Debtwatch No 34: The Confidence Trick

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“And, at this point, confidence is what it is all about… The first thing is to maintain some confidence in ourselves and the prospects for our country over time… Unfortunately, there is no lever marked ‘confidence’  that policy-makers can take hold of. Our task is very much one of seeking to behave, across the board, in ways that will foster, rather than erode, confidence.  It is such confidence that, more than anything else, will help to drive us along the road to recovery.” (Glenn Stevens, April 21st 2009)

“I fancy that over-confidence seldom does any great harm except when, as, and if, it beguiles its victims into debt.” (Irving Fisher, 1933)

In his recent speech “The Road To Recovery“, Australia’s Reserve Bank Governor Glenn Stevens used “the C word” 17 times–versus, for example, 15 uses of the “R” word (“recession”). The message was clearly that, if only we can all be confident, then the other “R” word (“recovery”–which received ten mentions) will surely occur.

Another prominent economist who had the same attitude at the outbreak of a financial crisis was Irving Fisher. Speaking to a bankers conference just two days before the Great Crash of 1929, Fisher argued that market downturns were caused by a “lunatic fringe”. Once they had exited, the bull market of the preceding years would resume:

“There is a certain lunatic fringe in the stock market, and there always will be whenever there is any successful bear movement going on… they will put the stocks up above what they should be and, when frightened, … will immediately want to sell out… when it is finally rid of the lunatic fringe, the stock market will never go back to 50 per cent of its present level…

We shall not see very much further, if any, recession in the stock market, but rather … a resumption of the bull market, not as rapidly as it has been in the past, but still a bull rather than a bear movement.”  (Fisher 1929)

Fisher’s confidence led him to hang on to his margin-financed stocks (worth over $100 million in 2000-dollar terms). Despite his confidence, the stock market continued its plunge from its peak of 31.3 in July 1929 to the nadir of 4.77 in May of 1932, while unemployment rose from zero to 25 percent. Fisher was wiped out financially, and left to ponder how he could have got the behaviour of the market, and the economy, so badly wrong.

Three years later, he reached the conclusion that he had been misled by two core elements of the neoclassical theory he had helped build: the beliefs that the economy was always in equilibrium, and that the debt commitments borrowers had entered into to purchase financial assets were based on correct forecasts of future economic prospects.

On equilibrium, he reasoned, even if it were true that the economy tended towards equilibrium, random events alone would ensure that all economic variables were either above or below their equilibrium levels. Therefore economic theory had to be about disequilibrium rather than equilibrium:

“Theoretically there may be— in fact, at most times there must be—  over- or under-production, over- or under-consumption, over- or under spending, over- or under-saving, over- or under-investment, and over or under everything else. It is as absurd to assume that, for any long period of time, the variables in the economic organization, or any part of them, will “ stay put,”  in perfect equilibrium, as to assume that the Atlantic Ocean can ever be without a wave.” (Fisher 1933)

This realisation in turn put paid to any notion that today’s debt commitments were based on an accurate prediction of tomorrow’s economic outcomes. Instead, he identified over-indebtedness as one of the two key causes of Great Depression:

“two dominant factors [are …] over-indebtedness to start with and deflation following soon after… these two economic maladies, the debt disease and the price-level disease, are, in the great booms and depressions, more important causes than all others put together.

Thus over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money. That is, over-indebtedness may lend importance to over-investment or to over-speculation.

The same is true as to over-confidence. I fancy that over-confidence seldom does any great harm except when, as, and if, it beguiles its victims into debt.” (Fisher 1933)

One would hope that economic theory had learnt from the Great Depression, and in particular from Fisher’s insights. Unfortunately, economics was eager to unlearn these lessons, because the very phenomenon of a Depression was anathema to a profession that had always sought to eulogise the market economy, rather than to understand it. Equilibrium came back again in the guise of the “Neoclassical-Keynesian synthesis” in the 1950s. By the 1990s, all vestiges of Keynes had been thrown away–and nothing of Fisher had been even assimilated in the first place (skerricks of his thought are percolating through now though: see The Economist for a pretty good overview of Fisher).

Today, macroeconomic models like TRYM (the TReasurY Macroeconomic model that is used to prepare the Australian Federal Budget) presume that the economy tends towards a “long run equilibrium”. The apparent dynamics such models display are simply the convergence of the model from an initial starting point to the assumed long run equilibrium.

