Analysing the Global Debt Bubble
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I had this on another comments page but have copied it here for response please.
Steve, a comment not related to the election but to some recent charts of yours that show business debt at higher levels (per GOS) than in the late 80’s - and increasing at faster rates.
Seems business has been slow to jump on the debt wagon, but now is catching up quick - even business debt as a % of total debt is increasing.
Should this get a mention in future debt watch as in the past business debt has been seen as very low and ‘in control’.
Business debt seems to be regarded as OK, as it is only replacing equity with debt, but there are exceptions. Obviously business debt can still be speculative, as it can be used to purchase real estate. It increases the risk of business failing during a recession. This probably results in a bit more speculation on the stock exchange, as profits will look better during a boom, but with increased risk during a downturn. Some of the current business debt is probably hidden public debt as state governments use public privates to avoid their need to borrow. This really needs to be researched more.
For something amusing read http://www.nytimes.com/2007/12/01/business/01econ.html?ref=business
Apparently Americans just need to borrow more.
Also, business debt is also seen as OK because it is used for investments (e.g. capital expenditure, etc) purposes, which in theory should increase the productive capacity of the economy in future.
Business is indeed accelerating its debt levels, largely I think as a belated (or lagged) response to the China boom. Ideally this investment should have occurred years earlier–and if it had, we wouldn’t have heard the stories of supply bottlenecks with respect to resources exports to China.
One of the dilemmas of investment is that it is often lagged till some time after it is needed–and hence this is a partial cause of the volatility of the trade cycle.
Some of this investment is undoubtedly speculative–especially that financing private equity buyouts, but there’s also some that’s undoubtedly financing share buybacks and similar asset price related activities. But the majority I expect (and hope!) is related to real needs.
By the way, I have been following the discussions on money creation and investment cycles, but I’ve been too busy to contribute. However I think all and sundry would benefit from a reading of Schumpeter’s Theory of Economic Development–easily the best elucidation of the trade cycle ever written, and a good foundation for understanding the basis of credit creation in a pure credit economy.
In lieu of reading the original, you could check my lectures on Managerial Economics, which are on my Debunking Economics website: http://www.debunkingeconomics.com.
On money creation, I disagree with the standard money multiplier argument, and the Austrian analysis as well. If I get some time, I’ll make a blog post on my analysis. Before then if I can, I’ll post a couple of PPT files of my model of pure credit creation.
I do by the way agree that
Hi Steve,
On a completely unrelated note, I was having a bit of fun criticising Kevin Young from The Investors Club on an online forum over his blog which regularly deals with economic issues that he is clearly clueless about. Here’s part of
one of his blogs:
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Has the Australian Reserve Bank’s high rate policy worked? No. In 1998, we sat on 4.75% and inflation was in a band averaging about 1.5%; in 2007 we are sitting up on a high 6.5% and in the Reserve Bank’s own words “we are near 3% and risingâ€. High interest rates are clearly a failed policy[9]. It is failed policy we can compare to other more sensible, in my opinion, Central Banks who operate under a low interest rate policy.
Again, let’s compare this to the United States which, while we were busy raising rates, they were busy lowering rates and saw a steady decline in inflation[10]. As it dropped rates down from 2001, there was a steady climb down in inflation bottoming in 2004 and in 2004 the US started to raise rates from the bottom of 1% up to its current 5.25%. Guess what? There has been a climb in US consumer prices in contrast to this rise in interest rates. This inflation has gone from just slightly over 1% to sitting just above 2.25% after visiting 3%. High interest rates lead to high inflation[11].
http://www.tic.com.au/kevin’s+blog.aspx?EntryID=10
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My comments were:
9. Higher interest rates cause higher inflation because interest rates and inflation aren’t negatively correlated? That’s silly.
10. As per 9. clearly interest rates are the main driver of inflation. Raise rates and inflation rises. Lower them and inflation falls.
11. In case 10. wasn’t completely clear… I cannot believe I’m reading this. “High interest rates lead to high inflation”.
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Subsequently, it was suggested that “Steve Keen may agree with him…..â€
I just wondered if you might care to comment?
Cheers, F.
Oh dear, some markup disappeared. My comment at [11] was meant to be clearly marked sarcasm.
The causal link between interest rates and inflation is far less solid than the RBA and most Central Banks believe. They follow what is known as the “Taylor Rule”, which is basically an elaborated version of Wicksell’s argument that there is a “natural” rate of interest, above which prices will fall and below which they will rise.
