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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  • Lyon­wiss

    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.

  • Ernie

    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.

  • Bull­turned­bear

    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.

  • ak

    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.

  • GSM

    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.

  • icon­o­clast

    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.

  • BrightSpark1

    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.

  • Lyon­wiss


    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

  • joshua

    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!

  • Bull­turned­bear

    Great post Icon­o­clast.

    Thank you.

  • Tel

    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.

  • 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.

  • Philip


    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)

  • Ernie

    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.

  • tom­myt

    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”

  • Tel

    “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.“–04/20/content_17636902.htm

    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.


    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;

  • Otto C.

    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?

  • Bull­turned­bear

    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.

  • Philip

    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.

  • jh

    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.

  • tom­myt

    Thanks Phillip, Amen!

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

    Thanks for entic­ing argu­ments.

  • tom­myt

    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!

  • boma

    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?

  • DrBob127


    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)