For example, the figure below shows the TRYM model’s predictions for unemployment from March 1995 till March 2010 (Figure 10: Dynamic Adjustment towards Steady State – Unemployment; Modelling Section, Macroeconomic Analysis Branch, Commonwealth Treasury, The Macroeconomics Of The Trym Model Of The Australian Economy,  Commonwealth of Australia 1996). The model “predicted” that unemployment would fall from around 9 percent in 1995 to just below 7 percent in 2010, simply on the basis that unemployment was assumed to converge to an a long run equilibrium rate of 7 percent over time (the actual level fell well below this, and the  assumed equilibrium unemployment rate–the “NAIRU”–was therefore later reduced to 5.25 percent).

Virtually everyone knows Keynes’s quip that “in the long run we are all dead”. Yet very few realise that Keynes’s target was precisely this approach to economic modelling–of assuming that the economy would simply tend to return to equilibrium after any disturbance:

“ But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.”   (Keynes, 1923)

Hobbled by this naive belief in equilibrium, the economics profession was as unprepared for today’s crisis as it had been for the Great Depression. Now that the crisis is well and truly with us, all conventional “neoclassical” economists can offer is the hope that the crisis can be overcome by a good, strong dose of confidence.

From Fisher’s point of view, such a belief is futile. In an economy with an excessive level of debt and low inflation, he argued that confidence was irrelevant–and in fact dangerously misleading, as he knew from painful personal experience. Given over-indebtedness and low levels of inflation, a “chain reaction” would occur in which: 

“(1) Debt liquidation leads to distress selling and to

(2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes

(3) A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be

(4) A still greater fall in the net worths of business, precipitating bankruptcies and

(5) A like fall in profits, which in a “ capitalistic,”  that is, a private-profit society, leads the concerns which are running at a loss to make

(6) A reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to

(7) Pessimism and loss of confidence, which in turn lead to

(8) Hoardinq and slowing down still more the velocity of circulation.The above eight changes cause

(9) Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.” (Fisher 1933; The Debt Deflation Theory of Great Depressions)

One key phenomenon that Fisher emphasised was that deflation could make the debt burden worse even as borrowers reduced their nominal debt levels–something I have termed “Fisher’s Paradox”. In Fisher’s words:

“Each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debts cannot keep up with the fall of prices which it causes.

In that case, the liquidation defeats itself. While it diminishes the number of dollars owed, it may not do so as fast as it increases the value of each dollar owed.

Then, the very effort of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed. Then we have the great paradox which, I submit, is the chief secret of most, if not all, great depressions:

The more the debtors pay, the more they owe. The more the economic boat tips, the more it tends to tip. It is not tending to right itself, but is capsizing.”

This is a “disequilibrium” phenomenon par excellence, because not only does it occur out of equilibrium, it actually drives the system further from equilibium. And it is indeed what happened during the Great Depression: America’s debt to GDP ratio rose even as nominal debt levels were reduced. The debt ratio rose from 175 at the end of 1929 to 235 percent in 1932, even as nominal private debt fell from US$163 billion to US$134 billion.

Even though the public’s initial attempt to reduce its debt burden was foiled, the reduction in debt nonetheless did have an impact: it drove the economy into Depression. In the credit-driven real world in which we live, aggregate demand is the sum of GDP plus the change in debt. The public’s attempt to reduce debt meant that the reductions in debt substantially reduced demand, and this deleveraging was the unstoppable force that made the Great Depression “great”.

As the next chart shows, during the Roaring Twenties, the annual increase in debt was responsible for up to ten percent of aggregate demand. But when the Great Crash brought this period of leveraged speculation to an end, the deleveraging that Fisher described meant that the change in debt started to reduce from demand–and at its peak, the reduction in debt in 1932 reduced aggregate demand by 25 percent.

As is obvious, unemployment skyrocketed as aggregate demand collapsed. When debt reaches the sky high levels it did before the Great Depression, deleveraging becomes the dominant force determining the level of unemployment–but obviously there is a lag. Unemployment is the classic “lagging indicator”, because firms take time to respond to a drop in demand, firstly by ceasing to hire new workers and then by sacking existing ones.

When working with annual data at the time of the Great Depression, this lag appears to be about one and a half years. Applying that lag to the period from mid-1929 till mid-1938 (when Government spending and armaments production for the looming war in Europe started to boost demand and caused unemployment to fall), the correlation between debt’s contribution to demand and unemployment was -0.85. The change in debt’s contribution to demand thus explains 85 percent of the unemployment experience of the Great Depression.

