No-one saw this com­ing?” Balder­dash!

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The widely believed propo­si­tion that this finan­cial cri­sis was “a tsunami that no-one saw com­ing”, and that could not have been pre­dicted, has been given the lie to by an excel­lent sur­vey of eco­nomic mod­els by Dirk Beze­mer, a Pro­fes­sor of Eco­nom­ics at the Uni­ver­sity of Gronin­gen in the Nether­lands.

Beze­mer did an exten­sive sur­vey of research by econ­o­mists or finan­cial mar­ket com­men­ta­tors, look­ing for papers that met four cri­te­ria:

Only ana­lysts were included who:

  1. pro­vide some account on how they arrived at their con­clu­sions.
  2. went beyond pre­dict­ing a real estate cri­sis, also mak­ing the link to real-sec­tor reces­sion­ary impli­ca­tions, includ­ing an ana­lyt­i­cal account of those links.
  3. the actual pre­dic­tion must have been made by the ana­lyst and avail­able in the pub­lic domain, rather than being asserted by oth­ers.
  4. the pre­dic­tion had to have some tim­ing attached to it.”

On that basis, Beze­mer found eleven researchers who qual­i­fied:

Researcher Role Fore­cast Date
Dean Baker, US Co-direc­tor, Cen­ter for Eco­nomic and Pol­icy Research 2006
Wynne God­ley, US Dis­tin­guished Scholar, Levy Eco­nom­ics Insti­tute of Bard Col­lege 2007
Fred Har­ri­son, UK Eco­nomic Com­men­ta­tor 2005
Michael Hud­son, US Pro­fes­sor, Uni­ver­sity of Mis­souri 2006
Eric Jan­szen, US Investor & iTulip com­men­ta­tor 2007
Stephen Keen, Aus­tralia Asso­ciate Pro­fes­sor, Uni­ver­sity of West­ern Syd­ney 2006
Jakob Brøch­ner Mad­sen & Jens Kjaer Sørensen, Den­mark Pro­fes­sor and Grad­u­ate Stu­dent, Copen­hagen Uni­ver­sity 2006
Kurt Richebächer, US Pri­vate con­sul­tant and invest­ment newslet­ter writer 2006
Nouriel Roubini, US Pro­fes­sor, New York Uni­ver­sity 2006
Peter Schiff, US Stock Bro­ker, invest­ment adviser and com­men­ta­tor 2007
Robert Shiller, US Pro­fes­sor, Yale Uni­ver­sity 2006

Hav­ing iden­ti­fied eleven researchers who did “see it com­ing”, Beze­mer then looked for the com­mon ele­ments in the way that these researchers analysed the econ­omy. He argued that if there were com­mon elements—and if these dif­fered from the approach taken by the over­whelm­ing major­ity of econ­o­mists, who didn’t have a clue that a cri­sis was approaching—then the only use­ful eco­nomic mod­els would be ones that included these com­mon ele­ments.

He iden­ti­fied four com­mon ele­ments:

  1. a con­cern with finan­cial assets as dis­tinct from real-sec­tor assets,
  2. with the credit flows that finance both forms of wealth,
  3. with the debt growth accom­pa­ny­ing growth in finan­cial wealth, and
  4. with the account­ing rela­tion between the finan­cial and real econ­omy.”

A non-econ­o­mist might look at these ele­ments in puz­zle­ment: surely all eco­nomic mod­els include these fac­tors?

Actu­ally, no. Most macro­eco­nomic mod­els lack these fea­tures. Beze­mer gives the top­i­cal exam­ple of the OECD’s “small global fore­cast­ing” model, which makes fore­casts for the global econ­omy that are then dis­ag­gre­gated to gen­er­ate pre­dic­tions for indi­vid­ual countries—like the ones touted recently as indi­cat­ing that Aus­tralia will avoid a seri­ous reces­sion.

He notes that this OECD model includes mon­e­tary and finan­cial vari­ables, how­ever these are not taken from data, but are instead derived from the­o­ret­i­cal assump­tions about the rela­tion­ship between “real” variables—such as “the gap between actual out­put and poten­tial output”—and finan­cial vari­ables. As Beze­mer notes, in the OECD’s model:

There are no credit flows, asset prices or increas­ing net worth dri­ving a bor­row­ing boom, nor inter­est pay­ment indi­cat­ing grow­ing debt bur­dens, and no bal­ance sheet stock and flow vari­ables that would reflect all this.”

