Delever­ag­ing, Decel­er­a­tion and the Dou­ble Dip

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Much opti­mism flowed from last week’s dec­la­ra­tion by the National Bureau of Eco­nomic Research that the US reces­sion offi­cially ended in June 2009. How nice of them to let us know. 

Mar­kets reacted warmly and the 8 per cent rally in US stocks through Sep­tem­ber seemed more impor­tant than the rev­e­la­tion that the US Fed is wor­ried enough about defla­tion to be plan­ning another round of quan­ti­ta­tive eas­ing — dubbed ‘QE 2’. 

I wish I could share the market’s (and the NBER’s) irra­tional exu­ber­ance, but the key indi­ca­tor that explains where the US econ­omy and its already dis­as­trous employ­ment sit­u­a­tion is headed implies that even QE2 won’t set the US on a course to renewed pros­per­ity.

It’s also impor­tant to note that the ‘strong’ Q2 US earn­ings fig­ures seen in July are partly the result of dra­matic cost-cut­ting in US firms – a nice way of say­ing mass lay-offs. Nonethe­less the stronger bot­tom lines keep pro­duc­ing mar­ket exu­ber­ance, even if the fac­tors behind those bot­tom lines will lead to future defla­tion rather than a boom. As Forbes writer Joshua Brown puts it “there is an effer­ves­cence in the air as we head into the Q3 report­ing period (start­ing Octo­ber 7)”. He thinks the mar­ket will once again turn south, and based on that pesky fun­da­men­tal called the real econ­omy, it should.

So should it on the basis of the key indi­ca­tor that explains the ori­gins of the appar­ent sta­bil­i­sa­tion that led the NBER to declare that the reces­sion was over in June 2009.

For a long time I’ve focused on the con­tri­bu­tion that the change in debt makes to aggre­gate demand, in the rela­tion that “aggre­gate demand equals the sum of GDP plus the change in debt”. An obvi­ous exten­sion of that was that “change in aggre­gate demand equals change in GDP plus accel­er­a­tion in the level of debt”—which would imply that change in unem­ploy­ment is dri­ven by changes in the rate of growth of debt.

Though I was aware of this impli­ca­tion of my analy­sis, I held off from test­ing it because I was con­cerned that this was push­ing the data one step too far.

A phys­i­cal sys­tem with a sim­i­lar rela­tion­ship between veloc­ity (the rate of change of one vari­able) and accel­er­a­tion (whether the veloc­ity of another vari­able is increas­ing or decreas­ing) would gen­er­ate a large vol­ume of suf­fi­ciently detailed data that the rela­tion­ship could be empir­i­cally tested.

But the eco­nomic sys­tem, with the large time lags in data col­lec­tion, sur­vey meth­ods rather than direct mea­sure­ment, and the dodgy prac­tices sta­tis­ti­cians are forced into by politi­cians and eco­nomic bureau­crats who often don’t want raw infor­ma­tion to be avail­able? I just thought that the rela­tion­ship, even though it made sense, wouldn’t be dis­cernible from pub­lished sta­tis­tics. So I held off.

It turns out that I shouldn’t have been so cau­tious: the data well and truly sup­ports this, on the sur­face, weird causal rela­tion: the change in employ­ment is strongly affected by the accel­er­a­tion or decel­er­a­tion of debt. This can give the para­dox­i­cal result that the level of employ­ment can rise, even when the econ­omy is delever­ag­ing, if the rate of delever­ag­ing slows. This phe­nom­e­non has dri­ven the appar­ent sta­bil­i­sa­tion of the US unem­ploy­ment rate (though of course the more mean­ing­ful U-6 mea­sure has risen to 17 per­cent, and Shad­ow­stats puts the actual unem­ploy­ment level at 22.5 per­cent–well and truly in Depres­sion ter­ri­tory), and it is highly unlikely that it will last.

My unchar­ac­ter­is­tic timid­ity means that I have to doff my cap in the direc­tion of the three econ­o­mists who first pub­lished on this topic: Biggs, Mayer and Pick. They first showed the cor­re­la­tion between what they called “the credit impulse”—the rate of change of the rate of change of debt, divided by GDP—and both GDP and employ­ment (for those who have access to research from Deutsche Secu­ri­ties, they have a sim­pler expla­na­tion of their analy­sis in Global Macro Issues for Decem­ber 17 2009: “The myth of the credit-less recov­ery”).

The chart below shows my con­fir­ma­tion of the rela­tion­ship with the data on the annual change in unem­ploy­ment in the USA and the annual rate of accel­er­a­tion of pri­vate debt since 1955. The cor­re­la­tion is –0.67: a stag­ger­ing cor­re­la­tion of a first and a sec­ond order vari­able over such a period, and across both booms and busts.

The two dot­ted red lines labelled “S” and “E” show when the NBER thinks this reces­sion started and ended, and they neatly coin­cide with turn­ing points in the credit impulse—an indi­ca­tor that the NBER is not even aware of, let alone one that it con­sid­ers when attempt­ing to date reces­sions.

