Deleveraging with a twist

Flattr this!

The latest Flow of Funds release by the US Federal Reserve shows that the private sector is continuing to delever. However there are nuances in this process that to some extent explain why a recovery appeared feasible for a while.

The aggregate data is unambiguous: the US economy is delevering in a way that it hasn’t done since the Great Depression, from debt levels that are the highest in its history. The aggregate private debt to GDP ratio is now 267%,  versus the peak level of 298% achieved back in February 2009–an absolute fall of 31 points and a percentage fall of 10.3% from the peak.

This dwarfs any previous post-WWII experience–even the steep recession of the mid-1970s.

US Debt Downturns Now 1990s 1970s
Duration in years 1.3 2.3 1.3
Peak Debt 298 169 114
Debt Trough 268 163 106
Fall in Debt 31 7 8
Percent Decline 10.3% 4.2% 6.7%
Rate of Decline p.a. 7.9% 1.8% 5.1%

The aggregate level of private debt now towers over the economy, putting into sharp relief the obsession that politicians of all persuasions have had with the public debt. Rather like Nero fiddling as Rome burnt, politicians have focused on the lesser problem while the major one grew out of control. Now they are obsessing about a rise in the public debt, when in a very large measure that is occurring in response to the private sector’s deleveraging.

If they had paid attention to the level of private debt in the first place, then we wouldn’t be facing exploding public debt today.

However, though the decline in private debt is steep and continuing, the rate of decline has slowed. Because debt interacts with demand through its rate of change, this has given a stimulus of sorts to the economy in the midst of its deleveraging.

This is obvious when one considers aggregate demand as I define it: the sum of GDP plus the change in debt (where this demand is spread across both goods & services and the asset markets). Though debt levels are still falling, because they are falling less rapidly there has actually been a boost to aggregate demand from debt from the fact that debt is declining less rapidly in 2010 than in 2009:

This is doubly so when the contribution to demand from the public sector is included, as this shorter term graph shows more clearly.

However while recent data shows a positive contribution to demand from debt falling more slowly, on an annualised basis, the change in debt is still subtracting from aggregate demand–and more so than in the previous year. So total demand (across all markets–commodity and assets) had to fall, even though GDP itself grew. Obviously most of the fall in demand has been absorbed by the asset markets, which have not recovered to the same level of turnover as in the boom years–and nor should they.

The next table, which uses the aggregate debt figure (public and private debt combined) from the Flow of Funds, shows that aggregate demand fell across July 2008 to June 2009, even though debt was still rising, because the rate of growth of debt fell from $3.7 trillion to $1.4 trillion. Across July 2009 to June 2010, the decline in aggregate demand was less than the previous year (a 9.7% fall versus a 15.2% fall), even though the change in debt had turned negative.

Variable\Year 2006.5 2007.5 2008.5 2009.5 2010.5
GDP 13,347,800 14,008,200 14,471,800 14,034,500 14,575,000
Change in Nominal GDP % 6.6% 4.9% 3.3% -3.0% 3.9%
Change in Real GDP % 3.0% 1.8% 1.2% -4.1% 3.0%
Inflation Rate % 4.1% 2.4% 5.6% -2.1% N/A
Total Debt 43,337,326 47,528,151 51,272,735 52,686,684 52,054,500
Debt Growth Rate % 10.0% 9.7% 7.9% 2.8% -1.2%
Change in Debt 3,934,348 4,190,825 3,744,584 1,413,949 -632,184
GDP + Change in Debt 17,282,148 18,199,025 18,216,384 15,448,449 13,942,816
Change in Aggregate Demand % 0.0% 5.3% 0.1% -15.2% -9.7%

The rise in aggregate demand supported a recovery in employment, but the prospects of this continuing to the point at which economic activity booms once more are remote: with debt levels as high as they are, the potential for further deleveraging still exceeds the worst that the US experienced during the Great Depression.

I have recently become aware of some other economists using a similar concept to my measure of the debt contribution to aggregate demand, which they call the “credit impulse” (Biggs, Mayer et al., They define this as the change in the change in debt, divided by GDP.

My definition emphasises aggregate demand and correlates this with the level of employment (or unemployment, as above), whereas theirs emphasises the change in aggregate demand and correlates with changes in the level of employment. The logic is identical, but has the advantage of being able to correlate the change in the change in debt with change in employment. It highlights an apparent paradox: the economy can receive a boost from debt, even though it is falling, if the rate of that decline slows.

