Debt­Watch No 28 Novem­ber 2008: What is Really Going On?

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2nd Anniver­sary Issue…

Why Did I See it Coming and “They” Didn’t?

The finan­cial cri­sis is widely accepted as hav­ing started in August 9 2007, with the BNP’s announce­ment that it was sus­pend­ing redemp­tions from three of its funds that were heav­ily exposed to the US secu­ri­ti­sa­tion mar­ket (click here for the BNP August 9 2007 press release).

Just three months before­hand, the OECD released its 2007 World Eco­nomic Out­look, in which it com­mented that:

In its Eco­nomic Out­look last Autumn, the OECD took the view that the US slow­down was not herald­ing a period of world­wide eco­nomic weak­ness, unlike, for instance, in 2001. Rather, a “ smooth”  rebal­anc­ing was to be expected, with Europe tak­ing over the baton from the United States in dri­ving OECD growth.

Recent devel­op­ments have broadly con­firmed this prog­no­sis. Indeed, the cur­rent eco­nomic sit­u­a­tion is in many ways bet­ter than what we have expe­ri­enced in years. Against that back­ground, we have stuck to the rebal­anc­ing sce­nario. Our cen­tral fore­cast remains indeed quite benign: a soft land­ing in the United States, a strong and sus­tained recov­ery in Europe, a solid tra­jec­tory in Japan and buoy­ant activ­ity in China and India. In line with recent trends, sus­tained growth in OECD economies would be under­pinned by strong job cre­ation and falling unem­ploy­ment.” (OECD World Eco­nomic Out­look Vol 81 p. 7; emphases added)

Sim­i­larly, Reserve Banks around the world had set inter­est rates to rel­a­tively high lev­els to restrain ris­ing infla­tion, which was then seen as the main threat to con­tin­ued eco­nomic pros­per­ity. Our own RBA increased rates when the cri­sis began, and three more times since. And it was not alone: the Euro­pean Cen­tral Bank also raised rates after the cri­sis (see Fig­ure One) .

Figure One

Reserve Interest Rates

Reserve Inter­est Rates

In Decem­ber 2005, almost two years before the cri­sis hit, I realised that a seri­ous finan­cial cri­sis was approach­ing. I was so wor­ried about its prob­a­ble severity–and the lack of aware­ness about it amongst pol­icy makers–that I took the risk (for an aca­d­e­mic) of going very pub­lic about my views. I began com­ment­ing on eco­nomic pol­icy in the media, started the Debt­Watch Report (the first was pub­lished two years ago in Novem­ber 2006), reg­is­tered a web­page with the apt name of, and estab­lished the blog Steve Keen’s Oz Debt­watch.

How come I got it right, and “they”–the offi­cial eco­nomic managers–got it so wrong?

It’s not because I’m any brighter than they are–there are plenty of highly intel­li­gent peo­ple in those organ­i­sa­tions. Instead, it’s because they fol­low main­stream views in eco­nom­ics, and I fol­low a minor­ity per­spec­tive. The eco­nomic his­tory we are cur­rently liv­ing through is proof that the main­stream is fun­da­men­tally wrong about the nature of the econ­omy, while my minor­ity per­spec­tive is at least par­tially right.

This is not some­thing one should be able to say about a sci­ence, and there lies the rub: eco­nom­ics is not even close to qual­i­fy­ing as a sci­ence. A bet­ter model for eco­nom­ics is a group of war­ring religions–or sci­ence, such as it was, before Galileo’s empir­i­cal rev­o­lu­tion, when what mat­tered to sci­en­tists was not empir­i­cal rel­e­vance, but con­for­mity to with the Bible.

Forty years ago, Keynes was The Mes­siah, and his Gen­eral The­ory was the Bible. But the “stagfla­tion” episode of the 1970s allowed a new Mes­siah to arise: Mil­ton Fried­man, with his doc­trine of Mon­e­tarism. Though Mon­e­tarism itself is no longer espoused, the eco­nomic reli­gion that Fried­man represented–known as “Neo­clas­si­cal Economics”–supplanted the pre­vi­ous Key­ne­sian ortho­doxy. Today, the major­ity of econ­o­mists know of no other way to think about the economy–and they run Cen­tral Banks and Trea­suries through­out the world, and dom­i­nate tuition in uni­ver­si­ties.