This is not good news for us today, for three reasons. Firstly, debt levels today are far higher than they were prior to the Great Depression–the force of deleveraging is thus likely to be greater now than it was in the 1930s. Secondly, given this higher level of debt, the correlation between the debt-financed proportion of aggregate demand and unemployment is even stronger now than it was during the Great Depression. Thirdly, given the greater dependence on debt today than ever before, and the social changes that have gone with the Ponzification of Capitalism, the lag between a fall in the debt-financed component of demand and a rise in unemployment has dropped to just two months.

The change in debt is therefore the best–and most ominous–predictor of future unemployment levels. Though well down from the peak level of being responsible for 25% of aggregate demand, private debt is still generating 10 percent of demand in the USA. Yet even with still positive debt-financed demand, unemployment has risen to 8.7 percent. If deleveraging results in debt reducing aggregate demand by 25 percent as it did in the Great Depression, then unemployment is going to go much, much higher.

The same analysis applies to Australia. Since the crisis has yet to hit Australia as strongly as it has the USA or Europe, the belief that “we are different”–which I call “Kangaroo Economics” in honour of our national fauna–is still prevalent here. So too is the belief that, if we do suffer a recession, it will be due to external forces rather than to our own economic circumstances.

The data begs to differ. Though our aggregate debt level didn’t reach Yankee heights–our peak debt to GDP level was about 165%, versus 290% in the USA before deflation started–our rate of growth of debt was much higher, so that at its peak the growth in debt was responsible for 22% of aggregate demand. Now that debt is starting to fall, unemployment is starting to rise. There is every reason to expect deleveraging in Australia to drive unemployment well into double digits.

So confidence is not “all it is about”: confidence played its role over the last thirty years as it “beguiled its victims into debt”, in Fisher’s evocative phrase. We don’t need more of it now, so much as less of it back then–but of course, we can’t amend history.

The victims of past overconfidence include Central Bankers, whose rescues of the financial system simply encouraged it to search out a new group of potential borrowers to replace those who had already been debt-saturated. They were victims of debt, as much as were the borrowers, because the naive theory of economics they followed ignored the role of debt completely. They therefore couldn’t see the process that was leading to crisis, even as their interventions egged that process on to heights that it could never have reached without them.

Had Greenspan and his equivalents around the world not intervened in 1987, it is quite possible that we would have experienced a mild Depression back then–mild because debt was only equivalent to 1929 levels then, because a larger Government sector than in the 1920s would have counterbalanced the private sector downturn, and because higher inflation in the late 80s would have helped reduced the real burden of debt.

Now we are sitting on the precipice of a mountain of debt twice as high as in the Great Depression, with low inflation turning into deflation as Fisher warned, and with Central Bankers who do not have a clue why the economy has suddenly gone from “the Great Moderation” to “the Greatest Crisis Since the Great Depression”.

Over-confidence in the face of rising debt did beguile us during the long boom. Confidence in the face of deleveraging will not save us during the coming Depression.


Comments on the Australian Data

Debt levels in Australia are very close to falling in nominal terms, and in fact only mortgage debt is still rising: both business and personal debt (other than mortgages) have fallen in the last few months. It is conceivable that, were it not for the “First Home Buyers Boost”, mortgage debt as well would be falling now too (the scheme is more aptly described as the “First Home Vendors Boost”, since prices at the low end of the market have been driven up by far more than the $7,000 increase in the grant).

As a result, the debt to GDP ratio has fallen for the last four months–though this is to some extent masked by Australia’s practice of summing the previous four quarters of GDP data to derive annual GDP, versus the American practice of simply multiplying the current quarter’s GDP figure by 4. Using the Australian approach, our debt to GDP ratio is now 160%; using the American, it is 162%, since GDP fell by 0.5% in the previous quarter.

Whichever way you cut it, deleveraging is now well and truly underway, and unemployment will therefore rise dramatically in the next few months. Most neoclassical economists are predicting 7.5% unemployment by mid-2010; I expect it will have entered double figures by early in 2010.

Table One

Table Two

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212 Responses to Debtwatch No 34: The Confidence Trick

  1. Lyonwiss says:

    Jim and Bullturnedbear

    The confidence tricks always work for awhile, despite very flimsy fundamental evidence. The rally encouraged by spin provide opportunities for insiders to off-load:

    Normally, insider selling is not a reliable indicator, because there may be genuine needs to raise funds. But in this case, because of the size and pace of selling, it may be significant. I suspect the weaknesses for the market which are foreseeable are: commercial real estate, US treasuries and credit derivatives.