Super­fi­cially, one might think that since the credit impulse does indi­cate when unem­ploy­ment is going to rise or fall, then the cur­rent data implies that the reces­sion is indeed over—even if the NBER doesn’t under­stand the actual causal dynam­ics at play.

But the chart also shows that there has never been a turn­down in credit like this one—the peak rate of decel­er­a­tion of debt was over 25 per­cent, ver­sus a mere minus 6 per­cent in the deep reces­sion of the 1970s. And though the rate of accel­er­a­tion of debt has the most direct impact on employ­ment, ulti­mately all three factors—the level of debt (com­pared to GDP), its rate of change, and whether that rate of change is increas­ing or decreasing—must be taken into account.

It’s com­pli­cated, so an anal­ogy with dri­ving makes it eas­ier to com­pre­hend.

Con­sider a drive from Los Ange­les to some des­ti­na­tion East (if you’re an Aus­tralian reader, con­sider a drive West from Syd­ney), where the drive out rep­re­sents increas­ing debt, and the drive back home rep­re­sents falling debt.

The level of debt com­pared to GDP is like the dis­tance to be trav­elled, and today the US has a lot fur­ther to travel than it did in the 1950s: 5 times as far, in fact. It’s like the dif­fer­ence between a drive to New York and back, ver­sus a return trip to Utah.

The rate of change of debt (with respect to GDP) is like your speed of travel—the faster you drive, the sooner you’ll get there—but there’s a twist. On the way up, increas­ing debt makes the jour­ney more pleasant—the addi­tional spend­ing increases aggre­gate demand—and this expe­ri­ence is what fooled neo­clas­si­cal econ­o­mists (who ignore the role of debt) into believ­ing in “the Great Mod­er­a­tion”. But it increases the dis­tance you have to travel when you want to reduce debt, which is what the USA is now doing. So it’s great when you’re dri­ving from LA East (increas­ing debt), but lousy when you want to head home again (and reduce debt).

With that far to travel back home, you might be tempted to accelerate—which is akin to increas­ing the rate of change of the rate of change of debt (it’s a mea­sure of the g-forces, so to speak, when they can be gen­er­ated by either rapid accel­er­a­tion or rapid decel­er­a­tion). Accel­er­a­tion in the debt level when it was ris­ing again felt great on the way out: booms in the Ponzi Econ­omy the US has become were dri­ven by accel­er­a­tions in the rate of growth of debt. Equally, accel­er­a­tion in the oppo­site direc­tion feels dread­ful: as the rate of decline of debt increases, aggre­gate demand col­lapses and unem­ploy­ment explodes.

What actu­ally feels bet­ter in the reverse direc­tion is deceleration—reducing the rate at which debt is falling—and that’s what’s been hap­pen­ing in the last year.

But here’s the prob­lem: too much decel­er­a­tion and you actu­ally reverse direc­tion: you start head­ing East again, rather than return­ing home. That wouldn’t be a prob­lem if all you’d done was drive to Utah, but instead you’ve hit New York instead: drive any fur­ther, and you’re in the Atlantic.

With the level of debt the USA has accu­mu­lated, the prospect that any sec­tor of it (apart from the gov­ern­ment) can be enticed to go back into accu­mu­lat­ing debt once again is remote. So the decel­er­a­tion in the rate of reduc­tion of debt that is occur­ring right now will ulti­mately give way to at best a con­stant rate of decline of debt, and at worst another acceleration—and the dreaded “dou­ble dip”.

These next two quar­terly charts empha­sise the dilemma: the sta­bi­liza­tion in employ­ment has occurred because the rate of delever­ag­ing has slowed, which reg­is­ters as a pos­i­tive in the “rate of change of the rate of change”:

But the rate of change of debt is still neg­a­tive: it’s just risen from a low of –6% to –2%. For the decel­er­a­tion effect to con­tinue, the US debt car would need to stop its return drive from New York to LA, and head back towards New York once more: the level of debt rel­a­tive to GDP would need to rise.

This is highly unlikely when all sec­tors of the Amer­i­can econ­omy bar one (non-finan­cial busi­ness) are already car­ry­ing more debt than they were in the depths of the Great Depres­sion, when the debt ratio had been dri­ven higher by defla­tion.

So the decel­er­a­tion in delever­ag­ing should give way again at some point, and then the NBER may be forced to begin dat­ing the next recession—which is still a con­tin­u­a­tion of the cur­rent Depres­sion.

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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  • bb


    Thanks for your feedback…very much appre­ci­ated.

    Try not to dif­fer­en­ti­ate from deposits and equity. They both sit on the same side of a Bank’s bal­ance sheet. They are both needed to fund the assets (loans).