The next few charts apply this concept using the recent Flow of Funds data, and shows why it is so important to consider the dynamics of debt when trying to understand why this downturn has been so severe—and why it also seems to have eased. Firstly, change in employment and change in real GDP are obviously correlated, and on this basis this downturn is bad, though not significantly worse than previous downturns in 1958, 1975 and 1983.

However when you consider the correlation between the “credit impulse” and the change in employment, this crisis has no precedent in the post-WWII period:

Furthermore, debt is the leading factor is this process. Though the correlation between changes in real GDP and changes in employment are higher than those for the acceleration in debt and changes in employment, the “credit impulse” leads changes in employment while GDP slightly lags changes in employment: credit, which is ignored by conventional “neoclassical” economics, is in the driving seat.

This is something that Keynes realized after writing the General Theory (Keynes 1936), but which never made its way into the textbook version of Keynes that conventional economists like Stiglitz and Krugman learnt as Keynesianism.

Planned investment—i.e. investment ex-ante—may have to secure its “financial provision” before the investment takes place; that is to say, before the corresponding saving has taken place. This service may be provided either by the new issue market or by the banks ;—which it is, makes no difference… let us call this advance provision of cash the ‘finance’ required by the current decisions to invest. Investment finance in this sense is, of course, only a special case of the finance required by any productive process; but since it is subject to special fluctuations of its own, I should (I now think) have done well to have emphasised it when I analysed the various sources of the demand for money. (Keynes 1937, pp. 246-247)

The good news in the latest Flow of Funds data is therefore that a slowdown in the rate of deleveraging can impart a positive impetus to employment. However the bad news is that the economy is now hostage to changes in the rate of deleveraging, from levels of debt that far exceed anything it has ever experienced beforehand. Since much of this debt was taken on to finance speculation on asset prices rather than genuine investment, it is highly likely that deleveraging will accelerate in the future, as speculators tire—literally as well as metaphorically—of carrying large debt loads that finance stagnant or declining asset prices.

Drilling down into the debt data, it’s apparent that the sector that caused the crisis—the finance sector—is the one that has delevered the most is also the one whose rate of delevering is slowing most rapidly.

This is not a good thing, nor is it likely to last. The finance sector exists to create debt, and the only way it can do that is by encouraging the rest of the economy to take it on. If they were funding productive investments with this money, there wouldn’t be a crisis in the first place—and debt levels would be much lower, compared to GDP, than they are today. Instead they have enticed us into debt to speculate on rising asset prices, and the only way they can expand debt again is to re-ignite bubbles in the share and property markets once more.

Here’s where the level of debt (when compared to income) matters, as opposed to its rate of change: reigniting these bubbles is easy when debt to GDP levels are low. But reigniting them when debt to income levels are astronomical is next to impossible. Speculators have to be encouraged to take on a level of debt whose servicing consumes a dangerously high proportion of their income, in the belief that rising asset prices will let them repay that debt with a profit in the near future.

With the debt to GDP levels for all non-government sectors of the American economy at unprecedented levels, the prospect that any sector can be enticed to take on yet more debt is remote. Deleveraging is America’s future.

Biggs, M., T. Mayer, et al. “Credit and Economic Recovery: Demystifying Phoenix Miracles.” SSRN eLibrary.

Keynes, J. M. (1936). The general theory of employment, interest and money. London, Macmillan.

Keynes, J. M. (1937). “Alternative theories of the rate of interest.” Economic Journal
47: 241-252.

Click here for this post in PDF format

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.
Bookmark the permalink.

132 Responses to Deleveraging with a twist

  1. brett123 says:

    Actually BrightSpark I don’t really on ABS for my unemployment figures.

    Steve has previously mentioned these 2 sites: and

    Both show we are almost back to pre-GFC levels. So yes “record unemployment” may be a tad of an exaggeration. But it doesn’t matter what figures you look at are unemployment stats are remarkably good.

    Even Steve can’t disagree with this.

  2. brett123 says:

    Mahaish re “its no surprise that we have dodged a economic bullet for the time being. but i think the news of steves demise when it comes to this debate is premature in the extreme,lets see what the picture looks like by the end of the decade”

    So you are giving it another 10 years before it hits Australia? This seems to be the case with a lot of people on this site. Every day they comeback and push the date of Australia’s reckoning back a year or 2.

