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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253 Responses to No-one saw this coming?” Balderdash!

  1. spadijer89 says:

    Your an arro­gant ponce. That is no way to win polit­i­cal support”

    Each com­ment oblit­er­ates your point – you have stum­bled from ignor­ing the facts alto­gether and hav­ing an no argu­ment what­so­ever, to ad hominems. Lovely. I sup­pose that is the way to win polit­i­cal sup­port (well, I sup­pose it worked for Paul Keating).

    I think it (an appeal to the FACTS and first hand PRACTICAL evi­dence) is cer­tainly a way to win polit­i­cal sup­port – who the hell wants to pay income taxes (which third to almost half of earn­ings go to) as well as taxes on petrol, GST and other taxes which hurt the poor? For the 100th fuck­ing time, my point was redis­tri­b­u­tion does NOT work because it over­looks the affect Ricardo artic­u­lated, and George expand on over a hun­dred years ago: deriv­ing rev­enue from cap­i­tal or labour exac­er­bates inequal­ity because it gives wind­falls to those who own land or other assets. As for the polit­i­cal point (assum­ing you take typ­i­cal left­ist view that peo­ple are stu­pid, and there­fore peo­ple do not under­stand how they are being screwed over), cor­rect me if I am wrong, was this not the argu­ment (i.e. fuck equal­ity and redis­tri­b­u­tion, through effi­ciency you have both) that brought Thatcher and Rea­gan to power and con­vinced a gen­er­a­tion of mid­dle class peo­ple to over Conservative?

    And if I may casu­ally ejac­u­late, I do not think the state, frankly, is there to help peo­ple, merely make things worse in order to legit­i­ma­tise its own expan­sion, but hey that’s just my view. This is why I said a place like Switzer­land, where the pop­u­lace already has LVT and is well read, may be a bet­ter hope.
    “he just ignored or belit­tled my points.”
    Belit­tled your points indeed – via the facts (either they were mean­ing­less, or could eas­ily be dealt with). Ignored? Give me evi­dence of what my ignored (I dis­sect your premises inch by inch, one by one) – I know, how­ever, you cer­tainly ignored my third request that you pro­vide evi­dence to your claim high mar­ginal income taxes reduce inequal­ity? Or why own­ing / inher­it­ing cap­i­tal is a bad thing?

    he doesn’t EVEN know what my views on .…redis­tri­b­u­tion are.”

    Well, you spent a great deal bang­ing on about the inequal­i­ties and hor­ror of busi­ness peo­ple allow­ing their chil­dren, their flesh and blood, from car­ry­ing on the fam­ily com­pany which they prob­a­bly had some involve­ment in since their youth (unless spe­cific oth­er­wise in one’s will). So, no they were not explicit, but you did make it clear you think inher­i­tance taxes *may* be required to reduce “inequal­ity” (ignor­ing the fact most inher­ited assets are land related and cap­i­tal or cash often has to be put into use – spent or used by labour­ers, pro­vid­ing employment).

    Ps gaday, yawn.

  2. reason says:

    Look Steve,
    to try and defuse this — an answer I might accept would go like:

    I under­stand that you are con­cerned about con­cen­tra­tions of wealth, and con­cerned about diver­sion of tax dis­tort­ing my lit­tle exper­i­ment. I per­son­ally don’t have a prob­lem with those things hap­pen­ing, and con­sider that they would not be major prob­lems any­way. If they did hap­pen and the demo­c­ra­tic process decides that for instance inher­i­tance taxes should be in place as well as the LVT, I would still con­sider that a net plus.

    At one stage you claim that reduc­tion in equal­ity is a plus for your sin­gle tax — but then you respond to qualms about poten­tial con­cen­tra­tions of wealth by claim­ing it is unim­por­tant, or doing some­thing about it is immoral. You can’t have it both ways.

  3. spadijer89 says:

    That’s what I said, albeit using sta­tis­tics cited above (who gets what — mostly landlords).

    Thus, I said the unearned income is immoral (i.e. land val­ues are cre­ated by the com­mu­nity) — you were bang­ing on about the inequal­ity gen­er­ated from the inher­i­tance of cap­i­tal and the like,which pro­vides employ­ment and goods and ser­vices (a quid pro quo) — it involves sweat, blood and tears. So, I can have it both ways (which to use your words: “I per­son­ally don’t have a prob­lem with those things hap­pen­ing, and con­sider that they would not be major prob­lems any­way. If they did hap­pen and the demo­c­ra­tic process decides that for instance inher­i­tance taxes should be in place as well as the LVT, I would still con­sider that a net plus”).

