Debt­watch No. 42: The eco­nomic case against Bernanke

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The US Sen­ate should not reap­point Ben Bernanke. As Obama’s reac­tion to the loss of Ted Kennedy’s seat showed, real change in pol­icy only occurs after polit­i­cal scalps have been taken. An eco­nomic scalp of this scale might finally shake Amer­ica from the unsus­tain­able path that reck­less and feck­less Fed­eral Reserve behav­ior set it on over 20 years ago.

Some may think this would be an unfair out­come for Bernanke. It is not. There are solid eco­nomic rea­sons why Bernanke should pay the ulti­mate polit­i­cal price.

Haste is nec­es­sary, since Sen­a­tor Reid’s pro­posal to hold a clo­ture vote could result in a deci­sion as early as this Wednes­day, and with only 51 votes being needed for his reap­point­ment rather than 60 as at present. This doc­u­ment will there­fore con­sider only the most fun­da­men­tal rea­son not to reap­point him, and leave addi­tional rea­sons for a later update.

Misunderstanding the Great Depression

Bernanke is pop­u­larly por­trayed as an expert on the Great Depression—the per­son whose inti­mate knowl­edge of what went wrong in the 1930s saved us from a sim­i­lar fate in 2009.

In fact, his igno­rance of the fac­tors that really caused the Great Depres­sion is a major rea­son why the Global Finan­cial Cri­sis occurred in the first place.

The best con­tem­po­rary expla­na­tion of the Great Depres­sion was given by the US econ­o­mist Irv­ing Fisher in his 1933 paper “The Debt-Defla­tion The­ory of Great Depres­sions”. Fisher had pre­vi­ously been a cheer­leader for the Stock Mar­ket bub­ble of the 1930s, and he is unfor­tu­nately famous for the pre­dic­tion, right in the mid­dle of the 1929 Crash, that it was merely a blip that would soon pass:

Stock prices have reached what looks like a per­ma­nently high plateau. I do not feel that there will soon, if ever, be a fifty or sixty point break below present lev­els, such as Mr. Bab­son has pre­dicted. I expect to see the stock mar­ket a good deal higher than it is today within a few months.”  (Irv­ing Fisher, New York Times, Octo­ber 15 1929)

When events proved this pre­dic­tion to be spec­tac­u­larly wrong, Fisher to his credit tried to find an explana­ton. The analy­sis he devel­oped com­pletely inverted the eco­nomic model on which he had pre­vi­ously relied.

His pre-Great Depres­sion model treated  finance as just like any other mar­ket, with sup­ply and demand set­ting an equi­lib­rium price. In build­ing his mod­els, he made two assump­tions to han­dle the fact that, unlike the mar­ket for, say, apples, trans­ac­tions in finance mar­kets involved receiv­ing some­thing now (a loan) in return for pay­ments made in the future. Fisher assumed

(A) The mar­ket must be cleared—and cleared with respect to every inter­val of time.

(B) The debts must be paid.”  (Fisher 1930, The The­ory of Inter­est, p. 495)[1]

I don’t need to point out how absurd those assump­tions are, and how wrong they proved to be when the Great Depres­sion hit—Fisher him­self was one of the many whose for­tunes were wiped out by mar­gin calls they were unable to meet.  After this expe­ri­ence, he real­ized that his equi­lib­rium assump­tion blinded him to the forces that led to the Great Depres­sion. The real action in the econ­omy occurs in dis­e­qui­lib­rium:

We may ten­ta­tively assume that, ordi­nar­ily and within wide lim­its, all, or almost all, eco­nomic vari­ables tend, in a gen­eral way, toward a sta­ble equi­lib­rium… But the exact equi­lib­rium thus sought is sel­dom reached and never long main­tained. New dis­tur­bances are, humanly speak­ing, sure to occur, so that, in actual fact, any vari­able is almost always above or below the ideal equi­lib­rium…

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, p. 339)

A dis­e­qui­lib­rium-based analy­sis was there­fore needed, and that is what Fisher pro­vided. He had to iden­tify the key vari­ables whose dis­e­qui­lib­rium lev­els led to a Depres­sion, and here he argued that the two key fac­tors were “over-indebt­ed­ness to start with and defla­tion fol­low­ing soon after”. He ruled out other factors—such as mere overconfidence—in a very poignant pas­sage, given what ulti­mately hap­pened to his own highly lever­aged  per­sonal finan­cial posi­tion:

I fancy that over-con­fi­dence sel­dom does any great harm except when, as, and if, it beguiles its vic­tims into debt. (p. 341)

Fisher then argued that a start­ing posi­tion of over-indebt­ed­ness and low infla­tion in the 1920s led to a chain reac­tion that caused the Great Depres­sion:

(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) Hoard­ing 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.” (p. 342)

Fisher con­fi­dently and sen­si­bly con­cluded that “Evi­dently debt and defla­tion go far toward explain­ing a great mass of phe­nom­ena in a very sim­ple log­i­cal way”.