    I don’t want to sound to harsh about Steve. As I’ve often said, I believe his theories have a lot of worth. There’s nothing wrong with admiting he got his original predictions wrong (as he has done). I just think he could be better channeling his efforts in helping Australia avoid a depression, instead of continually stating we can’t avoid it.

    And when it comes to theories, there is no point concentrating on the examples that back up what you are saying (eg USA, Japan). You need to look at the examples that seem to be going against them.

    It only takes one example of a theory being wrong and it means your theory is wrong.

  3. DrBob127 says:


    May I just say how refreshing it is for someone to admit that they have overstated something (“…yes “record unemployment” may be a tad of an exaggeration…”) rather than refusing to accept that anything that they say is not 100% correct.

    It sure does make this place a lot more pleasant.

    Yes I’m looking at you bb.

  4. bc says:

    Oops. For a plane curve curvature is K=y”/(1+y’**2)**3/2
    working from memory.

  5. majorowe says:

    Well at least someone in the US has the courage to say some truths – Reagans FED Chief Takes Aim at Americas Battered Financial System:

  6. noah cross says:

    Views on employment should reference Bill Mitchell as his analysis is good –

    Analysis requires more than reading stats and taking them at face value.

  7. Jason Murphy says:

    Brett, Citydoc, where do you stand on this question …

    If I have a loan half in Australian dollars and half in international currencies, and the trade weighted index moves up:

    (a) is the burden on the Australian economy to repay the $AUD component of that debt more, same, or less? and
    (b) is the burden on the Australian economy to repay the Int. Curr component of that debt more, same, or less?

  8. ken says:

    Somehow I wouldn’t feel employed if my job:
    1. Didn’t give me annual leave, sick leave and payed public holidays
    2. Didn’t pay enough to have a holiday, and I might lose my job because of being away
    3. My employment could be terminated with the words “Don’t come in tomorrow”

  9. BrightSpark1 says:


    Thanks for that response, I an aware of the COFEE site and the other that you quoted. But I fail to see the relevance of the unemployment levels being “almost as low as before the GFC” after all Steve Keen was making the point that the world economy was heading for disaster before the GFC when the unemployment figures (whichever dodgy ones you want to believe) were “at pre-GFC levels” that is a little lower than they are now.

    The rot of the global economy set in with the ascendancy of neoclassical economics (AKA Economic Rationalism) in the 1970’s at a time when unemployment (by a more realistic criterion) was lower that 2%. To find a time when unemployment was as high as it is now, and has been (or higher) for the last forty years we must go back to World Depression 1 (WD1). Over these 40 years we have been accumulating debt at an ever accelerating rate, while probably in excess of 10% of our peoples productivity has been wasted. We have also dumbed this country down to the extent that it should be classified as “formerly industrialised”.

    Steve Keen original predictions were not wrong his only error was in the timing but all of the “powers that be” are still listening to the Neoclassical Economists. They will not not start listening to Steve Keen until the deleveraging goes into full swing and it becomes obvious that we are in WD2.

  10. Jason Murphy says:

    re @ 70

    mahaish nice insight.

    The detail will reveal little edies and backwashes and so on.

    The central point however is that the external debt – the national “other peoples money” is in some ways a very broad basket for measuring how hard a government has gone – and in this case the answer for the US and Australia is equally.

    [Would the equity transfer you describe effect external debt? Were their any associated cashflows?]

  11. mahaish says:

    actually brett123,

    ive been pretty consistent on this site, about this,

    always thought latter part of this decade, early next decade

    the credit engine in oz, may have a little more petrol in the tank left.

    as for steve, his 15 year bet is a good one to have some money on,

    as in all these things, what the currency monopolist(the government) does, will have a significant baring on what happens how fast.

    by issuing more currency , or reducing the need for non bank individuals to pay back some of that currency in the form of taxes can drag the process out for longer than what many of us had in mind.

    i suspect though, that what ever largess the government bestowes in terms of balance sheet improvements to non bank individuals, it will be leveraged away again , which will create a even bigger debt overhang.

    my bet is though , that it wont necesserally be an endogenous dynamic in the economy that will lead to the next financial crisis, but perhaps an exogenous geo politicsl factor

    all it takes is a few poorly thought through foreign policy decisions by the americans,

    or a few zealots in north korea or iran

    let alone the potential for china to politically blow up in the next 20 to 30 years, its happened before over a 150 years ago, in circumstances not too dissimilar to what is transpiring now.

    the soviets got to 70 years before the wheels started falling apart, if they were ever on correctly in the first place.

    the americans got to a little under 80 years before they had their own big internal kerfuffil

    the chinese have got to 60 years and counting last august

    everything old is new again

  12. Neil says:

    All this is very interesting but how relevant is it to Australia? Just how much of the Australian economy is dependent, either directly or indirectly on the US or come to that the EU.