    Indeed, tough titties.

  4. reason says:

    Earn­ings based on the cap­i­tal earned by for bene­fac­tors are “blood, sweat and tears”. Really? Can I change places?

  5. spadijer89 says:

    So, to clar­ify, redis­tri­b­u­tion (i.e. theft by the use of force) does not reduce inequal­ity because it over­looks the fact that when gov­ern­ment expen­di­ture is deployed toward goods and ser­vices, it ben­e­fits land­lords — that is the major source of inequal­ity. Once you start wor­ry­ing about other peo­ple we’ll (prob­a­bly) return to a soci­ety with 1054343 taxes — so, mind your own busi­ness — what fam­i­lies do in their pri­vacy of their home is not your busi­ness — its only your busi­ness when they get 1) wind­falls due from the taxes YOU pay, 2) pop­u­la­tion around YOU and 3) with­draw valu­able land from sup­ply for spec­u­la­tive pur­poses, increas­ing mort­gages which YOU have to pay.

    Moroever, the things you listed as part of “inher­i­tance” such as cash, cap­i­tal or busi­nesses GIVE peo­ple oppor­tu­nity, employ­ment, involved care­ful deci­sion mak­ing, fam­ily his­tory, expe­ri­ence etc, a quid pro quo(not to men­tion your view ignores the fact most inher­i­tance, for the 100th time is backed on the value of land and other related assets).

  6. spadijer89 says:

    ps Yes, James Packer is cry­ing at how much he has left poor Kerry down.

    The sweat blood and tears mean this: the point is not using cap­i­tal (which depre­ci­ates) is not a lux­ury — you have to put in toward a cal­cu­lated use. Peo­ple have to plan, think and employ what they inherit *IF* it is some­thing like cap­i­tal, a busi­ness or any form of viable enterprise.

  7. Frank says:

    So, to clar­ify, redis­tri­b­u­tion (i.e. theft by the use of force).…”

    The prob­lem with this kind of Libertarian/Austrian out­look is that it assumes that with­out a gov­ern­ment, humans would co-exist with­out form­ing a new one through vio­lent com­pe­ti­tion and the emer­gence of a new mil­i­tary or intel­lec­tual elite.

    The truth is that noth­ing is “yours” with­out an agreed con­cept of prop­erty rights. This of course can only exist if an admin­is­tra­tive body exists to define those rights, update them, main­tain them and enforce them. The oper­a­tion of this body requires fund­ing, ie taxes.

  8. we_have_kangaroos says:

    MMitchell, some very insight­ful posting.

  9. Steve Keen says:

    I was at a talk in Par­ra­matta last night and didn’t get a chance to check blog posts until this morn­ing. I hope that the degree of anger on dis­play in some of these posts has dis­si­pated overnight. I expect civil­ity in how blog mem­bers debate here. If that is not main­tained, then regard­less of whether I agree with the views expressed or not, I will block future contributions.

    Remem­ber that your posts are read not solely by an indi­vid­ual you may be hav­ing a strong dis­agree­ment with, but by roughly 2,000 mem­bers of the blog. An angry riposte to one mem­ber may feel good at the time, but it will almost cer­tainly detract from your abil­ity to influ­ence the other 1999 members.

  10. PETER_W says:


    In the past 9 months

    The RBA 4% inter­est rate cuts = $60B stimulus

    The Gov­ern­ment = $20 — 30B cash stimulus

    The econ­omy went slightly back­ward accord­ing to the RBA

    The for­ward export income esti­mates for the com­ming year are $50B less national income now most of the April con­tract prices have been renegotiated.

    Does that mean Aus­tralia now needs $130B of aggre­gate stim­u­lus in the com­ming year just to have the econ­omy stand still again?


  11. Steve Keen says:

    That’s not a bad sum­mary Peter_W. As I have noted repeat­edly, aggre­gate demand is the sum of GDP plus the change in debt. The lat­ter has gone from +250bn a year in 2007-08 to near zero now, so to sim­ply stand still an addi­tional $250 bil­lion in demand is needed. With even the best out­come imply­ing GDP growth of less than $100 bil­lion (if out­put were inde­pen­dent of debt changes, which it’s not), some­thing of the order of $150 bil­lion has to be injected into the econ­omy to keep it from going backwards.

    Or another debt-financed bub­ble has to be gen­er­ated to keep the debt-fuelled pros­per­ity rolling–hence the First Home Ven­dors Grant… How­ever I think this is unlikely to work–deleveraging seems inevitable and is occur­ring now, with falls in busi­ness and per­sonal debt out­weigh­ing the increase in mort­gage debt.