So what did Ben Bernanke, the alleged mod­ern expert on the Great Depres­sion, make of Fisher’s argu­ment? In a nut­shell, he barely even con­sid­ered it.

Bernanke is a lead­ing mem­ber of the “neo­clas­si­cal” school of eco­nomic thought that dom­i­nates the aca­d­e­mic eco­nom­ics pro­fes­sion, and that school con­tin­ued Fisher’s pre-Great Depres­sion tra­di­tion of analysing the econ­omy as if it is always in equi­lib­rium.

With his neo­clas­si­cal ori­en­ta­tion, Bernanke com­pletely ignored Fisher’s insis­tence that an equi­lib­rium-ori­ented analy­sis was com­pletely use­less for analysing the econ­omy. His sum­mary of Fisher’s the­ory (in his Essays on the Great Depres­sion) is a barely recog­nis­able par­ody of Fisher’s clear argu­ments above:

Fisher envi­sioned a dynamic process in which falling asset and com­mod­ity prices cre­ated pres­sure on nom­i­nal debtors, forc­ing them into dis­tress sales of assets, which in turn led to fur­ther price declines and finan­cial dif­fi­cul­ties. His diag­no­sis led him to urge Pres­i­dent Roo­sevelt to sub­or­di­nate exchange-rate con­sid­er­a­tions to the need for refla­tion, advice that (ulti­mately) FDR fol­lowed. (Bernanke 2000, Essays on the Great Depres­sion, p. 24)

This “sum­mary” begins with falling prices, not with exces­sive debt, and though he uses the word “dynamic”, any idea of a dis­e­qui­lib­rium process is lost. His very next para­graph explains why. The neo­clas­si­cal school ignored Fisher’s dis­e­qui­lib­rium foun­da­tions, and instead con­sid­ered debt-defla­tion in an equi­lib­rium frame­work in which Fisher’s analy­sis made no sense:

Fisher’ s idea was less influ­en­tial in aca­d­e­mic cir­cles, though, because of the coun­ter­ar­gu­ment that debt-defla­tion rep­re­sented no more than a redis­tri­b­u­tion from one group (debtors) to another (cred­i­tors). Absent implau­si­bly large dif­fer­ences in mar­ginal spend­ing propen­si­ties among the groups, it was sug­gested, pure redis­tri­b­u­tions should have no sig­nif­i­cant macro­eco­nomic effects. ” (p. 24)

If the world were in equi­lib­rium, with debtors car­ry­ing the equi­lib­rium level of debt, all mar­kets clear­ing, and all debts being repaid, this neo­clas­si­cal con­clu­sion would be true. But in the real world, when debtors have taken on exces­sive debt, where the mar­ket doesn’t clear as it falls and where numer­ous debtors default, a debt-defla­tion isn’t merely “a redis­tri­b­u­tion from one group (debtors) to another (cred­i­tors)”, but a huge shock to aggre­gate demand.

Cru­cially, even though Bernanke notes at the begin­ning of his book that “the premise of this essay is that declines in aggre­gate demand were the dom­i­nant fac­tor in the onset of the Depres­sion” (p. ix), his equi­lib­rium per­spec­tive made it impos­si­ble for him to see the obvi­ous cause of the decline: the change from ris­ing debt boost­ing aggre­gate demand to falling debt reduc­ing it.