I could wax at length about the failings of this analysis, but the key one is “omitted variable bias”. Leaving debt out of the equation–as all the RBA’s (and all other Central Banks) formal model renditions of the Taylor Rule do–leaves out a major causal variable.
On whether higher interest rates can cause inflation, that relates to my remark about the most recent CPI changes, where the largest contributor was a 5.8% increase in rents (with an overall CPI of 1.9% p.a.). Since rising rents are a by-product of our preceding Clayton’s building boom (whereas America is experiencing falling rents, since it actually did build some housing during its boom), increasing rates will further reduce the incentive for landlords to build new accommodation, which will if anything bias rents further upwards.
Also, all of the elements of the CPI that increased above the average (bar food) were FIRE products. I very much doubt that increasing interest rates will cause these to fall–when they do, it will be because of a collapse in demand for financial products in the event of a credit meltdown.
TRANSFINANCIAL ECONOMICS, THE NEW PARADIGM.
We live in what can be best termed a debt based economy. I am in the process of doing a research, and development project known as Transfinancial Economics, or TFE for short. If true it is probably the greatest breakthrough in the history of economics because in the right hands it would solve a huge number of the worlds problems.
Before proceeding I should say that the ideas of TFE were accepted by a peer reviewed journal of reputre, but I had to withdraw it from publication due to a dispute with the editor/publisher. A new paper is being created which would be advanced than the present internet essay on the internet. It will include new research, and ideas making the subject more credible.
A problem with TFE is that it is a genuine paradigm, and could be “too advanced” for its time. However, time may not be on the side of humanity, and a new financial system no matter how evolved is desparetly needed. The present debt based one is not going to take us far.
Without going into graphic detail TFE believes in the following.
i) Apart from earned money new non-repayable funding could be created responsibly for governments without taxation. Likewise, NGOs could be treated likewise with either part, or full financial empowerment.
ii) Since virtually all money exists as electronic data transmitted from one bank account to another it can be directly tracked, and controlled. With advanced computer programming bank computers could control the price, and wage of most products, and services in a way unimaginable when compared with incomes policies. This whole process would involve high degrees of price flexibility necessary for the present capitalist.
iii) What does this all mean? The answer is various, and the implications for society, the economy, and politics are “fantastical” if have the vision to know, and understand……………Here, are some examples in brief.
iv) Those corporations using “unsustainable” technologies would have powerful financial incentives to change their ways by means of huge commercial grants created by new non-repayable money.
v) Universal healthcare for all could be created with new money. It could either be state, or privately run, or ofcourse a bit of both. But the point is that there would always be the capital available. The only limits are NATURAL ONES of planning, and ofcourse relevant resources whilst money itself is ARTIFICIAL and is created as electronic transmissions from one bank account to another.
vi) Many charities concerned with heart disease, AIDs, poverty alleviation, etc, etc would be fully funded properly with new unearned money.
The above three examples of TFE can give us some idea of what could be achieved!! Moreover, private banks can still exist, and profit as never before. So, it is in their interest (including corporations) for a tax, and indeed, an interest free economy to exist.
For more detail there is an internet essay but it will be improved upon greatly fairly soon including new concepts concerning super-flexible “controls” etc .
http://kheper.net/essays/Transfinancial_Economics.html
Apologies for any errors in the text of this blog comment section.
There really isn’t any place to comment on your DebtWatch publication, so I’m doing it here.
You point out that Howard hasn’t left exactly the best economy for Rudd. While this is true, Labor would have to take some responsibility for this. It is only 18 months ago they were still running the “high-taxing government” line. Good politics but not reality. Maybe Howard should have stuck to a more fiscally responsible economics (there was plenty of evidence that Costello didn’t approve of the size of tax cuts), but one look at both parties election policies shows that lower taxation is popular. Labor’s view that tax cuts should have been a couple of billion lower wouldn’t have made much difference anyway, not in an economy that is increasing debt at over $150 billion per year. It seems that this is the basis of your economic beliefs, that eventually flows of money through debt are so great that they exceed anything that a government can do, so when they stop, the economy stops. Seems sensible to me.
The political aspect also relates to the reason nothing has been done about debt. Steve has commented on the problems that will happen when debt stops growing, but any government that restricts debt growth will have the same problems, and would be blamed for the problems. Of course the earlier the better, but try explaining to an electorate that the policies that are making them worse off now, will in the long term make them better off. Things will change when there are no other options.
I agree entirely Ken. Once we’ve set up an economic structure that supports speculative behaviour, then we’re stuck with the ultimate consequences.