How come? Because stan­dard “neo­clas­si­cal” eco­nomic mod­els assume that the finan­cial sys­tem is like lubri­cat­ing oil in an engine—it enables the “real econ­omy” to work smoothly, but has no dri­ving effect—and that the real econ­omy is a mir­a­cle machine that always returns to a state of steady growth, and never gen­er­ates any pollution—like a car engine that, once you take your foot off the accel­er­a­tor or brake, always returns to a steady 3,000 revs per minute, and sim­ply pumps pure water into the atmos­phere.

The com­mon ele­ments in the mod­els devel­oped by the Gang of Eleven that Beze­mer iden­ti­fied are that they see finance as more akin to petrol than oil—without it, your “real econ­omy” engine revs not at 3,000 rpm, but zero—which can con­tain large doses of impu­ri­ties as well as hydro­car­bons. The engine itself is seen as a rather more typ­i­cal gas-guz­zler that pumps not merely water and car­bon diox­ide, but some­times unhealthy amounts of car­bon monox­ide as well.

That’s encap­su­lated in the flow­chart that Beze­mer copied from a paper by Michael Hud­son, shown below. With­out credit from the Finance sec­tor, producer/employers don’t get the finance needed to run their fac­to­ries and hire work­ers; but with credit they accu­mu­late debt that has to be ser­viced from the cash flows those busi­nesses gen­er­ate.

The com­po­nent left out of the above flowchart—but incor­po­rated in all the mod­els praised by Beze­mer for see­ing the cri­sis coming—is that the finance sys­tem can fund not merely “good” real econ­omy action but “bad” spec­u­la­tion on finan­cial assets and real estate as well. This also leads to debt, but unlike the lend­ing to finance pro­duc­tion, it doesn’t add to the economy’s capac­ity to ser­vice that debt.

The growth in thus unpro­duc­tive debt was the com­mon ele­ment iden­ti­fied by Bezemer’s “Gang of Eleven”, which was why we most def­i­nitely did see “It” com­ing.

I’ll fin­ish this anal­ogy-laden arti­cle with a side­swipe at an inap­pro­pri­ate one—that this cri­sis is “like a tsunami”. Though that image cap­tures the sud­den­ness and dev­as­tat­ing nature of the cri­sis, it is wrong not merely once but twice in char­ac­ter­iz­ing how it came about.

Firstly, unlike a tsunami, this cri­sis was pre­dictable by econ­o­mists who take what Beze­mer char­ac­ter­ized as a “Flow-of-fund or account­ing” approach. Sec­ondly, a tsunami is actu­ally caused by a huge shift in the planet’s tec­tonic plates, and the shift itself relieves the ten­sion that caused the tsunami in the first place: in a sense, the tsunami resets the sys­tem to a tran­quil state.

This finan­cial tsunami was caused by the burst­ing of asset price bub­bles dri­ven by exces­sive lev­els of debt, but the burst­ing of those asset bub­bles hasn’t elim­i­nated the debt—far from it. Instead, eco­nomic per­for­mance for the next decade or more will be dri­ven by the pri­vate sector’s attempts to reduce its debt lev­els, and this will depress eco­nomic activ­ity for years. Unlike a tsunami, a debt cri­sis is a wave of destruc­tion that keeps on rolling unless the debt is delib­er­ately elim­i­nated.

Every­thing that is being done by pol­icy mak­ers around the world is instead try­ing to restart pri­vate bor­row­ing. A bet­ter anal­ogy is there­fore not a tsunami but a drug overdose—and our “neo­clas­si­cal” eco­nomic doc­tors are attempt­ing to bring the patient back to health by admin­is­ter­ing more of the same drug.

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    By run­ning a Bal­ance of pay­ments deficit head­ing toward (7 — 9%) of GDP, Aus­tralia is import­ing $70 — 90 bil­lion of eco­nomic demand/stimulus per year.

    Our exter­nal trade cred­i­tor coun­tries are being far more gen­er­ous with their ‘Aus­tralian stim­u­lus’ than Rudd & Swan have been or the RBA 4% rate cuts for that mat­ter.