In equi­lib­rium, aggre­gate demand equals aggre­gate sup­ply (GDP), and defla­tion sim­ply trans­fers some demand from debtors to cred­i­tors (since the real rate of inter­est is higher when prices are falling). But in dis­e­qui­lib­rium, aggre­gate demand is the sum of GDP plus the change in debt. Ris­ing debt thus aug­ments demand dur­ing a boom; but falling debt sub­stracts from it dur­ing a slump

In the 1920s, pri­vate debt reached unprece­dented lev­els, and this ris­ing debt was a large part of the appar­ent pros­per­ity of the Roar­ing Twen­ties: debt was the fuel that made the Stock Mar­ket soar. But when the Stock Mar­ket Crash hit, debt reduc­tion took the place of debt expan­sion, and reduc­tion in debt was the source of the fall in aggre­gate demand that caused the Great Depres­sion.

Fig­ure 1 shows the scale of debt dur­ing the 1920s and 1930s, ver­sus the level of nom­i­nal GDP.

Figure 1: Debt and GDP 1920–1940

Fig­ure 2 shows the annual change in pri­vate debt and GDP, and aggre­gate demand (which is the sum of the two). Note how much higher aggre­gate demand was than GDP dur­ing the late 1920s, and how aggre­gate demand fell well below GDP dur­ing the worst years of the Great Depres­sion.

Figure 2: Change in Debt and Aggregate Demand 1920–1940

Fig­ure 3 shows how much the change in debt con­tributed to aggre­gate demand—which I define as GDP plus the change in debt (the for­mula behind this graph is “The Change in Debt, divided by the Sum of GDP plus the Change in Debt”).

Figure 3: Debt contribution to Aggregate Demand 1920–1940

So dur­ing the 1920s boom, the change in debt was respon­si­ble for up to 10 per­cent of aggre­gate demand in the 1920s. But when delever­ag­ing began, the change in debt reduced aggre­gate demand by up to 25 per­cent. That was the real cause of the Great Depres­sion.

That is not a chart that you will find any­where in Bernanke’s Essays on the Great Depres­sion. The real cause of the Great Depres­sion lay out­side his view, because with his neo­clas­si­cal eyes, he couldn’t even see the role that debt plays in the real world.

Bernanke’s failure

If this were just about the inter­pre­ta­tion of his­tory, then it would be no big deal. But because they ignored the obvi­ous role of debt in caus­ing the Great Depres­sion, neo­clas­si­cal econ­o­mists have stood by while debt has risen to far higher lev­els than even dur­ing the Roar­ing Twen­ties.

Worse still, Bernanke and his pre­de­ces­sor Alan Greenspan oper­ated as vir­tual cheer­lead­ers for ris­ing debt lev­els, jus­ti­fy­ing every new debt instru­ment that the finance sec­tor invented, and every new tar­get for lend­ing that it iden­ti­fied, as improv­ing the func­tion­ing of mar­kets and democ­ra­tiz­ing access to credit.

The next three charts show what that dere­lic­tion of reg­u­la­tory duty has led to. Firstly, the level of debt has once again risen to lev­els far above that of GDP (Fig­ure 4).

Figure 4: Debt and GDP 1990–2010

Sec­ondly the annual change in debt con­tributed far more to demand dur­ing the 1990s and early 2000s than it ever had dur­ing the Roar­ing Twen­ties. Demand was run­ning well above GDP ever since the early 1990s (Fig­ure 5). The annual increase in debt accounted for 20 per­cent or more of aggre­gate demand on var­i­ous occa­sions in the last 15 years, twice as much as it had ever con­tributed dur­ing the Roar­ing Twen­ties.

Figure 5: Change in Debt and Aggregate Demand 1990–2010

Thirdly, now that the debt party is over, the attempt by the pri­vate sec­tor to reduce its gear­ing has taken a huge slice out of aggre­gate demand. The reduc­tion in aggre­gate demand to date hasn’t reached the lev­els we expe­ri­enced in the Great Depression—a mere 10% reduc­tion, ver­sus the over 20 per­cent reduc­tion dur­ing the dark days of 1931–33. But since debt today is so much larger (rel­a­tive to GDP) than it was at the start of the Great Depres­sion, the dan­gers are either that the fall in demand could be steeper, or that the decline could be much more drawn out than in the 1930s.

Figure 6: Debt contribution to Aggregate Demand 1990–2010


Bernanke, as the neo­clas­si­cal econ­o­mist most respon­si­ble for bury­ing Fisher’s accu­rate expla­na­tion of why the Great Depres­sion occurred, is there­fore an emi­nently suit­able tar­get for the polit­i­cal sac­ri­fice that Amer­ica today des­per­ately needs. His extreme actions once the cri­sis hit have helped reduce the imme­di­ate impact of the cri­sis, but with­out the igno­rance he helped spread about the real cause of the Great Depres­sion, there would not have been a cri­sis in the first place. As I will also doc­u­ment in an update in early Feb­ru­ary, some of his advice has made America’s recov­ery less effec­tive than it could have been.

