Back to the Future?

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Things are look­ing grim indeed for the US econ­omy. Unem­ploy­ment is out of con­trol—espe­cially if you con­sider the U-6 (16.7%, up 0.2% in the last month) and Shad­ow­stats (22%, up 0.3%) mea­sures, which are far more real­is­tic than the effec­tively pub­lic rela­tions U-3 num­ber that passes for the “offi­cial” unem­ploy­ment rate (9.6%, up 0.1%).

The US is in a Depres­sion, and the sooner it acknowl­edges that—rather than con­tin­u­ing to pre­tend otherwise—the bet­ter. Gov­ern­ment action has atten­u­ated the rate of decline, but not reversed it: a huge fis­cal and mon­e­tary stim­u­lus has put the econ­omy in limbo rather than restart­ing growth, and the Fed’s con­ven­tional mon­e­tary pol­icy arse­nal is all but depleted.

This prompted MIT pro­fes­sor of eco­nom­ics Ricardo Cabellero to sug­gest a more rad­i­cal approach to mon­e­tary eas­ing, in a piece re-pub­lished last Wednes­day in Busi­ness Spec­ta­tor (repro­duced from Vox). Con­ven­tional “Quan­ti­ta­tive Eas­ing” involves the Trea­sury sell­ing bonds to the Fed, and then using the money to fund expenditure—so pub­lic debt increases, and it has to be ser­viced. We thus swap a pri­vate debt prob­lem for a pub­lic one, and the boost to spend­ing is reversed when the bonds are sub­se­quently retired. Instead, Caballero pro­poses

a fis­cal expan­sion (e.g. a tem­po­rary and large cut of sales taxes) that does not raise pub­lic debt in equal amount. This can be done with a “heli­copter drop” tar­geted at the Trea­sury. That is, a mon­e­tary gift from the Fed to the Trea­sury. (Ricardo Caballero)

The gov­ern­ment would thus spend with­out adding to debt, with the objec­tive of caus­ing infla­tion by hav­ing “more dol­lars chas­ing goods and ser­vices”. This is prefer­able to the defla­tion­ary trap that has afflicted Japan for two decades, and now is increas­ingly likely in the US. So on the face of it, Cabellero’s plan appears sound: infla­tion will reduce the real value of finan­cial assets, shift wealth from older to younger gen­er­a­tions, and stim­u­late both sup­ply and demand by mak­ing it more attrac­tive to spend and invest than to leave dol­lars lan­guish­ing, and los­ing real value, in the bank.

How­ever, though this is indeed the right time to con­sider rad­i­cal solu­tions, Cabellero’s pro­posal would do only half the required job. Focus­ing on the good bit, one rea­son we got into this predica­ment in the first place was because pri­vate sec­tor, debt-based money swamped pub­lic sec­tor, fiat money. Ulti­mately we need to return to the pub­lic-pri­vate money bal­ance we had in the 1950s and early 1960s.

But if get­ting “Back to the Future” was all we needed to do, then our prob­lems would already be over, because Ben’s Heli­copter Drop of late 2008 has got us there already: the ratio of M0 to M2 is now almost 0.25, far higher than the 1960 level of 0.14, while the ratio to M3 is back where it was then (using Shad­ow­stats data, which I can’t pub­lish here since it’s pro­pri­etary).


So why aren’t we “Back To The Future” already? Why isn’t the econ­omy boom­ing once more, and why is infla­tion giv­ing way to defla­tion?

Because, though the money sup­ply is back to where it was in 1960, the debt to money ratio is utterly dif­fer­ent. Even after Ben’s Heli­copter Drop, the debt to base money ratio is almost twice what it was in 1960, and over 3 times what it was back in the Golden Days of the 1950s.

This points out the blind spot in the think­ing of even pro­gres­sive Neo­clas­si­cals like Cabellero, who are will­ing to con­sider uncon­ven­tional poli­cies: they don’t under­stand how money is cre­ated in our credit-dri­ven econ­omy. Because of that, they don’t appre­ci­ate how much of that credit has financed a glo­ri­fied Ponzi Scheme rather than invest­ment, nor do they com­pre­hend the impact that pri­vate sec­tor delever­ag­ing is hav­ing on aggre­gate demand.

I’ve cov­ered the first topic ad nau­seam in my post “The Rov­ing Cav­a­liers of Credit”, so I won’t repeat myself here. Instead I’ll focus on the obvi­ous mes­sage from the above chart: if the gov­ern­ment sim­ply pumps its money into the sys­tem with­out restrain­ing the finan­cial sys­tem from financ­ing spec­u­la­tion on asset mar­kets, the best we can hope for is a repeat of this cri­sis, on an even larger scale, some years down the track. To see that, all we have to do is look at what hap­pened back in the 1980s.

