There is no GFC

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One of the unex­pected things I’ve learnt in Boston is that the Global Finan­cial Cri­sis is not called the Global Finan­cial Cri­sis in America–and there­fore the TLA of the GFC has no mean­ing here.

Instead, in Amer­ica this might be The Cri­sis That Has No Name (TCTHNN), because they don’t call it any­thing at all: it’s just how the econ­omy is right now.

Aus­tralians, it seems, are the ones who invented the moniker GFC as a way of describ­ing what they think they don’t have to under­stand. Over here, where it is actu­ally hap­pen­ing, it is just the day to day real­ity that must be con­tended with.

Even more pecu­liar is news from some finance sec­tor insid­ers here who have been in touch with Australia’s RBA and Trea­sury, that they describe it as not the GFC, but the “North Atlantic Finan­cial Cri­sis” (“NAFC”)–arguing once again by a label that this cri­sis is pecu­liar to the US and Europe.

Appar­ently when asked what Aus­tralia has learnt from the cri­sis, the answer was often “Noth­ing, because it didn’t hap­pen here”. The Lucky Coun­try, it seems, is seen as immune to the cri­sis by its eco­nomic man­agers.

I know that I’m more likely to be spo­ken to by Bears in Boston than Bulls, but even the Bulls find this Aus­tralian complacency–even smugness–about the cri­sis bemus­ing. One insider I spoke to–admittedly a Bear–commented that he found it so annoy­ing on his last visit to Aus­tralia that he’s sworn never to return.

Good rid­dance might be the atti­tude of some; who needs the neg­a­tiv­ity? Well, we might, if the causes of the cri­sis are not in fact pecu­liar to the North Atlantic.

For though the GFC might have had very lit­tle bite in Aus­tralia to date (and I admit that the mild­ness of the down­turn to date in Aus­tralia did sur­prise me) we can only kiss it good­bye if it was really just a North­ern Hemi­sphere Black Swan. If instead its causes are more gen­eral, then as the US now starts to fear a DDR (Dou­ble Dip Reces­sion), Aus­tralia might find that it’s not so Lucky after all.

Here there is one indi­ca­tor that I think explains why Aus­tralia has not suf­fered as badly as its North Atlantic coun­ter­parts, but also why there will be no easy recov­ery: the con­tri­bu­tion that ris­ing debt makes to aggre­gate demand. Though I am a critic of the extent to which our economies have become debt-depen­dent, there’s one unmis­take­able fact about our post-1970 recov­er­ies: they have all involved a ris­ing level of pri­vate debt com­pared to GDP.

I’ve recently done a com­par­i­son of how the US today com­pares to the US in the 1930s on this front, and the results–published in an ear­lier post–were intrigu­ing.

The US was actu­ally suf­fer­ing a more severe pri­vate sec­tor delever­ag­ing this time than in the 1930s: in 1928, ris­ing debt was adding about 8% to the level of aggre­gate demand. That is, demand was 8% higher than it would have been had debt been con­stant. By the depths of the Great Depres­sion, falling debt was mak­ing aggre­gate demand about 25% lower than it would have been had debt been con­stant.

The story for today is more extreme: at the end of 2007, ris­ing debt made aggre­gate demand 22% higher than it would have been had debt been constant–so ris­ing debt today was almost three times as impor­tant in our pre-GFC boom as it was in the 1920s. Two and a half years later, falling pri­vate sec­tor debt was reduc­ing demand by almost 15%. This was not as bad as the worst lev­els of the Great Depres­sion, but worse than in 1931, which was the com­pa­ra­ble time from the begin­ning of the down­turn in pri­vate debt.

The pos­i­tive dif­fer­ence between then and now in the USA turned out to be the con­tri­bu­tion to demand made by ris­ing Gov­ern­ment debt. The gov­ern­ment-financed pro­por­tion of demand in the Great Depres­sion was triv­ial two years into the cri­sis, and only became substantial–at about 7.5% of aggre­gate demand–three years in. In con­trast, gov­ern­ment spend­ing is mak­ing aggre­gate demand almost 13 per­cent higher now. But even then, the USA is still delever­ag­ing.