Obama came to office promis­ing change you can believe in. If the Sen­ate votes against Bernanke’s reap­point­ment, that change might finally start to arrive.


This is an advance ver­sion of my monthly Debt­watch Report for Feb­ru­ary 2010. Click here for the PDF ver­sion. Please feel free to dis­trib­ute this to any­one you think may be interested–especially peo­ple who may be in a posi­tion to influ­ence the Senate’s vote.

Pro­fes­sor Steve Keen

[1] This book was an untimely relaunch of his 1907 PhD the­sis.
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  • Steve the title of fig­ure 5 has the incor­rect date range. Thanks oth­er­wise for a sober­ing sum­mary of what awaits us, Bernanke or not. Greet­ings from Lon­don. Paul Amery

  • Don­last

    If you want more rea­sons why Mr Bernanke should not be re-apointed go to Brad De Long’s web­site today. He has a Fed insider ratio­nal­is­ing the Fed’s stance on bub­bles and other issues. Incroy­able!

  • johngn888

    Thanks for writ­ing this up. One thing I don’t quite under­stand. You say that Bernanke could have been more effec­tive at deal­ing with the cri­sis. He has tried to pre­vent debt-defla­tion. But is that in your view a long term solu­tion? Will we even­tu­ally deflate/depress busi­ness even more at a later date? If not, why?

    thanks again Prof Keen.

  • rob­joh


    As Pamery states, wrong title on fig­ure 5 or wrong fig­ure 5.

    Oth­er­wise a very good post, the only thing I miss is what we should do instead.

    Great­ings from Swe­den
    Robert Johans­son

  • Frank

    Every­time I come here I breathe a sigh of relief at the down to earth com­mon sense and no-non­sense ratio­nal­ity of this site. Thank good­ness for Steve Keen and(/or?) the Aus­tralian approach to things.

  • David Colquit­t49

    Steve, I agree but surely the Amer­i­can peo­ple should address the real prob­lem; in 1913 they lost con­trol of the issuance of their cur­rency to a cabal of world bankers. Wil­son later admit­ted he had made a grave mis­take while Lin­coln would have rolled in his grave. Abol­ish the Fed.

  • Thanks for that pamery, it’s now fixed on the blog and I’ll post an updated ver­sion of the PDF in a few min­utes.

    Please dis­trib­ute it as widely as pos­si­ble every­one; there’s a real chance to derail Bernanke’s reap­point­ment this week, and my extra argu­ment as to why that would be a good thing could help sway a vote or two in the Sen­ate if it gets into the right hands.

  • Hi johngn888,

    The main issue there is giv­ing the money to the banks rather than to the pub­lic as in Australia’s stim­u­lus pack­age. When I run the update next week I’ll include a sim­u­la­tion that shows giv­ing funds to the pub­lic is much more effec­tive in a credit crunch than giv­ing it to the banks.

    I believe defla­tion is the likely medium term out­come, as with Japan. Ulti­mately the sys­tem has to be righted by a mas­sive rebal­anc­ing of fiat to credit money, how­ever that hap­pens; my expec­ta­tion is that it will be via defla­tion rather than infla­tion.

  • Gamma

    I don’t see any­thing in the analy­sis which gives any rea­sons why delever­ag­ing will result in true defla­tion (ie gen­er­alised price decreases) rather than asset-spe­cific price defla­tion.

    After all, the lever­ag­ing period (specif­i­cally over the last 10–15 years), has not seen gen­er­alised price increases, but rather asset price increases. So isn’t it pos­si­ble we will see the reverse dur­ing the delever­ag­ing period? 

    I think true defla­tion is an unlikely sce­nario.

  • ak

    Below is what Bernanke wrote on 2009/07/21 in the con­text of wor­ries about infla­tion. He clearly believes in the money mul­ti­plier the­ory. He thinks that it should work but the impact has been very lim­ited.