    I have to give it to Kevin Rudd in The Age this week­end… Polit­i­cally savy enough to skirt directly drop­ping a polit­i­cal nuclear bomb on the great Aus­tralian dream of easy lim­it­less wealth derived from hous­ing own­er­ship ‘at any price’…


    Causes of the cur­rent cri­sis…

    …Aus­tralian con­sumers also spent up big. Between 1996 and 2007, there was a 460% increase in credit card debt, a 340% increase in house­hold debt, a 450% increase in cor­po­rate debt and a 200% increase in net for­eign debt.

    Sec­ond, these debts were racked up on the back of sky­rock­et­ing asset prices. In sev­eral coun­tries, stock prices and house val­ues soared far above their true long-term worth, cre­at­ing paper wealth that mil­lions of house­holds used as col­lat­eral for their grow­ing debts.

    Given Kevin Rudds premises…

    Rapidly expand­ing house­hold debt in Aus­tralia
    House­hold debt is secured by inflated assets
    The illu­sion is paper wealth

    The log­i­cal con­clu­sion is…

    Aus­tralian hous­ing assets are over priced

    Should I assume even Kevin Rudd believes Aus­tralian houses are over priced?

    If Kevin Rudd is not going to directly inform the gen­eral pub­lic, then he should at least inform the real estate indus­try. They have laws with huge penal­ties about under and over priced mar­ket­ing of houses.


  • ak

    The essay Kevin Rudd wrote is a direct attack at the Lib­er­als say­ing that the gov­ern­ment should not bor­row money and stim­u­late the econ­omy. He also wants to dif­fer­en­ti­ate him­self from the neolib­eral Coali­tion respon­si­ble for the cur­rent prob­lems. Only in this con­text he men­tioned the root causes of the cri­sis (the moun­tain of debt). 

    What he says next is in my opin­ion very impor­tant — he is aware that the next phase of the cri­sis in Aus­tralia will not be easy for us. Per­son­ally I think he may still believe to some extent in the rapid recov­ery of the global econ­omy and the coop­er­a­tion of G20 coun­tries in build­ing the new global order. 

    But what if this is all rub­bish? What if the US econ­omy (I’m not talk­ing about the casino econ­omy but the real one) keeps sink­ing at a steady pace? What if Rus­sia really wants to get Crimea back? What if China wants to look more after the inter­ests of the local com­pa­nies owned by the polit­buro rather than the multi­na­tion­als? What if sev­eral more “for­eign” exec­u­tives not loyal enough to the moth­er­land rot in jail? What if they just wanted to gauge the reac­tion of the west­ern gov­ern­ments before tak­ing on the Amer­i­cans?

    Could Kevin Rudd just tell peo­ple — this is all going to col­lapse? No he couldn’t — he didn’t want to com­mit a polit­i­cal sui­cide. By the way I don’t believe in a col­lapse. I think it will be messy here in Aus­tralia but there will be no col­lapse thanks to the Labor gov­ern­ment. They are not true believ­ers in the rub­bish neo­clas­si­cal the­o­ries and if they have to redis­trib­ute the wealth — they will do it.

    Men­tion­ing ris­ing petrol prices may sig­nal the will­ing­ness to restore the trade bal­ance by low­er­ing the exchange rate of AUD what makes sense to me.

    There are 2 things the cur­rent gov­ern­ment are going to defend — house prices and employ­ment. There is a direct con­tra­dic­tion between ris­ing inter­est rates and house prices. Kevin Rudd didn’t men­tion that. Per­son­ally I believe that 10% mort­gage rates would mean the same out­come as in the US — the col­lapse. The mar­gin left for mak­ing any adjust­ments is very nar­row. How­ever there are a few more rab­bits left in the hat — they will be pulled when nec­es­sary. Regard­ing unem­ploy­ment it is still pos­si­ble to tem­porar­ily halt immi­gra­tion to Aus­tralia (what will have long-term adverse con­se­quences to skill short­ages) what would “fix” the prob­lem of unem­ploy­ment.

    I think that we should not under­es­ti­mate the will­ing­ness of Kevin Rudd not to allow for dis­or­derly house bub­ble defla­tion at any cost even if there will be enor­mous mess cre­ated after­wards. But this is what we deserve and we should be thank­ful we have Kevin. We are not in the US and the Labor party is not a hostage of Wall Street as Barack Obama is.


    I think you are right. The Aus­tralian paper wealth illu­sion can be main­tained.

    An orderly 50% decline in the AUD would do it.