They also develop math­e­mat­i­cal mod­els of the econ­omy, which are in turn used to guage its health, and to advise politi­cians about pol­icy chal­lenges in the near future. Accord­ing to these mod­els, just over a year ago the econ­omy was in fine shape, and the main pol­icy chal­lenge was to avoid over­heat­ing that would lead to ris­ing infla­tion.

Well infla­tion did rise. But simul­ta­ne­ously the global econ­omy was falling into a seri­ous reces­sion dri­ven by a global finan­cial melt­down that these econ­o­mists and their mod­els com­pletely failed to antic­i­pate. Rarely in human his­tory have pol­icy mak­ers been so badly mis­led by the so-called experts.

The three key aspects of Neo­clas­si­cal eco­nom­ics that led to its wildly inac­cu­rate fore­casts are the beliefs that:

  1. A mar­ket econ­omy always tends towards equi­lib­rium;
  2. Money impacts “nom­i­nal” vari­ables like the rate of infla­tion, but has no long term impact on “real” vari­ables like employ­ment and GDP growth; and
  3. Finance mar­kets are ratio­nal; in par­tic­u­lar, the level of pri­vate debt reflects ratio­nal cal­cu­la­tions about future income, and can there­fore be ignored by pol­icy-mak­ers.

The key aspects of the approach that I take (the “Finan­cial Insta­bil­ity Hypoth­e­sis” devel­oped by Hyman Min­sky) that alerted me to the approach­ing dan­ger are the propo­si­tions that:

  1. A mar­ket econ­omy is inher­ently cycli­cal;
  2. Money is fun­da­men­tally credit-dri­ven, and has impacts on real vari­ables as well as nom­i­nal ones in the short and long term; and
  3. Finance mar­kets desta­bilise the real econ­omy, because they are prone to bouts of euphoric expec­ta­tions that lead to debt-financed spec­u­la­tive bub­bles.

These very dif­fer­ent per­spec­tives have two key effects on the econ­o­mists who hold them:

  • they focus atten­tion on very dif­fer­ent sets of eco­nomic data; and
  • they inspire math­e­mat­i­cal mod­els of the econ­omy that are very, very dif­fer­ent.

What is “a beautiful set of numbers” lies in the eyes of the beholder

Neo­clas­si­cal econ­o­mists focus upon three num­bers:

  1. The rate of eco­nomic growth (prefer­ably above 3% per year);
  2. Unem­ploy­ment (which they pre­fer to be low, but not “too low”–the mov­ing tar­get for which in Aus­tralia was 4.5% until recently); and
  3. The rate of infla­tion (which they pre­fer to be as low as pos­si­ble, and cer­tainly below 3%).

On all three fronts, from the van­tage point of 2006, 2007 looked like being a vin­tage year–except that the first num­ber was so high that the sec­ond was tend­ing too low, which could mean that the third could start to rise. Hence the eco­nomic focus was on reduc­ing growth via higher inter­est rates, to increase unem­ploy­ment slightly and thus reduce the rate of infla­tion (see Fig­ure Two).

Figure Two

Australian Growth, Unemployment and Inflation

Aus­tralian Growth, Unem­ploy­ment and Infla­tion

The RBA’s pol­icy response to this was imme­di­ate and deci­sive. Hav­ing already raised rates in 0.25% incre­ments five times since 2002, it accel­er­ated its infla­tion-con­trol pro­gram with three more increases in 2006, two in 2007 –the first of these com­ing just before the cri­sis broke, and the other famously dur­ing the 2007 elec­tion campaign–and two more dur­ing early 2008.