That’s the com­par­i­son the the USA today with itself 80 years ago; what about the com­par­i­son of the USA today with Aus­tralia today? The chart below pro­vides it.

Firstly, Aus­tralia is run­ning a cou­ple of months behind the USA in the cri­sis. But that’s minor com­pared to the dif­fer­ence in scale. Pri­vate debt added slightly less to demand in Aus­tralia dur­ing the boom times–a max­i­mum of 18.75% of aggre­gate demand was financed by pri­vate debt, com­pared to over 22% for the USA. But delever­ag­ing hasn’t even begun here: the pri­vate-debt-financed con­tri­bu­tion to demand flirted with zero in late 2009, but has been pos­i­tive through­out. Ris­ing pri­vate sec­tor debt today is adding about 2% to aggre­gate demand. Ris­ing gov­ern­ment debt is adding about another 2 per­cent on top of that.

So Aus­tralia hasn’t yet delevered–in con­trast to the USA. Does that mean we have a “get out of the GFC Free” card? That depends on whether we’ve avoided what caused the GFC in the first place–a runup of exces­sive pri­vate debt dur­ing a spec­u­la­tive bub­ble.

There the answer is equiv­o­cal. While we have sub­stan­tially less debt than the USA (though some cor­re­spon­dents have argued that the RBA fig­ures I use under­state the level of finance sec­tor debt here), our debt to GDP ratio is 90% higher than it was back in the Great Depres­sion.

So we have less delever­ag­ing poten­tial than the USA, and we haven’t even begun to do it yet–which is why the GFC has appeared to be a North Atlantic phe­nom­e­non. And if we can pre­vent delever­ag­ing, then we won’t see the depths of the down­turn that the North Atlantic has seen either.

But there is a down­side to no delever­ag­ing. We have a house­hold sec­tor that is even more indebted than its US coun­ter­part. The odds are that this sec­tor will be debt-con­strained in its spend­ing, and the recov­ery will be stalled as a result. So the GFC is not entirely a NAFC.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • debtjunkies


    Here is my con­cern with that method­ol­ogy and my apolo­gies in advance to all econ­o­mists.

    From what you say RP are say­ing what they think a prop­erty should be worth and are bas­ing all their report­ing and mar­ket news on these regressed, hedo­nic val­ues.

    But the mar­ket is doing some­thing com­pletely dif­fer­ent.

    Given their posi­tion and the respect they demand for their method­olo­gies (think of their ongo­ing spat with APM over val­ues) and the amount they charge, they should be report­ing the facts as they are not the facts as their eco­nomic mod­el­ing says they should be.

    Its a fault that has got most econ­o­mists and their mod­els into all sorts over the past 3 years.

  • Fred

    AK, VK. Well what is it (aggre­gate demand), a stock or a flow?

    GDP is Gross Domes­tic Prod­uct, and you say;

    The basic aggre­gate demand equa­tion is:

    GDP = C + I + G + (X – M)”

    So where is aggre­gate demand men­tioned or defined?

    GDP is the mar­ket value of all goods and ser­vices pro­duced (in a period), then that is clearly a his­tor­i­cal sta­tis­ti­cal fig­ure, mea­sured or esti­mated in a num­ber of ways. What is the rela­tion­ship between GDP and aggre­gate demand. Is what I say above not cor­rect?

  • BrightSpark1

    fred@102 +VK&AK

    As i see it demand is a capac­ity to absorb and as such has a mag­ni­tude (dol­lars per unit price) and a delay best quan­ti­fied as time to be half sat­is­fied (halv­ing time), or as I pre­fer time to be sat­is­fied by 1/e, (the nat­ural time con­stant). Prob­a­bly because the actual time con­stant is depen­dent on the sup­ply and sup­ply iner­tia or delay, actual demand should be con­sid­ered solely as a capac­ity to absorb anal­o­gous to capac­i­tance in an elec­tri­cal cir­cuit.

    It is a big mis­take to call it either a stock or a flow it is nei­ther. Also it is a big mis­take to just add demands to get a gross demand fig­ure as they all must have dif­fer­ent sup­ply delays as well as total capac­ity.

    If you live in a world with­out time as the neo­clas­si­cal econ­o­mists do you could just add demands to get aggre­gate demand but time and tide waits for no man par­tic­u­larly neo­clas­si­cal econ­o­mists.