  2. Ernie says:

    China doesn’t need as many exports as people like to make our, it has a massive developing middle class of domestic consumers that need raw materials. You only need exports if you have foreign debt to pay off.

    – Ernie.

  3. Bullturnedbear says:

    Hi Tel,

    Interesting discussion. I believe we are going to have a depression despite all the policy panic. As such, my argument is that when the full affects of the depression materialise, the value of metals and shares will fall further than anyone can imagine. This continual discussion that the US will “choose” inflation is a flawed theory.

    In a debt based system the market generates inflation/deflation. Read ” Roving Cavaliers of Credit”. The real people are paying off debt and hiding what ever money they have left, away. These are deflationary activities, not inflationary.

    China is simply putting its head in the sand and continuing its pre-bubble bursting activities. That is subsidising and fostering its export sector. China is using the “build it and they will come” theory. This will only work if demand holds up. World trade fell 35% in 2008. Did the MSM notice that? This is a depression level statistic that virtually no one has reported.

    Where will the new demand come from? The western world is heavily indebted. On a debt to equity ratio, they are now just about insolvent (because of crashing asset values). There is no consumer led capacity to re-inflate the bubble. Consumers are “quitting” the system in droves.

    The current media cycle will not confirm my prediction. But I say that China will lose big time on its bets to buy metals and shares in miners in this market.

  4. ak says:

    Regarding China,

    There are alternative universes and not everyone plays the same game.

    The Chinese do not have to follow the same rules. They don’t have hedge funds, Warren Buffet and they can redistribute the GDP (the party is still called “Communist”). They will consider free market as a tool to achieve social goals rather than a philosophical principle. Generally speaking all the prominent members of the decision-making oligarchy are very highly qualified academics or technocrats – not politicians selling rubbish ideas with the help of spin-doctors.

    “After he delivered a speech on climate change, Mr Miliband was twice asked about the fact that he wasn’t a scientist or even an environmental expert – he studied politics, philosophy and economics at university.”

    This site might also be very interesting, please look at the credentials of people involved in the dialogue on the Chinese side and at some ideas expressed there:

    The time horizon in which decisions are made in China is not determined by the election cycle and they have a tradition of “long marches” – things are planned for the decades to come. Obviously they do suffer from the inertia and they are conservative once they make a decision. Questioning authorities is not much on the agenda there…

    It is absolutely evident that GFC hurts China a lot but they don’t have certain problems we have in Australia (or US). They are not obsessed with the share market or the value of complex financial instruments. The society is not in a sub-prime debt, there are hundreds of millions of people willing to work for 1/10 of the minimum salary in Australia. What really matters there is the production and possession of physical goods not the post-industrial wealth creation rubbish based on speculation on real estate. This is not and will never be a consumerist society – being wealthy doesn’t mean being wasteful. Even in countries where ethnic Chinese are very rich they save rather than waste (“consume”). The cultural difference is striking for me who was brought up in the extremely frugal Eastern European (more Belarussian than Polish) culture. (I am on the Chinese side in this case of course).

    The following link was already mentioned in one of the earlier posts by ferb:
    What I would like to emphasize is the sheer size of savings of ethnic Chinese. I suggest asking one of you Chinese friends (I am sure you have many of them) what they think about the whole issue. I asked my friends and they all agreed – the article is accurate and there is more about that.

    Right now the Chinese government is propping up the domestic demand (and starting more infrastructure projects). Since their foreign currency reserves are huge they can afford buying commodities for years. (They are doing exactly that). They don’t have to succumb to the collapse in external demand or global trade. Obviously they do care about the potentially diminishing value of their savings in the US currency (and their PM has said that already). China may not save the world but they will save themselves for sure. The only risk is that the internal dynamics of short-term changes (like closing of factories there due to the drop in export) may lead to social instabilities – but in that case they can easily revert to the “manual control” mode.

    I would suggest reading posts from the professor Bill Mitchell’s blog – even if you don’t agree with his views he is a very smart person. I wouldn’t be surprised if the Chinese actually implement some of the ideas mentioned there:

    Whether this logics works better or not we will learn quite son.

  5. GSM says:

    I think there is no chance the US consumer can lead a recovery in the US- none. The US consumer has no collateral left against which to borrow. No consumer credit= no growth for the US economy.

    The realization of that will put an end to any rally soon enough. That realization will set a new time frame for the market as actual and sustainable recovery in the US will then be factored well into the future- trashing earnings in the meantime.