Figure Three

Movements in Australian Reserve Interest Rates

Move­ments in Aus­tralian Reserve Inter­est Rates

Unfor­tu­nately, the RBA’s response was also the wrong one. While infla­tion did rise, it was not the main prob­lem fac­ing the econ­omy. Try­ing to con­trol the infla­tion rate by rais­ing inter­est rates at that time was a bit like try­ing to con­trol a patient’s blood pres­sure when he was dying of can­cer. That can­cer, as is now widely acknowl­edged, was pri­vate debt. The eco­nomic vari­able that their Neo­clas­si­cal train­ing led them to ignore, the ratio of pri­vate debt to GDP, was now indis­putably the most impor­tant num­ber of all.

Econ­o­mists who are influ­enced by Hyman Minsky–broadly known as “Post Key­ne­sians”, since Min­sky was a fol­lower of Keynes–focus pre­cisely on that datum. This ratio of a stock (out­stand­ing debt at a point in time) to a flow (the annual out­put of goods and ser­vices) tells you how many years of income it would take to reduce debt to zero. It there­fore mea­sures the degree of pres­sure that finance is impos­ing on the real econ­omy.

A cer­tain amount of debt is vital to the proper func­tion­ing of a mar­ket econ­omy, since most com­pa­nies need flex­i­ble work­ing cap­i­tal to be able to oper­ate, and over­draft facil­i­ties and lines of credit pro­vide that flex­i­bil­ity. But too high a debt to GDP ratio means that the finan­cial bur­den of debt repay­ment on the econ­omy is exces­sive, and Minsky’s the­ory implies that there is a ten­dency for the debt to GDP ratio to ratchet up over a series of booms and busts, result­ing even­tu­ally to a Depres­sion.

I did not see the data in Fig­ure Three until Decem­ber 2005, since my “day job” is as an aca­d­e­mic rather than an eco­nomic pol­icy maker. I had signed a con­tract to pro­duce a book on finan­cial insta­bil­ity as long ago as 1998, but the unex­pected suc­cess of Debunk­ing Eco­nom­ics, and the fol­low-on debate that engen­dered amongst aca­d­e­mic econ­o­mists, forced me to delay com­menc­ing that task.

As soon as I did see the data–in Decem­ber 2005, when prepar­ing an Expert Wit­ness report for a court case (the “Cooks Case”)–my Min­skian eyes told me that a seri­ous cri­sis was on its way. Given that the debt to GDP ratio was far higher than dur­ing either major post-WWII cri­sis (1973 and 1989), it appeared obvi­ous that Aus­tralia was about to expe­ri­ence its most severe eco­nomic cri­sis since the Great Depres­sion.

Because I knew that neo­clas­si­cal econ­o­mists would not realise this was about to hap­pen, were likely to make things worse by increas­ing inter­est rates as the cri­sis approached, and would prob­a­bly mis-diag­nose the cause once it occurred–as they had dur­ing the Great Depression–I decided to go pub­lic with my analy­sis via the media, a reg­u­lar com­men­tary timed to coin­cide with the RBA meet­ing (Debt­Watch), and even­tu­ally a blog (

Figure Four

Australias Debt to GDP Ratio 1955-Now

Australia’s Debt to GDP Ratio 1955-Now

Minsky’s hypoth­e­sis warns that a cri­sis begins with the fal­ter­ing of an asset price bub­ble. That not one but two bub­bles were in progress was obvi­ous in both Aus­tralian and Amer­i­can stock mar­ket and hous­ing data.

Min­sky argues that there are two price lev­els in a mar­ket economy–one for com­modi­ties set largely by the costs of pro­duc­tion and financed largely from income, and the other for assets, set largely by people’s expec­ta­tions of future gain, and financed mainly by debt. The ratio of one price level to another thus gives an indi­ca­tion of whether the econ­omy is in a bub­ble, or a bust.

There are curly issues in the ratio of share prices to the CPI–the rein­vest­ment of retained earn­ings give shares an upward trend over time com­pared to the CPI, while the index itself over­states share returns due to sur­vivor bias. But the rel­a­tively rapid move­ment in share prices, ver­sus the slower changes in con­sumer prices, means that a blowout in the ratio is a good indi­ca­tor of a bub­ble. On that basis, Australia’s mar­ket had clearly entered a bub­ble in early 2003, while the USA’s began in 1995 (and had already burst in 2000, only to restart in 2003).