  • Fred

    Aggre­gate Demand is $ per unit price? That would make it dimen­sion­less. Not only that demand is what sets the price. So you char­ac­terise it in terms of a sup­ply chain with a half life to sat­isfy out­stand­ing orders. So with your def­i­n­i­tion you could never mea­sure it directly across an econ­omy but you could look at total orders out­stand­ing in say a par­tic­u­lar indus­try and the time it takes to sat­isfy half of those orders. This might work with some things, like com­modi­ties. Is this def­i­n­i­tion widely used?


    bb #89

    The net present value of $220pw pre­tax net cash yield grow­ing in per­pe­tu­ity at 4% using a 7.5% dis­count rate is ~$326,800

    The net present value of ~$31 bil­lion pre­tax net cash yield grow­ing in per­pe­tu­ity at 4% using a 7.5% dis­count rate is $885 bil­lion

    The net present value of $220pw pre­tax net cash yield grow­ing in per­pe­tu­ity at 3% using a 7.5% dis­count rate is ~$254,200

    The net present value of ~$31 bil­lion pre­tax net cash yield grow­ing in per­pe­tu­ity at 3% using a 7.5% dis­count rate is $688 bil­lion

    The mar­ket price vs value of bank­able cash­flow is very sen­si­tive to the dis­count rate and the assumed growth rate of the cash­flows. If we use $330 bil­lion of debt to aquire the cash­flow gen­er­at­ing asset at $885 bil­lion and the debt cost is equal to the dis­count rate then the ‘equity’ is worth the dif­fer­ence ~$555 bil­lion

    Presently the ‘equity’ is trad­ing at $1.2 tril­lion minus $330 bil­lion ~ $870 bil­lion

    If inter­est rates rise a lit­tle then the equity diver­gence is going to be larger.

    Mar­gin of safety’ has well and tru­ely van­ished.


    bb (Cap­tain) #89

    Sorry I am tired and not con­cen­trat­ing on spelling and def­i­n­i­tions.

    This is based on John Burr Williams opin­ion… Read ‘The The­ory of Invest­ment Value’ if you get a chance.

    War­ren Buf­fett, the rich­est investor in the world believes John Burr Williams is exactly right by the way! 

    The net present value of $220pw pre­tax net cash yield grow­ing in per­pe­tu­ity at 4% using a 7.5% dis­count rate is ~$326,800

    The net present value of ~$31 bil­lion pre tax net cash yield grow­ing in per­pe­tu­ity at 4% using a 7.5% dis­count rate is $885 bil­lion

    The net present value of $220pw pre tax net cash yield grow­ing in per­pe­tu­ity at 3% using a 7.5% dis­count rate is ~$254,200

    The net present value of ~$31 bil­lion pre tax net cash yield grow­ing in per­pe­tu­ity at 3% using a 7.5% dis­count rate is $688 bil­lion

    The mar­ket price vs value of bank­able cash­flow is very sen­si­tive to the dis­count rate and the assumed growth rate of the cash flows. If we use $330 bil­lion of debt to aquire the cash flow gen­er­at­ing asset at $885 bil­lion and the debt cost is equal to the dis­count rate then the ‘equity’ is worth the dif­fer­ence ~$555 bil­lion.

    Presently the ‘asset’ is trad­ing at $1.2 tril­lion minus $330 bil­lion ‘debt’ ~ $870 bil­lion ‘equity’ or the ‘equity’ could be $358 bil­lion (or lower) 

    If inter­est rates rise a lit­tle then the equity diver­gence is going to be larger and I don’t believe the dis­count rate should be equal to the risk free AAA deposit rate, it should be higher.

    Mar­gin of safety’ has well and truly van­ished.


    bb (Cap­tain)

    A prob­lem for ‘the effi­cient mar­ket hypoth­e­sis’ is what ‘spruk­ers’ loosely call ‘under­ly­ing demand’

    Under­ly­ing demand’ can be either pos­i­tive or neg­a­tive i.e. it can be inverted.

    When asset prices rise ‘under­ly­ing demand’ rises and that is what cre­ates asset bub­bles, the demand to buy pushes up asset prices draw­ing in more demand to buy increas­ing ‘under­ly­ing demand’.