    China will run 2 very distinct policies simultaneously. Internally it will substantially boost efforts and spending that stimulates domestic demand. And make no mistake- they can deploy these decsions faster than any other large economy. Externally, China will o for market share.They will do their best to support flagging exports and deal with the fallout. They will manage it.

    China is in a similar position as the US was in the 30’s in many respects. It is a nett LENDER not a nett borrower. Cheap abundant labour. Now lots of manufacturing capacity. While it does need to import commodities, the world now is awash in supply of raw materials. It’s weakness is it’s exposure to US treasuries.It has already begun diversifying that exposure and will continue to do so. China, unless it does something very stupid, will manage itself sufficiently well to travers the GFC. It will come out the other side in rather strong shape.

    Australia will not benefit as before from China demand.As nett borrowers we will be similarly afflicted as the US. A long period of economic decline after which will be sideways economic growth. Higher normal unemployment. Heavy debt servicing burdens. Which is why our Govt Deficit and offshore debts will be the 2 biggest impacts on our medium term (5-10 years) future. It’s going to be tough.

  6. iconoclast says:

    Something to think about, when you listen, watch, read main-stream media.

    The following is an excerpt from an interview with Noam Chomsky, titled Conversations with History March 22, 2002 (

    “You can lie or distort the story of the French Revolution as long as you like and nothing will happen. Propose a false theory in chemistry and it will be refuted tomorrow.”

    Yes, that’s the kind of thing I mean. Nature is tough. You can’t fiddle with Mother Nature, she’s a hard taskmistress. So you’re forced to be honest in the natural sciences. In the soft fields, you’re not forced to be honest. There are standards, of course; on the other hand, they’re very weak. If what you propose is ideologically acceptable, that is, supportive of power systems, you can get away with a huge amount. In fact, the difference between the conditions that are imposed on dissident opinion and on mainstream opinion are radically different. I’ll give you a concrete example, if you like.

    Yes, do that.

    Okay. For example, I’ve written about terrorism, and I think you can show without much difficulty that terrorism pretty much corresponds to power. I don’t think that’s very cover The more powerful states are involved in more terrorism, by and large. The United States is the most powerful, so it’s involved in massive terrorism, by its own definition of terrorism. Well, if I want to establish that, I’m required to give a huge amount of evidence. I think that’s a good thing. I don’t object to that. I think anyone who makes that claim should be held to very high standards. So extensive documentation, and from the internal secret records and historical record and so on. And if you ever find a comma misplaced, somebody ought to criticize you for it. So I think those standards are fine.

    All right, now, let’s suppose that you play the mainstream game. For example, the Yale University Press just came out with a volume called The Age of Terror. The contributors are leading historians, many of them at Yale, the top people in the field. You read the book The Age of Terror, the first thing you notice is there isn’t a single footnote, there isn’t a single reference. There are just off-the-top-of-your-head statements. Some of the statements are tenable, some are untenable, but there are no intellectual criteria imposed. The reviews of the book are very favorable, laudatory, and maybe it’s right, maybe it’s wrong. I happen to think a lot of it is wrong and demonstrably wrong. But doesn’t really matter, you can say anything you want because you support power, and nobody expects you to justify anything. For example, on the unimaginable circumstance that I was on, say, Nightline, and I was asked, say, “Do you think Kadhafi is a terrorist?” I could say, “Yeah, Kadhafi is a terrorist.” I don’t need any evidence. Suppose I said, “George Bush is a terrorist.” Well, then I would be expected to provide evidence, “Why would you say that?”

    So that you aren’t cut off right there.

    In fact, the structure of the news production system is, you can’t produce evidence. There’s even a name for it — I learned it from the producer of Nightline, Jeff Greenfield. It’s called “concision.” He was asked in an interview somewhere why they didn’t have me on Nightline, and his answer was — two answers. First of all, he says, “Well, he talks Turkish, and nobody understands it.” But the other answer was, “He lacks concision.” Which is correct, I agree with him. The kinds of things that I would say on Nightline, you can’t say in one sentence because they depart from standard religion. If you want to repeat the religion, you can get away with it between two commercials. If you want to say something that questions the religion, you’re expected to give evidence, and that you can’t do between two commercials. So therefore you lack concision, so therefore you can’t talk.

    I think that’s a terrific technique of propaganda. To impose concision is a way of virtually guaranteeing that the party line gets repeated over and over again, and that nothing else is heard.”

    During times of economic or social instability, the elites will try their utmost to obfuscate the truth and main-stream-media is part of the existing power structure, so don’t expect to get anything other than complete spin to maintain and perpetuate the existing power structure. We have already seen many instances of this.