    In Singapore 30 years ago I was derided by the few people who listened for suggesting that a lot more concentration should be placed on intra- Asian trade than trade with “The West”, possibly the insight was premature but today the economic activity internally generated ni China , India, Indonesia, Vietnam, Thailand etc, should not be ignored.

    Altogether it is considerably more important than the US and will only become more important as every year passes.

    It’s time we changed our focus as anyone who has lived in Asia will agree. Let’s move on.

  13. gaday says:

    Neil, 87
    You raise a vey good point. Some people like yourself were exposed to this thinking. I can remember talking with Russell Prowse the then General Manger and economist with The Bank of New South Wales when he informed me that they were going to change the name to Westpac for the vey reason the future trading partners for Australia will be from the Western Pacific Region.
    To move the traditional name from a State of Australia to an International Region -not including the U.K. or heaven forbid the U.S. of A. was a great feat. One that I don’t think the Australian business community relly understood.

    None the less America grabbed hold of the International Currency as the “standard” consumed more than any other country in the World and dominated power politics of being the Policeman of the free World. Conducting wars internatinally in the name of good for suppressed inhabitants-all of which have been a failure.
    So, why do we take notice of America in being affected by their economy?

    Our banks borrowed more money from them? Tradition, loyalty-they helped save us during the World War 11 crisis in the Pacific. Emotional Debt? or insecurity in having such a Great Island in Australia and no one to protect us- probably ALL OF THAT.

    Yes, we are part of ASIA in proximatey and in trading, very much so, however we are disparate in culture which need scareful understanding nurturing before trust can be accepted. After all we have given trust to Mother England and to the U.S. emotionally and financially and paid for it.

    We now have to decide what price we will have to pay for our new Asian Alliance for this is the bed we are now making.

  14. brett123 says:

    I don’t want to get into to much of a debate about whether Steve is right or wrong. As I have said I think his theories have a lot of merit. I just think anyone who gets on national TV proclaiming a depression is upon us – and cannot be avoided – deserves to be held accountable for what they say. And Steve did not put any timframe on what he said then. (And, I’m talking 2008 – pre Rory Robertson bet.)

    To his credit Steve has admitted he underestimated the impact of the stimuls in Australia. But we are now 2 years on from this. And I’m interested in his thoughts as to what the future holds for Australia.

    It’s not good enough for someone to wait to the next world shock occurs and then say – look I told you so. Anyone can do that. Anyone can sit back and say Australia will have a downturn in the next 10 years (gee after 30 years economic growth – I hardly call that a poor result).

    If his theories are worth anything he should be able to predict within at least 5 years what will happen in a given country – surely that is not too much too ask. Or will we be back here, long after Steve has passed (touched wood!) in 2050 – discussing how Steve will be right – next year…..

  15. gaday says:

    Correction to my post Russell Prowse was the Assistant General Manager of the Bank of NS.W. and their resident economist- in my opinion a great man in is own time with a vision

  16. Alan Gresley says:

    @brett123 89

    “If his theories are worth anything he should be able to predict within at least 5 years what will happen in a given country – surely that is not too much too ask.”

    How can Steve predict the geo-political dance?

    Now considering if my maths is correct.

    If Timothy Geitner and Co. have there way, the Yuan will appreciate 20% to 40%. This would make American manufacturing more competitive internationally but this new manufacturing (retooling etc.) can not be achieved in the same timescale as US currency depreciation.

    Gold has just now hit USD 1,300 and it could hit USD 1,820 to USD 2,080 if the USD depreciates by 40% to 80%.

    I myself have made predictions and will forever continue.

    I was wrong on the timing. Why was I wrong? The reason I give is that I didn’t know to the true extent how psychotic and blinded the international casino gamblers were and how narrowed viewed and non rational the American public was.

    You are inquiring when it will hit Australia. First we must witness the domino effect,

    or the house of cards.

    I prefer the house of cards argument since that works in with my theory of 20 years that Capitalism would fail since it is built like a pyramid and when the foundations (lower and middle class) are strained beyond structural integrity, the top of the pyramid falls.