    When asset prices fall ‘under­ly­ing demand’ falls and that is what busts asset bub­bles, the demand to sell pushes asset prices lower draw­ing in more ‘under­ly­ing demand’ to sell.

    Often asset price bub­bles col­lapse to prices well below rea­son­able dis­counted cash flow val­u­a­tions even using a large ‘mar­gin of safety’

    Grantham, Buf­fett and quite a few oth­ers not so well known, have become unbe­lie­ve­ably rich by under­stand­ing that an asset is worth the dis­counted cash flow and also that 99.999999999999% of the pop­u­la­tion don’t under­stand this and unfor­tu­nalely it’s more than likely they are vir­tu­ally bio­log­i­caly pro­gramed to only par­tic­i­pate as part of the ‘under­ly­ing demand’ dynamic.

    Ben Gra­ham had a term for the 99.999999999999% “Mr Mar­ket”


    bb (Cap­tain)

    To be crys­tal clear…

    Mar­ket price’ IS NOT ‘value’ and very rarely is.

    Mar­ket price’ is based on what the ‘next guy… Mr Mar­ket’ will pay for an asset irre­spec­tive weather it’s a Rem­brant or a Gov­ern­ment bond. ‘Mar­ket price’ is a num­ber that could be more or less than yes­ter­day or tomor­row.

    Value’ is much nar­rower and defin­able num­ber… it’s the pre­tax bank­able cash that can be extracted from an asset from now until eter­nity at an appro­pri­ate dis­count rate (the rate of return) tak­ing into account the long term growth in the cash­flow (with a mar­gin of safety appro­pri­ate for the risky ness of the asset).

  • ak

    Aggre­gate demand (AD) is the total demand for goods and ser­vices pro­duced in the econ­omy over a period of time and is equiv­a­lent to GDP.

    GDP = AD = C + I + G + (X – M)

    It is a flow as it is the value of final goods and ser­vices which change hands over a period of time. It is anal­o­gous to elec­tric cur­rent in the real world. 

    Aggre­gate demand must be equal to National Income
    GDP = NI = C + S + T. The rate of pri­vate money creation/destruction neg­a­tively con­tributes to S but it is not equal to (-S) (as the pri­vate sec­tor may also be sim­ply hoard­ing money). The rate of gov­ern­ment money creation/destruction is equal to (G-T).

    The rate of money cre­ation is equal to the rate of change in net debt as inter­est are accrued on the both sides of the ledger. This may not be true in regards to gov­ern­ment money as gov­ern­ment money can either be based on com­modi­ties or may not be off­set by gov­ern­ment debt (the point the MMT the­o­rists want to make).

    See also

    (in the sec­tion “Debt”)

    A Post-Key­ne­sian the­ory of aggre­gate demand empha­sizes the role of debt, which it con­sid­ers a fun­da­men­tal com­po­nent of aggre­gate demand. Aggre­gate demand is spend­ing, be it on con­sump­tion, invest­ment, or other cat­e­gories. Spend­ing is related to income via:
    Income – Spend­ing = Net Sav­ings
    Rear­rang­ing this yields:
    Spend­ing = Income + Net Change in Debt
    In words: what you spend is what you earn, plus what you bor­row: if you spend $110 and earned $100, then you must have net bor­rowed $10; con­versely if you spend $90 and earn $100, then you have net sav­ings of $10, or have reduced debt by $10, for net change in debt of –$10.”

    This is one of the things which I found the most con­fus­ing in macro­eco­nom­ics as we need to com­bine the knowl­edge about pri­vate and gov­ern­ment money creation/destruction with the knowl­edge about aggre­gate mon­e­tary flows. Neo­clas­si­cal econ­o­mists often for­get to include the changes in net debt of the pri­vate sec­tor while claim­ing incor­rectly that pub­lic debt is a bur­den on the real econ­omy and has to be paid back. We also need to admit that the basic frame­work of GDP/aggregate demand doesn’t cap­ture the spec­u­la­tive asset bub­bles well. 

