply, which will hardly re-inflate broad money (in which its infla­tion caused the asset price bub­ble in the first place). Japan did pre­cisely that and the result was the rise of the yen carry trade in which among other things, Japan­ese banks extended credit to Asian coun­tries.

    There­fore, in Japan’s case, I would not rec­om­mend mon­e­tary infla­tion to solve defla­tion prob­lems.

  • Clarification/correction on my pre­vi­ous post:

    … Japan’s defla­tion was caused by credit con­trac­tion that was caused by the col­lapse of asset prices. 

    To be more pre­cise, I meant that there was a vicious cycle of credit con­trac­tion and asset price col­lapse. Which of the two was the root cause of this vicious cycle would bet­ter be a sep­a­rate dis­cus­sion for another day.

  • Dear Con­trar­ian,

    I would also see credit con­trac­tion and asset price defla­tion as part of the process, but I take the causal mech­a­nism back one stage fur­ther to the exces­sive accu­mu­la­tion of debt–on the basis of “euphoric expec­ta­tions” about asset price inflation–over the pre­ced­ing decade.

    See the Novem­ber 2006 Debt­watch report, page 12, Fig­ure 14 for a nice empir­i­cal state­ment of this. While I don’t believe that the OECD debt fig­ures can be directly mapped to the RBA and US FRB debt fig­ures I use else­where in the report ( I expect the OECD’s clas­si­fi­ca­tion dras­ti­cally under­states Japan’s actual domes­tic debt lev­els), the dynamic between accel­er­at­ing debt and eco­nomic per­for­mance is quite clearly shown in the data.

    So I see the root cause as debt accu­mu­la­tion dur­ing a boom–which is what we are expe­ri­enc­ing now. Once that reaches exces­sive levels–which means once the debt ser­vic­ing com­mit­ments become extreme com­pared to cash flows from actual pro­duc­tive investments–then the sys­tem can tip over into a debt-induced down­turn. This is Minsky’s the­sis, which I’m attempt­ing to develop fur­ther.

  • foun­da­tion

    Hi Con­trar­ian,
    It’s good to see you con­tribut­ing here — your blog has been a great source of read­ing mate­r­ial for me lately. I will try to start giv­ing back to your blog in future. 

    I don’t have much to add here, except to say I can under­stand that there are argu­ments both for and against try­ing to inflate our way out of the mess we’re in. I’m not informed enough to com­ment on the prob­lems that might even­tu­ate. I just see a con­tin­u­a­tion along our cur­rent path tak­ing us fur­ther toward an unpleas­ant out­come.

    How is it pos­si­ble to engi­neer an infla­tion whereby only goods prices rises and asset price remain stag­nant? Any pol­icy of delib­er­ate infla­tion runs the risk of mis­fir­ing and thereby fur­ther inflat­ing asset prices.”

    I would have thought some com­bi­na­tion of credit con­trols (restric­tions or tax on equity with­drawal for starters) would do the trick in keep­ing asset prices in check. Are you say­ing that high wage and gen­eral infla­tion and lit­tle to no (real) debt growth would lead to mass unem­ploy­ment?

    Rather than sim­ply agree­ing to dis­agree on “mon­e­tary dynam­ics and the causes of infla­tion” would it be too much to ask for a brief expla­na­tion of the dif­fer­ences of opin­ion? Just the key points as they relate to the argu­ment? And no big words, okay? ;-P

  • Hi foun­da­tion!

    Firstly, please note that Aus­trian School’s def­i­n­i­tion of infla­tion is dif­fer­ent from the main­stream def­i­n­i­tion. Aus­trian School define infla­tion as the growth in money sup­ply (i.e. debase­ment of the cur­rency). In other words, accord­ing to the Aus­trian School’s def­i­n­i­tion, infla­tion is purely a mon­e­tary phe­nom­ena.

    A clear under­stand­ing of the dif­fer­ent def­i­n­i­tions is essen­tial to avoid mis­com­mu­ni­ca­tion in dis­cus­sions.

    Are you say­ing that high wage and gen­eral infla­tion and lit­tle to no (real) debt growth would lead to mass unem­ploy­ment?

    Not exactly. Let me quote the book, What You Should Know About Infla­tion by Henry Hazlitt (an Aus­trian School econ­o­mist):

    The same chain of cau­sa­tion applies to all the so-called “infla­tion­ary pressures“—particularly the so-called “wage price spi­ral.” If it were not pre­ceded, accom­pa­nied, or quickly fol­lowed by an increase in the sup­ply of money, an increase in wages above the “equi­lib­rium level” would not cause infla­tion; it would merely cause unem­ploy­ment. And an increase in prices with­out an increase of cash in people’s pock­ets would merely cause a falling off in sales. Wage and price rises, in brief, are usu­ally a con­se­quence of infla­tion. They can cause it only to the extent that they force an increase in the money sup­ply.