    Since the onset of the finan­cial cri­sis nearly two years ago, the Fed­eral Reserve has reduced the inter­est-rate tar­get for overnight lend­ing between banks (the fed­eral-funds rate) nearly to zero. We have also greatly expanded the size of the Fed’s bal­ance sheet through pur­chases of longer-term secu­ri­ties and through tar­geted lend­ing pro­grams aimed at restart­ing the flow of credit.
    These actions have soft­ened the eco­nomic impact of the finan­cial cri­sis. They have also improved the func­tion­ing of key credit mar­kets, includ­ing the mar­kets for inter­bank lend­ing, com­mer­cial paper, con­sumer and small-busi­ness credit, and res­i­den­tial mort­gages.”

    “When the Fed makes loans or acquires secu­ri­ties, the funds enter the bank­ing sys­tem and ulti­mately appear in the reserve accounts held at the Fed by banks and other depos­i­tory insti­tu­tions. These reserve bal­ances now total about $800 bil­lion, much more than nor­mal. And given the cur­rent eco­nomic con­di­tions, banks have gen­er­ally held their reserves as bal­ances at the Fed.
    But as the econ­omy recov­ers, banks should find more oppor­tu­ni­ties to lend out their reserves. That would pro­duce faster growth in broad money (for exam­ple, M1 or M2) and eas­ier credit con­di­tions, which could ulti­mately result in infla­tion­ary pressures—unless we adopt coun­ter­vail­ing pol­icy mea­sures. When the time comes to tighten mon­e­tary pol­icy, we must either elim­i­nate these large reserve bal­ances or, if they remain, neu­tral­ize any poten­tial unde­sired effects on the econ­omy.”

  • Hi David,

    I’m in favour of abol­ish­ing the Fed’s abil­ity to be any­thing other than a clear­ing house between banks, but I don’t believe that the pub­lic can ever be in charge of cur­rency issuance in a world with pri­vate bank­ing. As I note in my reform pro­pos­als, I’d rather try to make tak­ing on debt for lever­aged spec­u­la­tion unat­trac­tive than try to reform the nature of bank­ing.

  • Goldilock­sis­ableach­blond


    I’d like to sug­gest an addi­tional graph to add to your pre­sen­ta­tions to clar­ify the impact of debt on GDP growth. Here’s an exam­ple , using the well-known Shad­ow­stats analy­sis of CPI cal­cu­la­tion “lies”. ( Note : I’m only using this as an exam­ple of data pre­sen­ta­tion , not to sug­gest that the CPI data as cor­rected by Shad­ow­stats is the “right” data.)

    Here’s a graph from Shad­ow­stats , show­ing the year-by-year dif­fer­en­tial in GDP between the offi­cial stats and his own data , cor­rected for the phoney CPI calcs :

    There’s noth­ing wrong with this graph , but I don’t think it has nearly the impact of this one from itulip , which uses the same data , pre­sented in a ‘clas­si­cal’ GDP-growth-over-time for­mat :

    Just eye­balling your Fig. 5 above , it looks like if you net­ted out added pri­vate debt from the offi­cial GDP , you’d end up with a peak GDP of $10–11 tril­lion , rather than $14 tril­lion. Even if you ( more con­ser­v­a­tively ) net­ted out 60–70% of the added debt , the reduc­tion would still be sub­stan­tial and , of course , the fur­ther back in time you go , the more it adds up.

    The end result of this cal­cu­la­tion might pro­vide a rea­son­able sti­mate of what real GDP in the U.S. will look like in com­ing years , assum­ing total — pub­lic plus pri­vate — debt/GDP lev­els sta­bi­lize.

    Of course growth of pub­lic debt/GDP lev­els over the last few decades makes our cur­rent sit­u­a­tion look even worse. I know you intend to include pub­lic debt in your mod­els going for­ward , but it’s worth not­ing that the pri­vate debt lev­els prob­a­bly under­states the recent “debt-depen­dence” of U.S. eco­nomic growth.

  • Goldilock­sis­ableach­blond

    I for­got to men­tion that I intend to for­ward your pdf to my Sen­a­tors. I just emailed them on Fri­day to sug­gest vot­ing “No” on Bernanke , but this will make a nice fol­lowup.

  • Willy2

    Mr. Keen,

    There was — at least — some­one who saw already in 2005 what was com­ing. One Alan Greenspan !!!

    “We’ve lost con­trol over the bud­get””

    And you think Greenspan never ever dis­cussed this with Bernanke ?