    The best way to get the intu­itive under­stand­ing of the sys­tem is to cre­ate a model of a fake econ­omy on a piece of paper with bal­ance sheets cor­re­spond­ing to the the sec­tors. Only when the basic bound­ary con­di­tions are cap­tured the pri­vate sec­tor debt dynam­ics often affect­ing the busi­ness cycle may be intro­duced. How­ever a frame­work will still pro­vide only insight into the mon­e­tary side of the econ­omy, effec­tively ignor­ing the real goods and ser­vices aspect (which has been analysed by the Marx­ists and to some extend their slightly less enlight­ened twin brethren — Aus­tri­ans)

    The dia­grams and the expla­na­tions for the basic model are pro­vided there:

  • TruthIs­ThereIs­NoTruth

    Grantham, Buf­fett and quite a few oth­ers not so well known, have become unbe­lie­ve­ably rich by under­stand­ing that an asset is worth the dis­counted cash flow and also that 99.999999999999% of the pop­u­la­tion don’t under­stand this and unfor­tu­nalely it’s more than likely they are vir­tu­ally bio­log­i­caly pro­gramed to only par­tic­i­pate as part of the ‘under­ly­ing demand’ dynamic.”

    Wow, impres­sive!! — I guess you must be one of the ‘few oth­ers’. You should start the fright­engly high eco­nomic IQ PW soci­ety. But first learn that inver­sion is not quite the same as chang­ing sign.…

    Actu­ally quite on topic is a won­der­ful series of arti­cles, it’s about maths, but since we are dip­ping our fin­gers in all sorts of arith­metic I think quite appro­pri­ate and a great read.

  • kys

    debtjunkies #101

    that famous 4.6 is defined as :

    trimmed mean aver­age dwelling price/ aver­age house­hold dis­pos­able income &

    aver­age house­hold dis­pos­able income = gross dis­pos­able income/
    no of house­holds

    i.e. 431,129/(802,128 million/8.54 mil­lion) = 4.59

    but gross dis­pos­able income from ABS National Accounts is 792,128 mil­lion, so Joye seems to inflate our gross dis­pos­able income by 10 bil­lion. mar­vel­lous! (see page 62)$File/52040_2008-09.pdf

    now the ratio should be:

    431,129/(792,128 million/8.54 mil­lion) = 4.65

    but there are other prob­lems:

    - why trimmed mean? why trim that long fat tail, say 15% of the top end multi-mil­lion dol­lar man­sions? yes, the bot­tom 15% is also trimmed, but the bot­toms can never fall below zero. in most cases they are much above zero. to trim or to keep the bot­toms won’t impact that much as the top 15% sky high price tags, and wouldn’t the result of trimmed mean be a much lower numer­a­tor?

    –why gross dis­pos­able income from national accounts? i agree that’s the most com­pre­hen­sive income fig­ure we can have. no one’s income will be omit­ted within our national bor­der, includ­ing the wages of for­eign work­ers & expats, as well as inter­ests & div­i­dends paid to for­eign investors. it also count imputed rent which no owner occu­piers would regard as income. most impor­tantly, it is heav­ily skewed, just like our house prices. but this time no mat­ter how much you want, you can’t trimmed mean it on the house­hold level, because it’s a gross fig­ure. by the same token, you can not obtain a median from it. so wouldn’t it result in a hugely inflated denom­i­na­tor should we sim­ply divide it straight by the total house­hold num­ber?

    i think abs pro­vides many more real­is­tic data. why not try to get your own pre­ferred and sen­si­ble ratio? let’s for­get about 4.6!


    2007–8 aver­age gross house­hold income per week — $1649
    2007–8 aver­age dis­pos­able house­hold income per weel — $1366–06&num=&view=

    2005–6 aver­age gross house­hold income per week — $1410
    2005–6 median gross house­hold income per week — $1139

    rp data 2009 national median dwelling px — $405,000
    rp data 2009 trimmed mean dwelling price — $431,129 (not rec­om­mended unless used with cau­tion)


    TITINT #110

    I wish…

    If you’re sug­gest­ing I ‘chair’ a club of 3 or 4 sigma IQ’s you will be very dis­s­a­pointed. I will be the dumb­est guy in the room!

    I don’t man­nage $100 bil­lion for ‘investors’ and I’m not the CEO of a ~$170 bil­lion com­pany (almost debt free) with a ~1/3rd own­er­ship (debt free).