  7. BrightSpark1 says:

    ak and GSM

    Very good points.

    The US and Australia have technologically dumbed down while developing economic clap trap, derivative production, creative litigation, and creative debt creation. This has all lead to the creation of imaginary not real wealth. The imaginary nature of this wealth has not yet been undestood by Messrs Rudd and Turnbull they seen to think it has substance as have their predecessors. Unlike China we have few technocrats with political power.

    That the Rudd government is trying to negotiate a “free trade” agreement with China where labour, from unskilled to highly skill (more highly skilled at the top end than in Australia) is available at 1/10th of the Australian rate, with no comments from the oposition indicates that they are all out of touch with reality. That the union movement has not commented on this while trying to negotiate paid parenting leave and other benefits also indicates a distance from reality only found in the works of Lewis Carrol in Alice in Wonderland.

    They are not aware that real debt can only be serviced and repaid with real wealth.

    Their “confidence” and like thier vision of wealth, is, in reality, hubris.

  8. Lyonwiss says:


    You are spot on: “In the soft fields, you’re not forced to be honest. There are standards, of course; on the other hand, they’re very weak.” What’s more you can tell lies one after another and no one will remember or even notice. The recent stress test of the 19 major banks which supported the recent stock market rally was simply the latest in a series of virtually identical lies:,-Former-Bank-Regulator-Says?utm_source=feedblitz&utm_medium=FeedBlitzEmail&utm_content=442913&utm_campaign=On-Demand_2009-05-10+00%3a40

  9. joshua says:

    Hi Steve,

    I bet you must be throwing up trying to digest the indigestible how the Fed came to the rescue and Ben Bernanke avoided a depression

    It is so evident that the MSM is propping up the hope and ignoring the depressing news. Any one notice how they still put a positive spin on the bad reports?

    Not as bad! Better than expected profit losses! First quater we go bang! Banks reporting a profit! Stock Market is on a high! We can see those green shoots! We are truly headed for a late 2009 or mid 2010 recovery!

    Steve I wonder if you get hammered with the same questions that Roubini gets asked about ignoring caution and the bad shape of the economy can you see the green shoots? whether you will buckle down like Roubini and say yes? 🙂 I doubt it. 🙂

    Thats all that MSM wants to hear! and the markets will just go bang and fly off and you will lead the recovery! No doubt it doesn’t make sense!

  10. Bullturnedbear says:

    Great post Iconoclast.

    Thank you.

  11. Tel says:

    “War is the terrorism of the rich and powerful, and terrorism is the war of the poor and powerless.”
    – Peter Ustinov

    All the concision you need, and no evidence necessary.

  12. Steve Keen says:

    It does rather make me shake my head, but similar things happened in 1930 too. The basic analysis I have–that de-leveraging will drive the economy down just as leveraging drove it up–is unchanged, so my analysis and my expectations of the future remain intact. I expect a period of unrelenting growth in unemployment–and the US figures certainly had that in spades–as the green shooters start to expect a “typical” levelling off.

    Once that has passed post-WWII records–which could take 6-9 months in America–I think the current period of Dunkurkish optimism will end.

  13. Philip says:


    You mention some good points. The problems with political science and economics are twofold. The first is that, as a social science and not a natural science, experiments are difficult, if not possible, to perform. This is obvious and widely known. The second point is never spoken about: power. Behind political science is state power, and behind economics is corporate power.

    “Those who bear the costs of the system’s dysfunctions have been stripped of decision-making power and remain confused about the cause of their distress because the corporate-dominated media incessantly bombards them with interpretations of the resulting crisis based on the perceptions of the power holders. An active propaganda machine controlled by the world’s largest corporations constantly reassures us that consumerism is the path to happiness, government restraint of the market us the cause of our distress, and corporate globalization is both a historical inevitability and a boon to the human species. In fact, these are all myths propagated to justify profligate greed and mask the extent to which the global transformation of human institutions is a consequence of the sophisticated, well-funded, and intentional interventions of a small elite whose money enables them to live in a world of illusions apart from the rest of humanity.” (p. 22)

    Korten, David. 2001. When Corporations Rule The World (San Francisco, California: Berrett-Koehler Publishers)

    It is only natural for business, as a system of power, to twist economic theory as much as possible to its advantage. One needs to look no further than the hold that corporate America has on the university system, with the University of Chicago functioning as the Holy Corporate Temple. The neoclassicals are the “Fidei defensor” or Defenders of the Faith.