    And that’s the take of mr. Michael Hud­son ( as well. See the front­page of his web­site. But there was a clear rea­son to keep print­ing money like there’s no tomor­row: the socalled PETRODOLLAR, the war in Iraq and Afghanistan.
    Didn’t you read the book ““Super­impe­ri­al­ism”” by mr. Michael Hud­son ? It’s avail­able on his web­site. (it requires some dig­ging)

    There was a clear rea­son Greenspan low­ered agres­sively rates from 6% to 1%. Lend­ing broke down in the US in early 2001. This was a severe ““Credit Crunch””. And that was only two or three months after octo­ber 2000 when every­one who wanted to buy iraqi oil had to pay for that oil in Euro’s instead of USDs. (Coin­ci­dence ??? No way !!) That was sim­ply the last straw on the break­ing back of the camel. And Greenspan started to raise inter­e­strates in 2004 when he saw that lend­ing started to pick up again. I still have a graph of that.

    But I think there’s one MAJOR flaw in this entire USD Ponzi-scheme. The assump­tion that for­eign­ers always will use their USDs to buy US Trea­suries or Agency paper. For­eign­ers can also choose to sit on their pile of USD cash. That’s what hap­pened in the late 1970s when Europe called America’s bluff. And it seems the chi­nese are about to do the same thing. (i.e. stop or reduce buy­ing US Trea­suries). See the lat­est TIC data !

    It seems that:
    1. Sum­mers and Gei­th­ner are ““on the way out””
    2. Vol­cker and Don­ald­son are ““already in con­trol””.–1

  • Fea­si­ble Goldi, but I’ll have to see if I have time as I write the update for next week. I have a trip to Bangkok to meet with the UNEP and CSIRO to focus on in the mean­time.

  • Excellent–the more Sen­a­tors who start to ques­tion whether Bernanke is actu­ally an expert on the Great Depres­sion, the bet­ter!

  • Goldilock­sis­ableach­blond

    A good piece in the FT today , apro­pos to Steve’s post , com­par­ing the U.S.housing busts of the GD vs. the GFC , and not­ing the fail­ures of the Fed :

    Hous­ing, depres­sions and credit col­lapses”


    The les­son is not just that the Fed failed to antic­i­pate the col­lapse in the bub­ble: it also didn’t fore­see its dev­as­tat­ing con­se­quences. This is reflected in the can­did com­ment last year by Fed Vice Chair­man Don­ald Kohn (Cato Jour­nal): “I and other observers under­es­ti­mated the poten­tial for house prices to decline sub­stan­tially, the degree to which such a decline would cre­ate dif­fi­cul­ties for home­own­ers, and, most impor­tant, the vul­ner­a­bil­ity of the broader finan­cial sys­tem to these events.”

  • stf

    Great blog­post, Steve!

  • GSM


    Thanks once again for a clear, sim­ple and log­i­cal expla­na­tion of events that got us to this GFC.

    Can I humbly point to another dan­ger which I hope and trust you will be keep­ing your eyes on?;

    But since debt today is so much larger (rel­a­tive to GDP) than it was at the start of the Great Depres­sion, the dan­gers are either that the fall in demand could be steeper, or that the decline could be much more drawn out than in the 1930s.”

    In their ego­tis­ti­cal desires to become re-elected, Govts will attempt to oppose all efforts to delever. They have no choice really. To allow delever­ag­ing to occur, Govts are in essence admit­ting that it was the debt (and its atten­dant loose poli­cies which they actively encour­aged) that has brought about the GFC and so much pub­lic hard­ship. So, Govts will be sorely tempted to dra­mat­i­cally and con­tin­u­ously increase their own lev­els of debt fuelled spend­ing as an off­set to the with­drawal of the pri­vate sec­tor. It could be that the real Cri­sis is ahead of us with Sov­er­eign debt defaults being the big ham­mer to drop.

  • Kar­maisk­ing


    Couldn’t agree more. With this insane sys­tem we’re in, like a shark, debt lev­els need to con­stantly increase or the sys­tem dies (due to Fisher’s debt defla­tion the­sis, or Mises’ “crack up boom” — both talk about exactly the same con­se­quence of unsus­tain­able debt).

    Ice­land, Dubai, Ire­land, Greece, Por­tu­gal, heck, even the UK all have mas­sive govt debt loads now. When govt bonds yields spike or there’s a cur­rency cri­sis, these coun­tries will be on fire.