The day of “no other options” seems to be approaching now–and certainly Japan arrived there 15 years ago. The problem is that, unless there is prior awareness of what causes the crisis, the same conventional policies will be adhered to–as Japan itself has done, unsuccessfully, for fifteen years.
Hence my initiation of this blog and the DebtWatch Report in the first place. I fully expect policy makers to stick with the tried and untrue approaches during a debt deflation, should one eventuate. My hope is simply that having flagged the problem before it arises, policy proposals I make during it will be received more favourably than they would have been otherwise.
Robert - regarding Transfinancial Economics - from your short post it sounds a bit like you a proposing a capital allocation system that is effectively command and control (i.e. socialism). But just incase I’ve misunderstood I will read the paper that your post links too.
Steve, what exactly did Japan do wrong?
It pushed interest rates to near zero, it commenced a massive capital works program to try to stimulate the economy. I think the Government even posted cheques to people one year in order to boost the economy. All of this is classical Keynesian stuff yet it failed to stimulate the economy. How would you have played the game?
Dave, et al,
No, I am NOT ofcourse advocating a command economy. Rather we are talking about a free market capitalist system with little government intervention as possible.
However, the super-flexible pricing system allows for largely “natural” self-adjustments of prices necessary within the present set-up. It may well be infact that most products, and services would not require mandatory inflation registration. Instead, they would only apply to certain manufacturers, and suppliers of raw materials. Thus, the retail (and trade) pricing of products, and services could well be unnecessary, and thus, any changes in prices would occur more “naturally” within the present market economy.
The above as yet requires alot of research with the aid of established experts in economics, and IT. Moreover, there is reason to believe that such a super- advanced system of incomes policy (replacing direct, and indirect taxation) would require little, or virtually no “central planning”.
If inflation can be controlled directly,and effectively it means that electronic transmission of new unearned money (ie. non-repayable)would be possible with little, or no devaluation of currency. If society has the MENTAL MATURITY to accept this notion the implications for humanity are truly mind-boggling.
TFE can be seen to becoming painfully relevant especially in the light of the sheer costs involved in tackling, and adapting to Global Warming. It is becoming obvious that the present financial system is inadequate. The survival of humanity could well be at stake, and TFE may well hold the key.
CORRECTION TO PREVIOUS POST ONSITE
The sentence in paragraph two should ofcourse read “..Thus, inflation registration of retail (and trade) pricing of products, and servcies could well be unnecessary….”
Apologies for error, or as Shakespeare put it “To err is human….” at least to err as little as possible ofcourse!
RS.
Japans problem was dropping interest rates too low. This meant there was no pressure on anyone to sell and so prices fell slowly. The other problem that has been suggested (I don’t know if anyone has any evidence of this) is that low interest rates for borrowers means low interest rates for savers, which means lower incomes and less spending by them. It also has produced some massive distortions in the international credit markets and foreign exchange rates as the Japanese pursue higher interest rate abroad, something we will regret when it bounces the other way.
I expect there wont be a perfect solution or even one that will make most people happy. When someone buys an asset that is 50-100% overpriced there are really only two solutions; let them lose a lot of money or take money off other people to help offset the loss.
In Australia ultra low interest rates wont be a possibility, our currency would collapse.
Replying belatedly to SteveZ, if I had been in control of economic policy in Japan, I would have legislated an across the board increase in wages of, say, 15%, combined with strict regulatory supervision to make sure that price increases as a result were no greater than 15%, and on average 1-2% less.
This would have caused a bout of inflation over 6-8 years that would have rapidly reduced the real debt overhang, while allowing asset prices to remain at much their original nominal levels–rather than falling 70-90% as they ultimately did.
The approaches they tried to use to create inflation are standard quantity theory of money approaches–common to mainstream “Keynesian” and Monetarist theories of economcs–which failed abjectly in practice because the link that the presume between changes in the money supply and inflation simply doesn’t exist.
Increasing the stock of money can have bugger all impact in some circumstances, because what matters for prices and economic activity in general is the turnover of money–which is a flow issue.
On that point, Japan increased the stock of M1 by over 25% one year; and next year, the rate of wholesale price DEflation increased.
The same policy would be much more problematic in Australia and other currently endangered economies (such as the USA and UK) because of the much higher level of foreign debt. Currency depreciation changes caused by such a policy matter to these countries, whereas they would have been irrelevant to Japan because it is a substantial creditor.
A piece of trivia, relating to the latest DebtWatch. Increase in private debt for the year $240 billion, estimated federal government income 2007-8 budget $247 billion. Basically equal.