Figure Five

CPI-Deflated Stock Market Indices, USA and Australia

No such curly issues apply with the house price to CPI ratio. Espe­cially when deal­ing with estab­lished houses, there is no long term trend, as the Heren­gracht Canal index estab­lishes. In a real price series going back over 300 years, house prices have risen and fallen com­pared to con­sumer prices, but there is clearly no ris­ing trend (see Fig­ure Five).

Figure Six

CPI-Deflated Price Index for Amsterdams Herengracht Canal

CPI-Deflated Price Index for Amsterdam’s Heren­gracht Canal

On this basis, both Aus­tralian and US house mar­kets were clearly in bub­bles, and the US bub­ble was unprece­dented in its his­tory.

Figure Seven

CPI-Deflated Herengracht Canal Index: 350 Years from 1928-1970

USA and Aus­tralian House Price Indices

The final piece of evi­dence that pushed me from expect­ing a seri­ous reces­sion to quite pos­si­bly a Depres­sion was pro­vided by the RBA in Sep­tem­ber 2007–a month after the cri­sis began–with a chart show­ing Australia’s pri­vate debt to GDP ratio going back till 1860.

Even after I aug­mented it to include an esti­mate for non-bank debt prior to 1953 (which made cur­rent data look less extreme com­pared to his­tor­i­cal data), it implied that our debt cri­sis was more than twice as severe as the one that caused the Great Depres­sion. When the Great Depres­sion began at the end of 1929, Australia’s debt to GDP ratio was 65 per­cent. It has now reached a peak of 165 per­cent.

Figure Eight

Australias Debt to GDP Ratio from 1860-Now

Australia’s Debt to GDP Ratio from 1860-Now

That impres­sion was con­firmed when I later saw the US data–courtesy of Ger­ard Minack and the avail­abil­ity online of US Cen­sus reports. Its debt to GDP ratio was 150 per­cent at the end of 1929 (and sub­se­quently blew out to 215 per­cent as prices and GDP col­lapsed in the first 3 years of the Depres­sion).

With finan­cial sec­tor debt included, the USA reached that peak again in 1987–the year Greenspan, despite his “Aus­trian” approach to eco­nom­ics that decried gov­ern­ment inter­ven­tion of any sort, per­formed his first “suc­cess­ful” res­cue dur­ing the Stock Mar­ket Crash in Octo­ber.

That res­cue worked, not by over­com­ing the prob­lem of exces­sive debt-financed spec­u­la­tion, but by re-ignit­ing so that it reached even higher lev­els. Though bor­row­ing slumped after the Sav­ings and Loans col­lapse in 1989/90–falling from 170 to 165 per­cent of GDP–the bub­ble began once more in 1994. It then rock­eted on through the Dot­com Bub­ble, and didn’t even draw breath then since there were now two asset mar­ket bub­bles feed­ing off each other–the Sub­prime Bubble’s expan­sion more than coun­ter­acted the Dot­com Bubble’s coll­pase, until finally there were two debt-financed asset bub­bles run­ning at once–an unprece­dented event in America’s finan­cial his­tory.

By 2004, even non-finan­cial pri­vate debt had exceeded the level that trig­gered the Great Depres­sion, while total pri­vate sec­tor debt reached a stag­ger­ing 290 per­cent of GDP (with­out includ­ing the impact of finan­cial deriv­a­tives, another form of debt that did not exist in the 1920s).