The Debt to M0 ratio, which had risen six­fold since the 1950s, went into sud­den reverse as the econ­omy imploded when the Sav­ings and Loans fiasco ended. The growth of debt col­lapsed, and the State tried to res­cue the finan­cial sec­tor from its fol­lies by fis­cal pol­icy and boost­ing the money sup­ply. That res­cue ulti­mately suc­ceeded when the reces­sion of the 1990s finally ended, but since finance was embold­ened rather than reformed, it sim­ply financed two fur­ther fias­cos: the Dot­Com mad­ness and then the Sub­prime scam.

The rea­son why the 1990s res­cue isn’t work­ing this time stands out more clearly when you look at the changes in debt and M0 in raw dol­lar terms (the scale of the change in M0 is 1/5th that for the change in debt in next two graphs). In the 1990s cri­sis, the rate of growth of pri­vate debt slowed by 2/3rds, but it didn’t actu­ally fall; and a qua­dru­pling of the rate of growth of M0 (start­ing half a year after debt growth slowed down) was enough, after sev­eral years, to let the Wall Street party resume.

This time, the change in debt has turned solidly negative—having growth at up to $4 tril­lion p.a., it is now shrink­ing at over $2 tril­lion. Ben’s far larger quan­ti­ta­tive eas­ing (when com­pared to Alan’s back in 1990–94) sim­ply hasn’t been enough to fight a pri­vate sec­tor that is now seri­ously delever­ag­ing.

QE2 could nonethe­less work, if Cabellero’s plan was exe­cuted with gusto. But if all we do is effect a mon­e­tary res­cue, and yet leave the finance sec­tor untouched, then it will reborn once again as an even big­ger Ponzi Scheme.

Do we really want to go through all that again?

I’ll explain two truly major finan­cial reforms that could pre­vent another credit and asset bub­ble in a sub­se­quent piece.

Click here for this post in a PDF doc­u­ment.

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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  • steve2

    Hi Steve,I con­stantly read your blogs reli­giously dur­ing the GFC cri­sis until about a year ago.What has sparked my con­cern now is via a tech­ni­cal trad­ing web­site I reg­u­larly view.Just lately they have been refer­ring to the “Con­sumer Met­rics Insti­tute Growth Index” which is show­ing alarm­ing data for the U.S. Economy.I was hop­ing you could please inves­ti­gate and give your opin­ion as to what this all means.Best regards.

  • Hi Steve2,

    That is an intrigu­ing set of data. Since this par­tic­u­lar debt cri­sis is the first in which debt has been imposed to a maxed-out level on the house­hold sec­tor, I’ve always expected that it would be char­ac­terised by a col­lapse in con­sumer spend­ing. I made the com­par­i­son between an indebted busi­ness sec­tor and house­hold sec­tor ages ago: an indebted busi­ness sec­tor can elim­i­nate debt and/or costs by ceas­ing to exist via bank­ruptcy, sack­ing the work­ers or ceas­ing to invest; an indebted house­hold sec­tor can’t dis­ap­pear via bank­ruptcy (unlike a firm, a bank­rupt per­son remains alive), you can’t sack the kids, and you can’t cease to con­sume either. So all you can do is cut back as much as pos­si­ble on con­sump­tion.

    That seems to be what that data shows, and it appears to be a fairly strong lead­ing indi­ca­tor of GDP as well.

  • In rela­tion to Caballero’s pro­posal, Steve Keen says “The gov­ern­ment would thus spend with­out adding to debt, with the objec­tive of caus­ing infla­tion by hav­ing “more dol­lars chas­ing goods and ser­vices”. Why on Earth would any infla­tion nec­es­sar­ily ensue? Infla­tion occurs when aggre­gate demand exceeds the capac­ity of the econ­omy to sup­ply (“aggre­gate sup­ply” if you like). With unem­ploy­ment at its present level, there is con­sid­er­able scope for let­ting the deficit just accu­mu­late as extra mon­e­tary base before any infla­tion kicks in.

  • Hi Ralph37 re Back to the Future #53.

    That’s quite cor­rect. I wrote that piece pri­mar­ily for a busi­ness news web­site (Busi­ness Spec­ta­tor), so there was a word con­straint. And notice that I said “with the objec­tive of caus­ing infla­tion”, not “to cause infla­tion”. I’ve argued often enough that mon­e­tary expan­sion is a very inef­fec­tive means to cause infla­tion; a far more effec­tive means is to increase wages.