  17. Hawkeye_Pierce says:


    You say that :”I have recently become aware of some other economists using a similar concept to my measure of the debt contribution to aggregate demand, which they call the credit impulse”

    Have you come across the english economist Peter Warburton? I recall in his excellent book “Debt & delusion” (for which he does make reference to Minksy) he had a chapter about the marginal productivity of debt to GDP growth, and it’s recent diminishing returns. Written in 1999. Fekete references him in this article:

    (Actually I’m a bit surprised that Warburton didn’t make the notable Bezemer list!)

  18. Pingback: GOP Will Not Pull Plug on Murkowski North Capitol Street

  19. Citydoc says:

    Alan Gresley @ 91,

    You mentioned:

    “How can Steve predict the geo-political dance?”

    He can’t and nor can anyone else. In fact, a person who is knowledgeable about a particular topic or issue can still have a major blindspot in their thinking. It happens to you, happens to me and happens to everyone else at various times.

    And despite the best laid plans, theories or strategies, you can still be stopped in your tracks by an unforeseen event or series of events.

    People need to focus on what is important and knowable.

    Because there is certainly no guarantee that the Chinese will let the Yuan appreciate 20% to 40%. And whilst Peter Schiff (Euro Pacific Capital) reckons gold can get to $5000 or higher, others (e.g George Soros) have suggested that gold is currently a bubble.

    But in relation to Steve’s situation, and to speak quite frankly, I am not sure whether his theories will ideas, beliefs and theories will come to fruition at this point in time. And if it does occur, it may end up being a short wait or a rather long wait. So my personal feeling at the present time, is that there is too much uncertainty in the eventual outcome for longer term investment decisions to be made.

    But if you like to gamble with your capital, then that’s different.

  20. Jason Murphy says:

    Citydoc @ 90

    I quote: “In fact, a person who is knowledgeable about a particular topic or issue can still have a major blindspot in their thinking. It happens to you, happens to me …”

    It may be that the only conclusion of the two conclusions of your research that the researcher has actual data on is the latter?

    But seriously, Citydoc, are you saying that a deleveraging influence cannot be offset by an external real product demand trade weighted index influence [given that debt is denominated in particular currencies]?

  21. Citydoc says:

    Jason @ 90,

    The validity of a conclusion depends on your actual rate of return. And it can be irrelevant to the amount and type of data one possesses.

    In response to your second point, I believe the answer is no in the current situation.

  22. brett123 says:

    Re: Alan and Jason

    “Are you saying that a deleveraging influence cannot be offset by an external real product demand trade weighted index influence”

    “How can Steve predict the geo-political dance?”

    Are you guys trying to defend Steve, or mount a case against him?

    This is exactly what Steve believes. He believes that too much debt to GDP means that an economy will eventually start deleveraging – and enter a depression (or long term recession). He regurlary states that nothing can stop the deleveraging (including external influences or increasing government debt). He’s tempered his statements recently saying that these things can have a short term influence, but eventually deleveraging must resume. I think we need greater clarity on what the “eventually” time period is.

    As it stands Australia seems to be doing a great job of proving Steve wrong and proving both of you right.

  23. Jason Murphy says:

    Citydoc @ 96 – So you and Brett123 are saying that you book a Credit on your balance sheet when the bank calls in the loan backed by the asset you purchased which you priced at Rent Plus Price Growth with the market not now being prepared to offer you the Price Growth component is different to the Debit you book to your balance sheet when the number of International Dollars you need to pay the Creditor to extinguish the loan reduces with trade weighted index appreciation.

    Two things are clear:

    1. The data backing conclusion 2 of your aforementioned research program mounts daily, and

    2. You are now saying that 10 – 5 + 5 = 5

    Certainly if your intention is to claim a position higher than the Professor in terms of makimg a statement you believe in irrespective of the opposition to it’s validity that you may face then your 2 above should certainly see you well on the way to achieving that goal!

  24. Jason Murphy says:

    Brett123 @ 97.

    I’ll tell you what we are rock solid on.

    We are rock solid on noticing that you and your associate Citydoc still haven’t answered the question put to you @82 so I’ll ask it again:

    If I have a loan half in Australian dollars and half in international currencies, and the trade weighted index moves up:

    (a) is the burden on the Australian economy to repay the $AUD component of that debt more, same, or less? and
    (b) is the burden on the Australian economy to repay the Int. Curr component of that debt more, same, or less?

  25. brett123 says:

    Jason @ 99 – How about you tell me Jason? Personally, I have no idea why this is valid to anything I have said.

Leave a Reply