  12. PETER_W says:

    $130 — $150B stimulus

    The RBA can take the cash rate to zero but the banks can’t pass on the full 3% because they are only 60% deposit funded but 40% com­mer­cial funded. Also they need a mar­gin. As a ball­park fig­ure I guess the best the banks can pass on is 1 — 1.5%. At best = 25B stimulus

    So were now rely­ing on $95 — 125B of stim­u­lus from the Gov­ern­ment just to stand still!


    The AUD could fall ALOT which would boost export income


  13. PETER_W says:

    Is the best solu­tion to the $150B stimulus/demand gap to run a 15% GDP ~ $150B trade surplus.

    Would a mas­sive fall in the AUD work?

    That would seem a bet­ter solu­tion than ratch­et­ing up aggre­gate debt.


  14. spadijer89 says:

    The prob­lem with this kind of Libertarian/Austrian out­look is that it assumes that with­out a gov­ern­ment, humans would co-exist with­out form­ing a new one through vio­lent com­pe­ti­tion and the emer­gence of a new mil­i­tary or intel­lec­tual elite…”

    Firstly, in West­ern­ised, Euro­pean soci­eties (like Switzer­land), I think this could indeed be pos­si­ble. So, dom­i­na­tion does not go from being covert (i.e. the nation state), to overt (Soma­lia). But this can be dis­cussed in the future.

    Sec­ondly, Frank, in case you missed it, we all agreed here there is a need for “taxes” – a sin­gle tax of 100%, in par­tic­u­lar – except I noted that other taxes (e.g. income taxes) are often coun­ter­pro­duc­tive, plant seeds which legit­i­ma­tise the need for a even big­ger state (to address the “mis­takes” the state itself gen­er­ated in the first place), or really sim­ply a result of jealously.

    A sin­gle tax on land, I think in and of itself, is enough to fund a) the mil­i­tary, b) a police force, c) a legal sys­tem and d) infra­struc­ture (roads, sci­en­tific research funds to uni­ver­sity etc), endow­ments all of which are deposited through higher land values.

    I don’t think there is any “anger” or “angry riposte” but merely a pas­sion­ate plea (with a few caps locks here and there) request­ing a clear, lucid (rather than merely asser­tions), which ought to have been sus­tained / main­tained through­out the blog com­ment, or response and sup­ple­ment by empir­i­cal evi­dence. After this failed, exac­er­ba­tion / frus­tra­tion set in.

    Now indeed, return­ing back to notions of an argu­ment, here is an inter­est­ing paper which shows beyond rea­son­able doubt how neo­clas­si­cal the­ory was a direct attempt to divert atten­tion away from Henry George’s ideas:

  15. ueberbaer says:

    a mas­sive fall in AUD = a mas­sive increase in imported infla­tion. It’s not only flatscreen tel­lies we’re import­ing, but food, cloth­ing, fuel, fer­tiliser etc. etc. Basic essentials.

    Which means peo­ple will have less dis­pos­able income which means more unem­ployed = crash­ing home prices = less tax receipts = more stimuli?

    Not look­ing rosy. Glad we’re hav­ing 4 par­ties today look­ing at buy­ing our home.

  16. PETER_W says:

    An AUD cur­rency cor­rec­tion does not have to be fast. It could be done over 5 years to allow inven­tory, pur­chase pat­terns, jobs, wages to adjust.

    It occured dur­ing the 1890’s 1930’s 1950’s 1970’s 1980’s

    Yes it’s infla­tion­ary BUT that’s the rem­edy for a debt deflation.

    It’s not a new concept.


  17. bfg says:

    PETER_W, but won’t every­body do the same thing? Cur­rency value is only relative.

  18. mahaish says:

    hi peter w,

    your assump­tions about falling domes­tic demand will depend on wether we get any fur­ther credit growth or not. so the financ­ing requirment for the gov­ern­ment may be con­sid­er­ably less than you antic­i­pate. or am i wrong about this. please feel free to cor­rect me.

    and accord­ing to chris richard­son, the women of this nation havnt stopped being shop aholics just yet.

    since we are com­ing off a lower debt to gdp base than the US, per­haps we can lever­age things up a bit more before we suf­fer the consequences.

  19. PETER_W says:

    I don’t know the answer.

    The AUD is presently 80+ and if it stays around that level or goes higher then our net trade income is likely to be worse not better.

    The present macro plan seems is the gov­ern­ment will bor­row to to stim­u­late the econ­omy and fill the demand gap while GDP stands still.