    Over 10 years it would imply ~ 7% inter­nal infla­tion

    The RBA could hold deposit rates at zero for 10 years

    The banks would have to adjust mort­gage inter­est rates up over time by roughly 40% X 7% or 2.8% because their com­mer­cial fund­ing cost com­po­nent would rise by 7%

    Wages would also have to rise with infla­tion (dou­ble over 10 years) and the nom­i­nal price of houses would have to remain fairly sta­ble but they would be down 50% in real terms (infla­tion adjusted).

    The illu­sion can be main­tained.


  • Josie

    Ueber­baer said:

    just think­ing.. so many econ­o­mists with the wrong mod­els and ideas…and so many cli­mate sci­en­tists also using mod­els and the­o­ries to explain their assump­tions and believes…”

    No, these are not equiv­a­lent in any way. The term ‘model’ is mis­lead­ing. Cli­mate mod­els are based on the laws of physics and chem­istry, which have been dis­cov­ered through empir­i­cal research over cen­turies. All they do is solve lots of equa­tions. Their out­puts are then tested against real data and found to repli­cate and pre­dict it very well. 

    Econ­o­mists just make up their ‘mod­els’ and the­o­ries and equa­tions. That is what is so shock­ing about the sub­ject if you are used to sci­ence- none of it arises out of empir­i­cal research. 

    Eco­nom­ics is psue­do­science. That has no bear­ing on real sci­ence. If econ­o­mists behaved like real sci­en­tists the sub­ject would be very dif­fer­ent.

  • A good book that need to be revived is The Cap­i­tal­ist Man­i­festo by Mor­timer J Adler and Louis O Kelso.

  • Suit­ablyIron­ic­Moniker

    Hi Josie,

    There is a lot of truth to what you say — but any pre­dic­tive model in a chaotic sys­tem will only have a lim­ited scope to see into the crys­tal ball. Futur­ol­ogy will always be an impre­cise sci­ence, due to those very same las of physics.

  • Josie


    I don’t want to hijack this blog into a dis­cus­sion of cli­mate sci­ence, but it is not really true that the cli­mate is a chaotic sys­tem. Weather is chaotic, which is what pre­vents accu­rate long term weather pre­dic­tions, but cli­mate is the long run sta­tis­ti­cal aver­age, which is dif­fer­ent. The exam­ple often given is that you can’t pre­dict on the toss of a coin whether it will fall heads or tails, but you can make a pretty good esti­mate of the like­li­hood of get­ting dif­fer­ent num­bers of heads and tails if you toss it 1000 times. 

    We are very famil­iar with the cli­mate being a very pre­dictable sys­tem, not a chaotic one. The sea­sons come in a reg­u­lar fash­ion. You may get a cold day in sum­mer (which is weather) but you won’t get all the days in sum­mer being colder than win­ter. If you turn down the sun, the tem­per­a­ture drops very pre­dictably. After a vol­canic errup­tion, the earth cools very pre­dictably. If you dou­ble the amount of an impor­tant green­house gas in the atmos­phere, the tem­per­a­ture rises.

    Of course there is a great deal of uncer­tainty in cli­mate sci­ence, and cli­mate sci­en­tists empha­sise it every step of the way. But not know­ing every­thing is very dif­fer­ent from know­ing noth­ing. If someone’s body is racked with ter­mi­nal can­cer you can’t pre­dict exactly when they will die, but you can pre­dict that they will almost cer­tainly not live another 20 years.

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  • Inter­est­ing that my prob­lem with mod­ern day Geor­gians, is EXACTLY the same prob­lem that peo­ple had with the orig­i­nal Henry George’sCritics.pdf

    By the way, I didn’t reply to a request for links about increas­ing inequal­ity and declin­ing inter­gen­er­a­tional mobil­ity and declin­ing mar­ginal tax rates because it is not con­tro­ver­sial (i.e. there is so much evi­dence and dis­cus­sion about it), the request seemed sim­ply unrea­son­able time wast­ing to me. A good sum­mary here:

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  • McMa­hon Michael

    I would like to add to your list of econ­o­mists with great foresight.William Kaye,an Amer­i­can based in Hong Kong writ­ing in The Far East­ern Review in 1999 could see the future.William Slat­tery in feb­ru­ary 2000 fore­cast here in Ire­land that a prop­erty col­lapse due to ris­ing pri­vate debt was inevitable.A Gary Shilling writ­ing in Forbes june 2006 fore­cast a hous­ing crash.
    I like the story that Pro­fes­sor Tom Woods of The Vom Mises Insti­tute in Amer­ica tells quot­ing Peter Shiffs book about the cir­cus com­ing to town and the local restau­rant owner see­ing so many clowns and trapeze artists fill­ing up his restau­rant every night decides to get a loan from his bank man­ager to expand his busi­ness and off course no sooner has he done that the cir­cus leaves town leav­ing him with empty tables and loans he can’t pay.
    Ire­land today looks like the town the cir­cus just left,only we seem to be left with the clowns still run­ning the show.
    In the US or Europe or even Aus­tralia nobody in author­ity had stud­ied the work on Lud­wig Von Mises,Joseph Schumpeter,Hyman Min­sky or Nicholai Kon­drati­eff.
    Steve,How do you com­pare this Great Reces­sion with 1873–1896.I think the ghost of Hetty Green is walk­ing down Wall St.
    Michael McMa­hon Ire­land

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  • Ren­tier Fungi­cide

    Many pre­dicted the cri­sis even fur­ther back, with time­lines less pre­cise, nat­u­rally, but argu­ing that defla­tion­ary col­lapse had been merely tem­porar­ily post­poned. Some of these accounts were more than pre­scient.

    In 1999–2000, for instance, Alain Parguez’s pre­dicted the finan­cial cri­sis in his arti­cle “The long-run fis­cal defla­tion: a real inter­pre­ta­tion of the late twen­ti­eth-cen­tury world cri­sis” in The Eco­nom­ics of Pub­lic Spend­ing: Debts, Deficits and Eco­nomic Per­for­mance, ed. Has­san Bougrine, Edward Elgar, Chel­tenham, U.K.

    As a taste of Parguez’s Min­skyan analy­sis, take the fol­low­ing para­graph:

    The plan­ners of fis­cal defla­tion dreamed of restor­ing the econ­omy of fear and power so as to pro­mote effi­ciency. They trig­gered a cumu­la­tive process that is destroy­ing the foun­da­tions of accu­mu­la­tion. The finan­cial cri­sis that occured in Japan, East Asia and other emerg­ing economies is a con­se­quence of this process. In the United States and Europe, the cri­sis is being post­poned by grow­ing house­hold indebt­ed­ness and a pure finan­cial infla­tion gen­er­ated by bank cred­its to finance merg­ers and acqui­si­tions of stocks by non-bank­ing insti­tu­tions such as pen­sion funds”.

    Of course, insti­tu­tional investors played a smaller part than this para­graph sug­gests, but he pre­dicted this even before the col­lapse of the tech boom.

  • Love your by-line!

    Yes of course, many oth­ers did; my ear­li­est call was 1995, but there were many oth­ers who fore­saw a cri­sis from a Min­skian per­spec­tive.

    Dirk Bezemer’s paper was look­ing for spe­cific pub­lic pre­dic­tions of this down­turn how­ever, which is why and a hand­ful of oth­ers got the guernsey, but there’s no doubt that many of those influ­enced by Min­sky both felt a cri­sis was highly likely from the early 1990s on, and said so in aca­d­e­mic pieces–though not in pub­licly acces­si­ble media as well.

    Alain and I met way back in 1996 by the way, when he invited me (and also Trond Andresen) to sub­mit papers to a spe­cial issue of Mon­naie et Pro­duc­tion on finan­cial crises. We’ve caught up sev­eral times since, at Post Key­ne­sian con­fer­ences.

  • gweirydd

    Fred Har­ri­son pre­dicted the crash, with accu­rate dates, back in 1997, not 2005.

  • I know this is an old post but Geoff Tily pre­dicted the crash fairly accu­rately in his 2007 book ‘Keynes Betrayed’ which is an excel­lent read, btw.

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  • Ron Walker

    Hi again,
    I can­not con­fess to ‘see­ing this com­ming’. What I did see was from 2000 many peo­ple were get­ting into debt on a scale that it appeared nobody cared about how much debt you had just go and spend and they did.
    How­ever Prime Min­is­ter (PM) Cameron acusses (PM) Blair and (PM) Brown of delib­er­ately encour­ag­ing peo­ple to spend more than ever before. Since 2002 I per­son­ally took st

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  • Kozak

    This is a very sim­ple expla­na­tion of the Min­skian moment that you can for­ward to your non econ­o­mist friends

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