    I know my ‘cir­cle of com­petance’ and I try to stay inside it.

    If I have a micron of insight it is via apply­ing the knowl­age of other much brighter peo­ple than me. 

    TITINT… I’m in the 99.999999999999999% who make up “Mr Mar­ket”.

    Ordi­nary peo­ple like me are the ‘under­ly­ing demand’ in one direc­tion or the other.

  • BrightSpark1


    If demand is anal­o­gous to elec­tric cur­rent then money would need to be anal­o­gous to elec­tric charge. 

    My con­cern here is that none of these equa­tions or “equi­lib­ria” used in con­ven­tional eco­nomic thought take time into account other than as sim­ple fixed peri­ods for exam­ple “per year”. This leaves no way to cor­rectly con­sider feed­back effects (as in credit cre­ation) as well as sup­ply delays, delays in demand growth, delays in meet­ing demand, and con­sump­tion rates. 

    All these equa­tions may be valid account­ing but that is all. As I see it this is not what most peo­ple would under­stand the aim of eco­nom­ics to be. Also this does not reveal the dan­gers of unlim­ited growth in debt, and expo­nen­tial growth let alone give any valid chances of pre­dict­ing or con­trol­ling out­comes. When we say “macro­eco­nom­ics” per­haps we mean “macroac­count­ing”.

    Just some thoughts on neglect of old man time.


  • Fred

    ak by equat­ing aggre­gate demand to GDP you’ve com­pletely ignored the point I made and that is that aggre­gate demand applies to the future and GDP is the fig­ure applic­a­ble to the past (trad­ing period). So when you say aggre­gate demand is equal to GDP you are actu­ally say­ing that it WAS equal to GDP but you can’t say that it is that now changed by the increase or decrease in debt because if it was it would be some­thing dif­fer­ent to GDP.

    For an intu­itive under­stand­ing try a “mar­ket day”. Aggre­gate demand is the total $ (pre­pared to be spent) in the pock­ets of the that peo­ple go to the mar­ket with plus what $ mar­ket par­tic­i­pants spend on the day out of their earn­ings plus the IOU’s that peo­ple walk away with less the IOU’s paid back. GDP is the total value of goods/services chang­ing hands.

  • TheEngi­neer

    Elec­tronic sim­u­la­tion tools (spice based) could be use­ful in mod­el­ing dynamic finan­cial sys­tems. These tools solve very large non lin­ear prob­lems.
    There are two fun­da­men­tal sources.
    Cur­rent and Volt­age
    There are three fun­da­men­tal devices in elec­tronic sys­tems.
    Resis­tance, Induc­tance, Capac­i­tance
    There are many oper­a­tions that can be per­formed (by active cir­cuits) but basi­cally boil down to
    Mul­ti­pli­ca­tion, Divi­sion, Addi­tion, Sub­trac­tion

    The inter­est­ing prop­erty elec­tronic sim­u­la­tion has, is non lin­ear­ity. It effec­tively works in the com­plex num­ber domain solv­ing mul­ti­ple dif­fer­en­tial equa­tions.
    Elec­trons would rep­re­sent money.
    Cur­rent (elec­tron flow) rep­re­sents money flow
    Volt­age (poten­tial dif­fer­ence) rep­re­sents poten­tial sources of money.

    Cur­rent would rep­re­sent the flow of money.
    Capac­i­tance the stor­age of money where cur­rent leads volt­age. (eg sav­ings in a bank)
    Induc­tance the stor­age of money where volt­age leads cur­rent. (eg when you invest money in a new busi­ness it ini­tially cre­ates no cur­rent out­put, but it builds up poten­tial to cre­ate money in the future)

    Yes, it’s not per­fect, but it does have the whole non lin­ear com­plex solv­ing engine already cre­ated. This could be bolted on to finan­cial busi­ness logic to sim­u­late finan­cial sys­tems.