Figure Nine

USAs Long Term Debt to GDP Ratio 1920-Now

USA’s Long Term Debt to GDP Ratio 1920-Now

The RBA data in Fig­ure Eight was first pub­lished in a speech by Deputy RBA Gov­er­nor Ric Bat­tellino (“Some Obser­va­tions on Finan­cial Trends”). I found his inter­pre­ta­tion of the chart both stun­ning, and pre­dictable:

The fac­tors that have facil­i­tated the rise in debt over the past cou­ple of decades –  the sta­bil­ity in eco­nomic con­di­tions and the con­tin­ued flow of inno­va­tions com­ing from a com­pet­i­tive and dynamic finan­cial sys­tem –  remain in place. While ever this is the case, house­holds are likely to con­tinue to take advan­tage of unused capac­ity to increase debt. This is not to say that there won’ t be cycles when credit grows slowly for a time, or even falls, but these cycles are likely to take place around a ris­ing trend. Even­tu­ally, house­hold debt will reach a point where it is in some form of equi­lib­rium rel­a­tive to GDP or income, but the evi­dence sug­gests that this point is higher than cur­rent lev­els.” (empha­sis added)

This was stun­ning, because the pre­vi­ous two peaks in the debt to GDP ratio were fol­lowed by Depres­sions, and yet they were far lower than the cur­rent level. Even the most anec­do­tal approach to his­tory would imply that all might not be well at present.

It was pre­dictable, because it was con­sis­tent with the mind­set that has dom­i­nated eco­nom­ics for three decades now, ever since Friedman’s counter-rev­o­lu­tion against Key­ne­sian eco­nom­ics in the 1970s. Whereas the once-dom­i­nant Key­ne­sian approach saw the econ­omy as poten­tially unsta­ble, Friedman’s revived “Neo­clas­si­cal” approach pre­sumed that the econ­omy was self-equi­li­brat­ing. Thus data which an engi­neer would see as indi­cat­ing an approach­ing break­down was inter­preted by an econ­o­mist as indi­cat­ing an approach­ing equi­lib­rium. 

This belief in a ten­dency to equi­lib­rium is built into the mod­els of the econ­omy that neo­clas­si­cal econ­o­mists construct–which is why these mod­els gave no warn­ing of the approach­ing cri­sis, and why econ­o­mists were the last ones to realise that a cri­sis was actu­ally hap­pen­ing. I’ll dis­cuss their models–and the Min­skian alternative–in next month’s Debt­watch.

Australian Private Aggregate Debt Table

Aus­tralian Pri­vate Aggre­gate Debt Table

Australias Private Debt Table Disaggregated

Australia’s Pri­vate Debt Table Dis­ag­gre­gated

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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  • David


    Unfor­tu­nately, cer­tainly for eco­nom­ics, these types of maps can change the ter­ri­tory. They for­got that also.

  • David

    You maybe right though, it maybe the hope that one day with “very good approx­i­ma­tion” our maps could also be for­tu­nate, who knows, maybe it could be with a dis­cov­ery and map that we are not just exter­nally moti­vated but inter­nally moti­vated to reach and strive. 

    Good luck on the road.

  • OldSkep­tic

    Been really busy recently and head­ing for a hol­i­day in the newly refur­bushed truck (1989 model and still going strong), Nullar­bor here we come!

    Rea­sons, Steve and oth­ers: I sent Steve copy of my paper and I’ll set up a link when I get back.

    Rea­son: I agree, when in doubt brute force it. I could build a model, say using tax data (I wish), of every per­sons’ income and tax, then put in tax changes and cal­cu­late, basi­cally exactly, the impacts on every­one.

    There seems to be a reluc­tance to cre­at­ing mod­els using the mas­sive data avail­able now, peo­ple keep using apprix­i­ma­tions based on, some­times, ques­tion­able assump­tions.

    Tech­ni­cally I think it is the a com­bi­na­tion of atti­tude and soft­ware that peo­ple use. A lot of large data han­dling soft­ware is inad­e­quate for mathematical/statistical cal­cu­la­tions. The ones that do the maths/stats well, often strug­gle with large data vol­umes.

    Me? I use ‘old fash­ioned’ APL which does both extremely well, so I reg­u­larly analyse and build mod­els based on large vol­umes of very low level data. Hun­dreds of giga­bytes of data? Run it on my PC eas­ily.