    This may work for a while but in all pre­vi­ous exam­ples in Aus­tralias his­tory we ulti­mately solved the same basic prob­lem by depre­ci­at­ing the AUD, earn­ing more than we spent and pay­ing down debt.

    Maybe it’s dif­fer­ent this time!


  20. spadijer89 says:

    unem­ployed = crash­ing home prices = less tax receipts = more stimuli?”

    (Not a crit­i­cism), but I’m curi­ous about why you put unem­ploy­ment before “crash­ing house prices” because I would like to see a graph which con­trasts, in a reli­able time series, monthly changes in res­i­den­tial or com­mer­cial prop­erty, changes in the growth debt, changes in unem­ploy­ment, changes in growth in credit – my bet is that prop­erty prices leads the cycle.

    A sim­i­lar result was found here:

    For me the next few years will be inter­est­ing because recall that the Great Depres­sion started in the US and Europe fol­low­ing a huge build­ing boom (25% of US GDP was con­struc­tion based, 8% ALONE was res­i­den­tial con­struc­tion)- the con­struc­tion indus­try was ruined dur­ing the Depres­sion (due to over­build­ing)- Aus­tralia bore the brunt of this through the falling terms of trade and demand for goods.
    Accord­ingly, I believe most of our prob­lems will be the result of endoge­nous struc­tural weak­ness (i.e. huge mort­gage debts which will threat­ened the sol­vency of our bank­ing sys­tem)- although a drop in trade might be the fuel to the fire of a spi­ralling debt defla­tion (which has spill over effects in a credit mar­kets, which deter­mines output).

    Today, con­struc­tion con­tributed less to US GDP (so we have to see whether the down­turn will be as deep and how big, if any, should ini­tial shock be to trickle over to other parts of the econ­omy). So, we may after all require a cap­i­tal the­ory to under­stand the dynam­ics and what trig­gers a debt deflation…

    What do other peo­ple think?

  21. PETER_W says:

    If Steve’s right and we need $150B p.a. of stimulus/demand just to have GDP stand still then Aus­tralias aggre­gate pub­lic & pri­vate debt/GDP ratio will be ~ 220% GDP in three years.

    At an AUD 80+ Aus­tralia will be run­ning a Bal­ance of Pay­ments deficit near 9% of GDP

    If this tran­spires my best guess is our exter­nal cred­i­tors would be look­ing to down­grade our credit rat­ing which would ulti­mately raise domes­tic inter­est rates despite a zero RBA cash rate.

    The ultra sim­ple con­clu­sion is that as an indi­vid­ual, a fam­ily, a com­pany, a nation, you can’t for­ever spend more than you earn.


  22. ned says:

    Hi PeterW,

    I have heard the idea of the planned cur­rency de-valuation before, and as far as I can see it is one of Bernake’s main strat­e­gys. I just fail to see how it is accom­plished in an orderly fas­sion as you described. If peo­ple get wind that this is the plan then it ends up caus­ing a crash, we have seen this with the Fed inter­ven­tion to con­trol long term trea­sury rates in the US.

  23. clive says:

    What I find amaz­ing is the lit­tle effect some of these fig­ures com­ing out have on the mar­kets at present.
    The lat­est from the UK is ter­ri­ble…
    “Fig­ures from the Office for National Sta­tis­tics showed that GDP shrank at a rate of 0.8% between April and June, far faster than the 0.3% econ­o­mists had been expecting.

    This fifth suc­ces­sive quar­ter of con­trac­tion means that the econ­omy has shrunk 5.7% since the reces­sion began in the sec­ond quar­ter of 2008.”

    The Mar­ket pun­ters just shrugged this off, some even didn’t believe the fig­ures were cor­rect. Look­ing at the UK fig­ures where are the green shoots.

    In the US, ana­lysts seem to have the approach that if a com­pany shows a profit of minus 50% and even it got that result from a tax­payer injec­tion of cash then “core earn­ings beat ana­lysts’ expec­ta­tions” and up goes the mar­ket. These clowns would be intel­lec­tu­ally chal­lenged with the aver­age house­hold bud­get let alone the world econ­omy. No won­der the worlds in such a mess.

  24. bfg says:

    Yes, some­thing is cer­tainly not right…

  25. PETER_W says:

    Assum­ing S&P earn­ings nor­malise in the $40 — 60 range over 3 — 5 years (they are depressed by write downs) and US GDP growth is ~ zero (like Japan) for a long time the S&P p/e @ 20 seems over­priced whereas a p/e 8–9 would make more sence.

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