  • Fred

    The Engi­neer. Money doesn’t flow as an elec­tron or water in a pipe, stor­age tank, with pumps and poten­tial energy. One person’s sav­ings is another’s lia­bil­ity (adds up to zero). At the end of a days trad­ing, money can change hands and everyone’s account bal­ance could be exactly as it was at the start of the day. If your model just cov­ered “money” it would be an abstrac­tion of the real goods and ser­vices that were chang­ing hands, along with ver­bal and writ­ten oblig­a­tions and IOU’s, so to be com­plete it needs to include these as well. Once you have got to this point you need to model sen­ti­ment and human behav­iour, and then you would still find out that when we all run to the same side of a boat, it tips over. The real issue is that our col­lec­tive eco­nomic bal­ance sheet doesn’t include “the com­mons”.

  • ak


    I agree that the con­cept of aggre­gate demand which is nom­i­nally equal to GDP is very crude and a lot of infor­ma­tion is lost if we only count final pro­duc­tion. All eco­nomic events (trans­ac­tions) are atomic but they occur in con­tin­u­ous time. We have to aggre­gate them first in time (for exam­ple count houses sold over the period of one month) in order to esti­mate rates at which these events occur. The same applies to finan­cial events which are cap­tured by the frame­work used to analyse the GDP.

    How­ever I would argue that from the fact that left hand side must be equal to right hand side we can­not infer that there is a sta­tic equi­lib­rium of any kind. 

    The equa­tion for the GDP only defines bound­ary con­di­tions which must always be sat­is­fied. I haven’t said any­thing in favour of the exist­ing sta­tic mod­els.

    The GDP iden­tity merely states that NI=AD

    C + S + T = C + I + G + (X – M)

    what has to be read as:

    d value_of_total_final_consumption(t)/dt +
    d value_of_total_private_saving_including_private_debt(t)/dt +
    d value_of_taxes_paid(t)/dt +
    d value_of_total_final_consumption(t)/dt +
    d value_of_total_private_investment(t)/dt +
    d value_of_total_government_spending(t)/dt +
    d value_of_total_net_exports(t)/dt

    These val­ues are “stocks” — they are counted from “year zero”.

    Dou­ble-entry book­keep­ing prin­ci­ples are anal­o­gous to the law of physics.

    The basic GDP iden­tity is just an equiv­a­lent of the Kirchhoff’s cur­rent law applied at the state level. 

    I would argue that there is no equiv­a­lent to Kirchhoff’s volt­age law as there is no equiv­a­lent of poten­tial. How much money is spent is deter­mined by eco­nomic agents, by the tax­a­tion law and by the gov­ern­ment. The neo­clas­si­cal eco­nom­ics makes cer­tain over­sim­pli­fied and incor­rect assump­tions about the behav­iour of the agents. This is what is wrong there not the GDP iden­tity.

    If we ditch these assump­tions and for exam­ple realise that often peo­ple spend as much as they can on goods and ser­vices pushed to them by mar­keters or that peo­ple often join Ponzi pyra­mids to make quick money then we may build a more accu­rate model than one based on ratio­nal expec­ta­tions and sta­tic equi­lib­ria.

  • ak

    One person’s sav­ings is another’s lia­bil­ity (adds up to zero).”

    In prin­ci­ple yes (how­ever gov­ern­ment money may be nobody’s lia­bil­ity) but this doesn’t cap­ture the way bank­ing sys­tem works as debt is not neg­a­tive money. The pres­ence of debt in the sys­tem leads to addi­tional redis­tri­b­u­tion of the income due to inter­ests accrued on debt and may lead to reduc­tion of amount of pri­vate money in cir­cu­la­tion if debt is repaid.

  • cred­it­de­fault­swap

    I believe the US will be call­ing it the Greater Depres­sion before it is over.

  • noah cross

    Longer than the 1873 Long Depres­sion per­haps.

    A con­cise wrap on debt and out­look -

    Peter Cec­chini, chief strate­gist at BGC Finan­cial, talks to Pimm Fox about the U.S. econ­omy and con­sumer credit

  • bb

    Peter_W @ 105,106,107

    Thanks for your thoughts and com­ments.

    For the record, I am a long time fol­lower of Ben Gra­ham.

    I read his book “The Intel­le­gent Investor” a long time ago, and it has framed my invest­ing and work life ever since.