    I sup­port a free mar­ket in money (ie a return to a pre­cious met­als based mon­e­tary sys­tem) and nation­al­i­sa­tion, then a break up of all TBTF banks, then the elim­i­na­tion of the lender of last resort func­tion from cen­tral banks to remove the moral haz­ard issue that infests the sys­tem at present.

    I guar­an­tee these are the only viable long term solu­tions (regard­less of the short term pain of adjust­ing to a defla­tion­ary mon­e­tary sys­tem). The longer the cur­rent insane sys­tem drags on like a zom­bie the more govt and pub­lic debt, the more mal­in­vest­ments, the more unem­ploy­ment when even govt employ­ees have to be laid off and pub­lic ser­vices are wiped out (like in Ice­land today). 

    Financ­ing “con­sump­tion” through debt is a recipe for dis­as­ter and govts are now financ­ing health care, and basic ser­vices (not cap­i­tal invest­ment!) with debt. This is yet another dis­as­ter in the mak­ing. I don’t they’ll be able to blame “the free mar­ket” this time around.

  • Kar­maisk­ing

    I doubt”

  • noah cross

    Bill Mitchell exam­ines Bernanke’s record on his post yes­ter­day -

    The Great Mod­er­a­tion myth

  • GSM


    From the prior thread;
    “How do you cre­ate all these jobs ‘and have them pro­duc­tive’, if you have at least a gen­er­a­tion whose prin­ci­pal skills are
    “shuf­fling paper’?”

    My sense is that pro­duc­tiv­ity will be of sec­ondary con­cern. The head­line Job­less­ness will be all that mat­ters to Obama’s admin­is­tra­tion come end 2010 and beyond. We can expect to see mas­sive pub­lic renewal and con­struc­tion pro­grams com­bined, I sus­pect, with a much higher level of protectionism.All of it funded by mon­e­ti­za­tion of new debt. If we have con­cerns about the sta­tus of Sov­er­eign debt now, it will be noth­ing com­pared to what it will be in a cou­ple of years.

  • TheAn­tipodean

    Long­time lis­tener, first­time caller.
    Another eru­dite con­tri­bu­tion thank you.
    It was your much sim­pler com­ments on the pro­gres­sive tight­en­ing of Westpac’s LVR reported in the main­stream media today that will finally give you the credit you deserve. I think that the Great Unwashed are finally wak­ing up to the fact that debts must be repaid, and that the orgy of cheap debt is over.
    May you con­tinue to receive the kudos you deserve.

  • Goldilock­sis­ableach­blond


    One minor quib­ble I have with your post:

    Bernanke said :

    Fisher’ s idea was less influ­en­tial in aca­d­e­mic cir­cles, though, because of the coun­ter­ar­gu­ment that debt-defla­tion rep­re­sented no more than a redis­tri­b­u­tion from one group (debtors) to another (cred­i­tors). Absent implau­si­bly large dif­fer­ences in mar­ginal spend­ing propen­si­ties among the groups, it was sug­gested, pure redis­tri­b­u­tions should have no sig­nif­i­cant macro­eco­nomic effects. ”

    To which you coun­tered with:

    “If the world were in equi­lib­rium, with debtors car­ry­ing the equi­lib­rium level of debt, all mar­kets clear­ing, and all debts being repaid, this neo­clas­si­cal con­clu­sion would be true.” 

    I don’t think Bernanke’s state­ment is nec­es­sar­ily true even in the ide­al­ized world he describes , because in an econ­omy with extreme lev­els of wealth and income inequal­ity ‚such as the one that’s evolved in the U.S. over the last three decades , there are PLAUSIBLY large dif­fer­ences in mar­ginal spend­ing propen­si­ties. The after-tax mar­ginal propen­sity to con­sume for some­one like Bill Gates might be very near zero , while the same mea­sure for many in the bot­tom 90% of the income/wealth dis­tri­b­u­tion could approach 100%.

    Sim­ple , mar­ket-clear­ing dis­tri­b­u­tions from debtors to cred­i­tors would likely have sig­nif­i­cant impacts on aggre­gate demand , even if there were no defaults , just because of their con­tri­bu­tion to inequal­ity. On the other end of the spec­trum , the same process con­tributes to the phe­nom­e­non of “hot money” chas­ing global asset bub­bles , as many of these folks choose gam­bling over con­sump­tion.