    “In the quest for economic growth, free-market ideology has been embraced around the world with a near-religious fervor. Money is its sole measure of value, and its practice advances policies that are deepening social and environmental disintegration everywhere. The economics profession serves as its priesthood. It champions values that demean the human spirit. It assumes an imaginary world divorced from reality. And it restructures our institutions of governance in ways that make our most urgent problems more difficult to resolve. Yet to question its doctrine has become heresy, invoking risk of professional censure and damage to one’s career in most institutions of business, government, and academia.” (p. 75)

    Korten, David. 2001. When Corporations Rule The World (San Francisco, California: Berrett-Koehler Publishers)

    Students and academics of the natural sciences (physicists, chemists, biologists, etc) simply can’t function under the ideological conditions that are imposed upon the social sciences such as political science and economics. That’s why the hope of a new economic theory lies with engineers and physicists, whose training would not allow them to accept conventional economic dogma at face value (equilibrium, rational expectations, etc).

    “Modem economics is “sick.” Economics has increasingly become an intellectual game played for its own sake and not for its practical consequences. Economists have gradually converted the subject into a sort of social mathematics in which analytical rigor as understood in math departments is everything and empirical relevance (as understood in physics departments) is nothing. If a topic cannot be tackled by formal modeling, it is simply consigned to the intellectual underworld.” (pp. 12-13)

    Blaug, Mark. 1998. “Disturbing Currents in Modern Economics”, Challenge, Vol. 41, No. 3, pp. 11-34

    “Often, the people who live ordinary lives far removed from the corridors of power have the clearest perception of what is really happening. Yet they are often reluctant to speak openly about what they believe in their hearts to be true, because it is too frightening and differs too dramatically from what those with more impressive credentials and access to the media are saying. These suppressed insights leave people feeling isolated and helpless.” (p. 12)

    Korten, David. 2001. When Corporations Rule The World (San Francisco, California: Berrett-Koehler Publishers)

  14. Ernie says:

    The US is hiring about a million workers at the taxpayers expense for the 2010 census. That will of course distort their employment figures and they will spin it as productive employment.

    – Ernie.

  15. tommyt says:

    Thank you phillip for your clear and enlightening explanation! Your entry explains may things none more important than why it is important for us all to have Dr Steve Keen explain the economics (in plain english) via this ‘blog’ and secondly to remind us to ‘stay awake and think!” why “..the corporations rule the….mind”

  16. Tel says:

    “The depreciation of the dollar has become an inevitable historical trend,” Zheng Xinli, vice-president of China Center for International Economic Exchanges, said at the forum. “Countries with considerable holdings, such as China, India, Japan and South Korea, should join hands to demand that the US make commitments to peg the value of US Treasury bonds to the inflation rates of the US dollar.”

    I can see billions of reasons why the US would be in a very difficult position if China managed to get the debt indexed to inflation. Even worse if the index is against the CPI which is really just a gauge of the price of Chinese exports.

  17. MACCA says:

    Every now and then discussion here turns to the prudence of owning gold.Those that ridicule gold as an investment might want to consider this chart;

  18. Otto C. says:

    I have an off-topic question, can somebody provide an answer?

    Banks show an amount in their balance sheet for derivatives, e.g. ANZ $57.4 billion and elswhere in the last report there is reference to derivatives having a nominal value of $1.8 trillion.

    As I understand it banks are supposed to use mark-to-market acoounting, but how is a market value established for these derivatives?

    I can see how this is possible for options and warrants that have a market price, but in the case of futures the nominal value is the only available price (and that would be a big number). CDS’s aren’t publicly traded so how does one get a value?

    Currently bank deposits are safe because of the government guarantee, at least until 2011, but a bank failure would still cost the taxpayer. A substantial fall in real estate, business failures and unemployment growth would be dangerous for Australian banks, despite the rhetoric about how safe they are. One significant item that spells danger is that ‘black box’ which holds the derivatives.

    Maybe the valuation issue is simpler than I think, does anyone know how it’s done?

  19. Bullturnedbear says:

    Hi Otto,

    80% to 90% of derivatives in Australia are interest rate swaps.

    The loss or gain from this trading can be hard for the public to quantify. Here’s why.

    1. The banks have “trained” their customers well. Banks force customers to buy their own interest hedge. So a bank may make very little (a tiny spread) selling a swap. But the customer might get creamed. Eg, When rates were peaking mid last year, anyone that locked in (hedged) their rate now has a massive loss on that hedge because rates have fallen a long way. Retail customers know this as “break fund costs”. ie, The cost you incur when you break a fixed rate. Many large commercial customers, councils with debt and corporates will wipe out a lot of their profit this year just because they hedged against rates going higher last year.