    I once did a project for a major organ­i­sa­tion, down­load­ing hun­dreds of giga­bytes of very low level data .. and ran analy­ses on a lap­top, live in front of peo­ple. Twice I’ve built cost­ing mod­els for insur­ance com­pa­nies that cal­cu­late the cost (and profit) of every sin­gle per­son, with the last one I could rec­on­cile back up to the pub­lished accounts to an accu­racy of 1%.

    With the com­put­ing power avail­able nowa­days it is easy, real tough back in the days of punched cards or “shud­der” paper tape.

  • Greenspan is no Aus­trian, lets get this straight.

    The Aus­trian school pre­dicted this mess. Frac­tional Reserve Bank­ing cre­ated the biggest credit bub­ble in his­tory.

  • The Aus­trian school pre­dicted this mess. Frac­tional Reserve Bank­ing cre­ated the biggest credit bub­ble in his­tory.”

    Yes, like Trot­sky­ists they have suc­cess­fully pre­dicted ten of the last 2 reces­sions…

    The prob­lem with the “Aus­trian” school is that it does not recog­nise that frac­tional reserve bank­ing is a nat­ural evo­lu­tion­ary devel­op­ment by profit seek­ing com­pa­nies (banks). In other words, it com­plains that cap­i­tal­ist banks act like, well, cap­i­tal­ists!

    More­over, their “the­ory” of the busi­ness cycle is root­ing in equi­lib­rium (the “nat­ural” rate of inter­est). Given that the rest of their ide­ol­ogy assumes (or, more cor­rectly, they state) that equi­lib­rium can­not be reached and so is a mean­ing­less con­cept, this is some­what ironic.

    Sim­ply put, banks in the pur­suit of profit will set inter­est rates appro­pri­ately. Dur­ing a cri­sis and after it, the inter­est rate will approx­i­mate the “nat­ural” rate but (as Min­sky argued) with the boom the banks will seek to increase prof­its, adjust to demand and so cre­ate credit. The inter­est rate no longer is close to the “nat­ural” rate because of the entre­pre­neur­ial actions of banks.

    But the credit cre­ation comes in response to other fac­tors and while it may make them big­ger, it does not cre­ate them.

    Marx wrote inter­est­ing mate­r­ial on credit and how it inter­acts with the real econ­omy. It con­tains the true part of the “Aus­trian” school (namely that credit expan­sion can make a boom big­ger and a bust deeper) but with­out the silly bits.

    Ulti­mately, there is a rea­son why von Hayek lost the busi­ness cycle debates of the 1930s. Sraffa and Kaldor suc­cess­fully destroyed his argu­ment and that is why the “Aus­trian” school remains a sect.

    for more dis­cus­sion:

  • Jono,

    I have to agree that Greenspan is no Austrian–I made a com­ment on ABC Radio National Per­spec­tive recently that if he had been true to his alleged Aus­trian beliefs, he would have stood back in 1987 (let alone later) and not done any of his res­cues.

    How­ever, to pre-empt a post from a new mem­ber Anar­cho (that I’ve already approved, but which for some rea­son hasn’t got through to the blog yet–Wordpress and/or my ISP is doing some strange things on post­ing right now), the Aus­trian the­ory of both money and cycles is defi­cient.

    I’ll add just one thing to that post–prior to its arrival here. As well as it being quite valid to describe frac­tional bank­ing as an evo­lu­tion­ary devel­op­ment in cap­i­tal­ist bank­ing, there is more to credit gen­er­a­tion than frac­tional bank­ing alone. In fact, the frac­tional money the­ory can only explain about 10 per­cent of the money sup­ply, and the tim­ing of eco­nomic data strongly con­tra­dicts it as a sole model of money cre­ation.

    Were it true, move­ments in Base Money and/or changes in reserve ratios would pre­cede move­ments in credit/broad money. In fact, the sequenc­ing is the reverse: move­ments in credit money pre­cede changes in Base Money by roughly a year.

    The empir­i­cal and the­o­ret­i­cal issues behind this are ones I intend explain­ing in the long-promised post on the dynam­ics of credit money.

