Naked Cap­i­tal­ism and My Scary Min­sky Model

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I met with Yves Smith of Naked Cap­i­tal­ism on the week­end, at a superb Japan­ese restau­rant that only New York locals could find (and I’ll keep its loca­tion quiet for their benefit–too much pub­lic­ity could spoil a spec­tac­u­lar thing). Yves was kind enough to post details of my lat­est aca­d­e­mic paper at her site in a post she enti­tled “Steve Keen’s scary Min­sky model”.

Yves found the model scary, not because it revealed any­thing about the econ­omy that she didn’t already know, but because it so eas­ily repro­duced the Ponzi fea­tures of the econ­omy she knows so well.

I have yet to attempt to fit the model to data–and given its non­lin­ear­ity, that won’t be easy–but its qual­i­ta­tive behav­ior is very close to what we’ve expe­ri­enced. As in the real world, a series of booms and busts give the super­fi­cial appear­ance of an econ­omy enter­ing a “Great Moderation”–just before it col­lapses.

The motive force dri­ving the crash is the ratio of debt to GDP–a key fea­ture of the real world that the main­stream econ­o­mists who dom­i­nate the world’s aca­d­e­mic uni­ver­sity depart­ments, Cen­tral Banks and Trea­suries ignore. In the model, as in the real world, this ratio rises in a boom as busi­nesses take on debt to finance invest­ment and spec­u­la­tion, and then falls in a slump when things don’t work out in line with the euphoric expec­ta­tions that devel­oped dur­ing the boom. Cash flows dur­ing the slump don’t allow bor­row­ers to reduce the debt to GDP ratio to the pre-boom level, but the period of rel­a­tive sta­bil­ity after the cri­sis leads to expectations–and debt–taking off once more.

Ulti­mately, such an extreme level of debt is accu­mu­lated that debt ser­vic­ing exceeds avail­able cash flows, and a per­ma­nent slump ensues–a Depres­sion.

There are 4 behav­ioural func­tions in the model that mimic the behav­iour of the major pri­vate actors in the economy–workers, cap­i­tal­ists and bankers. Work­ers wage rises are related to the level of employ­ment and the rate of infla­tion; cap­i­tal­ists invest­ment and debt repay­ment plans are related to the rate of profit; and the will­ing­ness of banks to lend is also a func­tion of the rate of profit.

The model is explic­itly monetary–with bank accounts for work­ers, bankers and capitalists–and the cri­sis is marked by a col­lapse in deposits and a rise in inac­tive bank reserves.

The same phe­nom­e­non is evi­dent in the data, though the sharp­ness of the turn­around is far greater than can be repli­cated by the smooth func­tions in my model.

There’s a lot more work to do before the model is complete–notably includ­ing the impact of a gov­er­ment sec­tor that can add its own spend­ing power to a depressed economy–but its basic fea­tures ful­fil Minsky’s chal­lenge:

Can “It”-a Great Depres­sion-hap­pen again? And if “It” can hap­pen, why didn’t “It” occur in the [first 35] years since World War II? These are ques­tions that nat­u­rally fol­low from both the his­tor­i­cal record and the com­par­a­tive suc­cess of the past thirty-five years. To answer these ques­tions it is nec­es­sary to have an eco­nomic the¬ory which makes great depres­sions one of the pos­si­ble states in which our type of cap­i­tal­ist econ­omy can find itself.

This is the first eco­nomic model ever that meets Minsky’s stan­dards for real­ism. Its final stage empha­sises a mes­sage that Michael Hud­son, one of the very few oth­ers to see this cri­sis com­ing, puts very sim­ply: “Debts that can’t be repaid, won’t be repaid”. As Amer­i­cans now seem to be real­is­ing, the finan­cial cri­sis has not gone away, because the debt that caused it is still there.

Hav­ing got our­selves into a debt-induced eco­nomic cri­sis, the only per­ma­nent way out is to reduce the debt–either directly by abol­ish­ing large slabs of it, or indi­rectly by inflat­ing it away. I have very lit­tle con­fi­dence in the abil­ity of the Fed­eral Reserve to do the lat­ter, while the for­mer will take a level of polit­i­cal for­ti­tude that is far beyond our cur­rent politi­cians.

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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  • sir­ius

    I just posted a very long post pro­vid­ing evi­dence for my claim and it did not appear.

    I shall not attempt to repost it.

  • sir­ius
  • It was cap­tured by the spam fil­ter because of the num­ber of links sir­ius. I’ll clas­sify it as not spam now that I am awake.

  • sir­ius


    Thank you. Peo­ple are thus free to make up their own mind.

    Is the fed­eral reg­u­la­tor going to get tough or is it just noise ?

  • DrBob127
  • Philip

    Here’s a good blog post on Aus­tralian res­i­den­tial prop­erty his­tory.

  • Gee­Dub­b­leya

    A few here are dis­cussing rent and sup­ply and demand. Let me just say that as a renter I can tell you why rents rise even when there is no hous­ing short­age. It’s called sales & mar­ket­ing. I won­der if econ­o­mists ever take into con­sid­er­a­tion when devel­op­ing mod­els? Let me explain.

    20 years ago I was a stu­dent. When we needed to rent a place we’d give the agent a fifty and grab the key, visit the house and return the key and get our fifty back. If we wanted the place we’d fill out an appli­ca­tion form.

    Over the ensu­ing 20 years I bought and paid off a home and owned an invest­ment prop­erty. We chose to rent it our­selves rather than use an agent and we picked our ten­ant by way of a ‘home open’. That was 11 years ago. Seems we were ahead of our time.

    Now, I am a renter again, due to cash­ing in my real estate chips to fund a busi­ness. Now when I turn up at a house I’d like to rent I am lit­er­ally given a 15 minute win­dow to view the prop­erty with every­one else who is inter­ested. The agent turns up 5 min­utes late, every­time, and hands out appli­ca­tion forms as you go through the door.