    2. If a bank makes a bad call on interest rates, they can smooth that loss over the entire book. It is still a loss, but we can’t see that they made a loss betting on interest rates. Eg, Lets say last July Suncorp panicked and hedged a large amount of their book against further rate rises. Then rates started falling and they did not unwind those contracts. Instead of booking massive trading losses, they could simply complain that their margin is being squeezed and either put up their rates or not reduce them as fast as the RBA. Profit will fall because the margin shrinks, but you can’t tell that the cause was trading losses.

    Maybe a lot of the banks’ complaints late last year about higher funding costs came partly from trading losses (interest rates did unexpectedly change directions very fast) and the collapse of confidence in the swaps market.

  20. Philip says:

    tommyt, you’re welcome.

    It’s taken me a while to realize how far the neoclassical profession goes to protecting corporate power above all else. What neoclassicals are to the corporation, Marxists are to the state. A great deal of the effort that goes into defending business corporations lies in economic theory.

    After all, think of the following assumptions that underlie neoclassical economic models: perfectly infallible, utterly omniscient, infinitely long-lived identical consumers; zero transaction costs; complete markets for all time-stated claims for all conceivable contingent events; no trading of any kind at disequilibrium prices; infinitely rapid velocities of prices and quantities; no radical, incalculable uncertainty in real time but only probabilistically calculable risk in logical time; only linearly homogeneous production functions; no technical progress requiring embodied capital investment, etc.

    These assumptions are not just unrealistic assumptions but transparent fabrications needed to maintain the illusion that corporate capitalism is an efficient economic system and thus socially desirable. However, it is neither efficient nor socially desirable. Furthermore, even if markets worked as neoclassicals believe they do, it still does not follow that corporate capitalism is an efficient system because the greatest enemy of the market are not the firebrand trade unionists or the radical Marxists but rather, the corporate executives in pin-striped suits who extol the virtues of competitive markets with every breath while attempting to extinguish them with every action.

    Enacting “free market” policies (the phrase “free market” should really be known as “selective market fanaticism”) gives more freedom to the greatest enemy of both the market and political democracy to defile both: corporations.

    As I pointed out in a previous post, US CPA Ralph Estes constructed a conservative cost analysis of the US corporate sector’s negative externalities, state protection, and crime, which added up to $US2.6 trillion while corporate profits were $US530 billion in 1994. If this analysis were to be applied to the Australian corporate sector, a similar result would emerge. Corporate capitalism is radically inefficient yet we continually hear the drum-beat of “market efficiency”, “wealth creation”, “technological innovation”, etc. In this environment, government with all its known inefficiencies and bureaucracy would be far more efficient at performing many of the tasks that the corporate sector currently carries out.

    Over the decades in our secular society, religious belief has moved from the traditional church sector to the state and corporate sectors where the typical priesthood of intellectuals have congregated around power in order to derive its benefits.

  21. jh says:

    I was listening to the radio and came across this.

    Shows some of the side effects of a failure in the currently taught theories. Brief summary is that teachers and students are struggling with clear evidence that the theories are not working yet still have to set and answer the exams according to the theory.

  22. tommyt says:

    Thanks Phillip, Amen!

    It is the ‘socially destructive’ part that destroys and offends every ‘dna’ in me!

    Thanks for enticing arguments.

  23. tommyt says:

    Forgot to advise anyone interested that the SBS show ‘insight’ screening in Sydney Tuesday 12/5 will showcase the severe debt problems of the U.S. economy!! Should be good!

  24. boma says:

    All of a sudden government paper is getting hard to sell.,25197,25458154-5015025,00.html

    ‘Horrible bond auction’ lifts long-term rates

    “A SHIVER ran through world bond markets on Friday after a US Treasury auction of $US14 billion ($18 billion) in 30-year bonds on Thursday night struggled to find buyers…”

    Is the 50 year old debt train about to reach the end of the line? Or is just that investors are back on the equities gravy train again?

  25. DrBob127 says:


    The show on SBS is the documentary at 8:30pm just after Insight (which is at 7:30pm):
    8:30pm Us Debt: Ten Trillion And Counting

    This week, Insight is looking at the problems of 16 year olds in Australia.

    Times and programs correct for Sydney, Melbourne, Queesnland, SA, Tas and WA (according to sbs guide)


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