  • Pingback: Matt’s Internet Page » Blog Archive » " DebtWatch No 28 November 2008: What is Really Going On? Steve Keen’s Oz Debtwatch: Analysing Australia’s 45 Year Obsession with Debt()

  • Well-deserved con­grat­u­la­tions, Steve, on your anniver­sary.

    In Europe, it is Ital­ian Finance Min­is­ter Giulio Tremonti who, as a gov­ern­ment rep­re­sen­ta­tive, has had the courage to call a spade a spade, when he com­pared the finan­cial cri­sis to a video game, in which every time you kill one mon­ster, another pops up.

    And when you kill all of them, along comes the super-mon­ster, which is deriv­a­tives out­stand­ing.

    This is exactly where the body is buried!

    Now panic is set­ting in, as investors in Novem­ber have been mas­sively with­draw­ing their deposits from hedge funds and finan­cial insti­tu­tions, in turn, forc­ing these to sell what­ever assets they can.

    This gen­er­ates a dou­ble feed­back-loop: Since the depres­sion is com­ing to a head, asset prices are falling — most of them hav­ing been bought on credit in the first place — which fur­ther stresses the bal­ance sheets of banks and hedge funds, which there­fore cur­tail their lend­ing even fur­ther.

    These var­i­ous inten­si­fy­ing phases of “delever­ag­ing” of so-called struc­tured paper are the main prob­lem.

    The vol­ume of deriv­a­tive con­tracts out­stand­ing was said to be, accord­ing to the Bank for Inter­na­tional Set­tle­ments, $675 tril­lion at the end of 2007; the French mag­a­zine Mar­i­anne recently gave the fig­ure as $1.4 quadrillion, but it could be much more.

    If an attempt is now made to hon­our what these bankers them­selves call “toxic waste”, then, on the one hand, this leads to hyper­in­fla­tion, since more and more liq­uid­ity is pumped in to try to back up the vir­tual val­ues; but at the same time, it brings on defla­tion, since the col­lapse of the real econ­omy leads to falling prices.

    This is the rea­son for the breath­tak­ing speed of col­lapse of the real econ­omy world­wide — the auto sec­tor, the steel indus­try, petro­chem­i­cals, con­struc­tion, ship­ping, etc., etc.

    And it is a global phe­nom­e­non: The U.S.A. is plung­ing into depres­sion; China’s Amer­i­can export mar­ket is col­laps­ing; the Chi­nese econ­omy is falling apart; China is no longer buy­ing tex­tile machin­ery in Ger­many; ship­ping is col­laps­ing, since in the four or five weeks that it takes a ship to go from Europe to Asia, con­di­tions have dra­mat­i­cally changed, so that the let­ters of credit are no longer accepted, etc., etc.: a down­ward spi­ral to … !

    Until an orderly bank­ruptcy reor­gan­i­sa­tion of the finan­cial sys­tem is car­ried out.

  • Thanks Richard,

    There are other sorts of anniver­saries I would pre­fer to be cel­e­brat­ing, but real­ism must be given its due.

    You’re quite right about the need for bank­ruptcy reor­gan­i­sa­tion as the only way out of this mess. There is sim­ply no way that the cri­sis can be “papered over” and the out­stand­ing lev­els of debt honoured–particularly as the toxic unwind of deriv­a­tives pro­ceeds. Debt lev­els, which on the recorded stats are already twice as bad (rel­a­tive to GDP) as those prior to the Great Depres­sion, will ulti­mately turn out to be worse again by god knows how many mul­ti­ples, once all those posi­tions col­lapse.

    What we now need is a cam­paign to legit­imise what, in nor­mal cir­cum­stances (what­ever they are) is seen as ille­git­i­mate behav­iour: debt can­cel­la­tion. And we need a revised finan­cial sys­tem that removes the encour­age­ment for debt-financed asset price speculation–I agree with you as I’ve seen on your blog that reform and reg­u­la­tion won’t con­trol this beast.

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