    With regard to your sen­si­tiv­ity analy­sis, I would argue if growth (infla­tion + real wages) falls from 4% to 3% in per­pe­tu­ity, then it is lik­ley that inter­est rates (or oppor­tu­nity cost) falls by a sim­i­lar amount. we saw this dur­ing the GFC.

    Under these scenario’s, your value assess­ment is less volatile and there­fore your mar­gin for safety is less sen­si­tive.

    This is the basis for the the­o­ret­i­cal con­struct of a cap­i­tal­i­sa­tion rate used in com­mer­cial val­u­a­tions, ie: pass­ing income divided by “real inter­est rates”.

  • bb


    Fur­ther to the Ben Gra­ham / Buf­fett way of invest­ing.

    DCF analy­sis is a good start­ing point for invest­ing. It should then be over­layed with other indus­try spe­cific fac­tor such as “bar­ri­ers to entry”, “eco­nomic moat”, “agency risk” and other qual­i­ta­tive fac­tors.

    In this regard, when the NPV of free cash­flows is less than the cost of pro­duc­tion, one must con­sider what impact this has on Indus­try. Specif­i­cally of three sce­nar­ios occurs;

    - Indus­try fails, and there is no sup­ply of addi­tional prod­uct
    — prices must rise so that the fac­tors of pro­duc­tion (labour & cap­i­tal) attract a fair rate of return
    — the cost of oppor­tu­nity (ie: required returns / inter­est rates) must fall. That is, cap­i­tal and labour providers become sat­is­fied with a lower returns

    I believe hous­ing rep­re­sent crit­i­cal infra­struc­ture in soci­ety, and as such sce­nario 1 is not pos­si­ble.

    There­fore, with respect to hous­ing, if the NPV of rents falls below the cost of pro­duc­tion then
    — Rents (and prices) must rise to that new sup­ply is encour­aged or
    — the cost of oppor­tu­nity (inter­est rates) fall so the lower return on hous­ing is ade­quate such that the PV of rents = cost of pro­duc­tion.

    This is why I kept “bang­ing on” about the cost of pro­duc­tion, or replace­ment cost. It is impos­si­ble to have a bub­ble when the price of a prod­uct is less than the cost of pro­duc­ing a prod­uct.


    bb #122

    You may be cor­rect but the cost of ‘hous­ing pro­duc­tion’ may be a moot point if we become uncom­peta­tive and ulti­mately loose jobs because ‘indus­trial pro­duc­tion’ is uncom­peta­tive.

    The hous­ing cost of liv­ing reflected in the difer­en­tial cap­i­tal price of hous­ing in Aus­tralia vs the USA may ulti­mately push up wages costs in Aus­tralia vs the USA.

    The Median house in the USA is @ $155,000 USD
    The Median House in Aus­tralia is @ $500,000 AUD

    The hous­ing inter­est rate in the USA is ~5%
    The hous­ing inter­est rate in Aus­tralia is ~7.5%

    At 80% LVR the inter­est cost in the USA is $6,200 USD
    At 80% LVR the inter­est cost in Aus­tralia is $30,000 AUD

    Hous­ing is 1.3X US GDP
    Hous­ing is 3.2X Aus­tralian GDP

    Wages in both coun­tries are roughly 50% GDP

    Clearly Australian’s pay sig­nif­i­cantly more out of wages as a per­cent­age of GDP vs the USA


    bb #123

    What makes the dif­fer­en­tial USA vs Aus­tralian hous­ing cap­i­tal price/GDP ratio even more per­ni­cious for Aus­tralians is the 4 big Aus­tralian banks have sourced $650 bil­lion net for­eign debt of which ~25% is USD and ~25% GBP to lend to Aus­tralians their delu­sional priv­e­lage of hav­ing a high cost of liv­ing.

    It not only makes our labour poten­tially uncom­peta­tive it extracts roughly $10 bil­lion USD and $10 bil­lion GBP in for­eign debt inter­est pay­ments out of Aus­tralian pock­ets into the pock­ets of the US and the UK.

    Who’s the greater fool?

  • mfo

    Some Amer­i­can ana­lysts are call­ing this reces­sion the “Great Win­ter”.

    I think it might be more of a “Great Eco­nomic Iceage”, with the Amer­i­can land­mass being bridged to the rest of the world by oil and debt rather than ice.