    This cre­ates the IMPRESSION that there is a huge demand for the prop­erty. So as a viewer, you get the feel­ing that unless you 1) put in an appli­ca­tion now, you aint gonna get another chance and 2) Offer more than the rest of the herd, you’re gonna miss out too!

    The demand is an illu­sion! It’s cre­ated by great sales and mar­ket­ing tech­nique.

    And run­ning a busi­ness I know that price isn’t just about sup­ply and demand…its about emo­tion too! Tap into that emo­tion and you can quite lit­er­ally sell ice to eski­mos.

    Aus­tralia has built 800,000 more homes since 1990 than there are house­holds to to fill them. The fig­ures are avail­able on the ABS and takes half an hour to com­pile. There may have been more immi­grants com­ing here in the last 4 years on aver­age than the aver­age for the pre­vi­ous decade and a half but 800,000 spare houses is a big num­ber and the addi­tional migrants haven’t made much of a dent yet. And the stats show that most of these ARE houses, not addi­tions, car­a­vans or lean to’s.

    There is no hous­ing short­age! There are plenty of places to rent! Spruik­ers, who know how to sell and mar­ket to the pan­icky emo­tional renters are what has been dri­ving rents higher. Put that vari­able in the num­ber dri­ven text­book demand and sup­ply analy­sis of the Aus­tralian hous­ing mar­ket and see what comes up!



    David Air­ley com­par­ing real estate with the ASX is an inter­est­ing… the ASX fell 50%

    David Airey, pres­i­dent of the Real Estate Insti­tute of Aus­tralia, says the mar­ket is slow­ing to the extent that list­ings are accu­mu­lat­ing, and “buy­ers have lost their desire”.

    We are just going through an adjust­ment period, no dif­fer­ent to what the stock mar­ket is expe­ri­enc­ing. The ASX peaked, and has come back, and the same thing is hap­pen­ing in the prop­erty mar­ket. You run out of buy­ers, but they’ll be back.”



    When this bub­ble busts it will be inter­est­ing to see just how many ‘liar loans’ are on the books in Aus­tralia.

    How many bank­rupt sole pro­pri­etor ser­vice com­pa­nies paid phan­tom wages to spouses.

    How much ‘equity’ got extracted into spouse deposit accounts at ‘record break­ing auc­tion prices’.

    ~40% refi­nance and ~40% invest­ment of total monthly lend­ing is an omi­nous sign that alot of ‘equity’ is being extracted into a safe place.

    Very rem­i­ni­cent of 1880’s land boom

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    Any sim­i­lar­ity between the New Zealand and Aus­tralian bank­ing sys­tem is purely coin­ci­den­tal.

    Any creep­ing nation­al­iza­tion of the Aus­tralian resource com­pa­nies over the next 5 years via increas­ing the resource tax is purely coin­ci­den­tal.

    Krona Plunge

    Iceland’s finan­cial cri­sis was exac­er­bated by banks that bor­rowed in cur­ren­cies such as Japan­ese yen and Swiss francs to take advan­tage of lower inter­est rates, then repack­aged them as kro­nur loans for clients. The krona has lost 39 per­cent against the yen and 31 per­cent against the franc since Sept. 15, 2008. The rul­ing lim­ited bor­row­ers’ lia­bil­i­ties to the prin­ci­pal, while lenders were left to foot the bill for cur­rency losses. 

    Ice­landic banks have as much as 900 bil­lion kro­nur ($7.2 bil­lion) of for­eign cur­rency loans and may have to write down their value by 40 per­cent to 60 per­cent, Finance Min­is­ter Ste­in­grimur J. Sig­fusson said July 7. 

    By com­par­i­son, the three biggest bank have com­bined equity of 340 bil­lion kro­nur, said Gun­nar Bjarni Vidars­son, an econ­o­mist at IFS Con­sult­ing in Reyk­javik, which pro­vides research for finan­cial com­pa­nies and investors. 

    If the banks have to write off 40 to 60 per­cent” of their for­eign cur­rency loans “they are bank­rupt,” he said.

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  • glu­bilee

    the start of US real estate bub­ble burst­ing was decrease in vol­ume of sales, vol­ume went down, then prices…hardest hit areas are still see­ing declines

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  • cred­it­de­fault­swap

    Steve, rather late to ask this, but as your model ends at 40 per­cent unem­ploy­ment, any ideas on when/if the recov­ery occurs?
    Also the US col­lects a pay­roll tax on all wage income, 2.9 per­cent for Medicare. From the US Trea­sury reports we can see that this is now run­ning about 4 per­cent below last year. US wage income has an incred­i­ble amount of iner­tia, it has fallen less than half as much as full time jobs for exam­ple.

  • It comes down to Michael Hudson’s oft-repeated phrase: “Debts that can’t be repaid, won’t be repaid”, and the only way out is debt reduc­tion via either bank­ruptcy or delib­er­ate repu­di­a­tion. I favour the lat­ter course.

    My model doesn’t yet include bank­ruptcy and its effects on eco­nomic per­for­mance, and effec­tively any unpaid debt sim­ply con­tin­ues to com­pound. If I work out a way to validly model bank­ruptcy and the like, then I could get a reset­ting effect turn­ing up.

    My expec­ta­tion is that we’ll need 2–2 years before debt falls sub­stan­tially and the effects of delever­ag­ing dimin­ish; at the moment I think they’re still accel­er­at­ing, which is why I expect the US econ­omy to tip back into reces­sion.

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  • Kozak thor­oughly rec­om­mend it. Much work based on Taleb’s fragility the­o­ries. Intel­li­gent com­men­tary.