    When the assets become impaired and a bank needs to recap­i­talise, all that hap­pens is a trasnfer from deposits to equity. Some delever­ag­ing occurs since bank assets have fallen..but since banks oper­ate on an 8% cap­i­tal mar­gin, this does not de-lever the sys­tem by much.

    The small amount of delever­ag­ing comes coutesy of the old equity hold­ers of the bank who lose their money (wealth transafer from equity owner to bor­rower).

    Most of the deposits remain in place. A small amount of deposit get reclas­si­fied as equity to replace to old equity which has been writ­ten off to delever the sys­tem. This process is done via a rights issue or place­ment.

    So even dur­ing asset defla­tion Assets = Lia­bil­i­ties at all times. You just need to treat equity as a lia­bil­ity as it sits on the same side of the bal­ance sheet as deposits.

    But as SK says, the de-lev­er­ing has to occur slowly. I now under­stand why. And the issue remainsn. too much pri­vate debt, and ther­fore too much pri­vate cap­i­tal (cap­i­tal in the form of equity and deposits).

    I’m now so obsessed by this I am find­ing it hard to sleep.

  • bb


    I just read your post. Agree.

  • mahaish

    yes vk, i think we are in agree­ment, not really ques­tion­ing the logic of dou­ble entry book keep­ing,

    i was more inter­ested in the macro level effect of a large scale write down of bank assetts would have on the deposit base if any.

    ulti­mately all roads lead to the equity account of a bank, and thats where the bank will take it in the neck unless the cen­tral bank inter­venes. but a cred­i­tor bank can go after any col­la­toral includ­ing an indi­vid­u­als deposit base

    how­ever in a defla­tion, does the process of liq­ui­da­tion real­is­ing val­ues at lower than book value add to or draw down the deposit base, thus reduc­ing non bank cap­i­tal

    if i have to liq­uidte in a hurry at a loss, then that is going to neces­si­tate my hav­ing to tap into other parts of my assett base includ­ing bank deposits to cover my posi­tion.

    the ques­tion is whats valid at the micro level , valid at the macro level

  • mahaish

    hi bb,

    Try not to dif­fer­en­ti­ate from deposits and equity. They both sit on the same side of a Bank’s bal­ance sheet. They are both needed to fund the assets (loans”


    assetts(bank resources) = lia­bil­i­ties + stock holder equity( both claims on resources)

    the prob­lem i have , is that in a mar­ket where assett val­ues are falling, the liq­ui­dated val­ues realised are going to be lower than the book value,

    nett equity on the bal­ancr sheet , takes a hit,

    i cant see how this sit­u­a­tion is con­sis­tent with the notion of there being too much cap­i­tal, when reduc­tions in nett equity are tan­ta­mount to a destruc­tion of cap­i­tal

  • vk

    @127 mahaish

    Please check my com­ment 336 here:

    debtjunkies also added a bit a few posts below.

    The account­ing entries are the same regard­less of the envi­ron­ment (infla­tion or defla­tion).

    A bank cant “draw down the deposit base” to off­set loan losses (unless it is declared bank­rupt and there is no gov­ern­ment guar­an­tee).

    A bank cant “tap into other parts of my asset base” to off­set loan losses. As strange as it sound it should use a lia­bil­ity account — pro­vi­sions for doubt­ful debts, main cap­i­tal, retained prof­its, etc — to bal­ance the loan write-offs.

    Hope this helps.

  • mahaish

    A bank cant “draw down the deposit base” to off­set loan losses (unless it is declared bank­rupt and there is no gov­ern­ment guar­an­tee”

    hi vk,

    not talk­ing about the bank side of the equa­tion,

    im refer­ring to the non bank coun­ter­party

  • bb

    the prob­lem i have , is that in a mar­ket where assett val­ues are falling, the liq­ui­dated val­ues realised are going to be lower than the book value,

    nett equity on the bal­ancr sheet , takes a hit,

    i cant see how this sit­u­a­tion is con­sis­tent with the notion of there being too much cap­i­tal, when reduc­tions in nett equity are tan­ta­mount to a destruc­tion of cap­i­tal”


    The prob­lem is that bank cap­i­tal only rep­re­sents c8% of the loan book. So at most pri­vate debt can only get reduced by 8% at any one time, then the banks need to sig­nif­i­cantly recap­i­talise. Yes there is a cor­re­spon­f­ing fall in debt, but this is very low in the con­text of pri­vate debt to GDP of +150%.

    The real­ity is that write­offs prob­a­bly have to come at a slower pace than this to stop the entire sys­tem col­laps­ing.

    This was the expe­ri­ence in Japan where asset write­downs were the norm for more than 10 years.

    If the de-lev­er­ing process takes time, it means there remains too much impa­tient cap­tial on the side­lines.

  • bb


    A bank cant “draw down the deposit base” to off­set loan losses (unless it is declared bank­rupt and there is no gov­ern­ment guar­an­tee).”

    I dis­agree.

    The legal process to do this is via a rights offer, or pri­vate place­ment. This is the legal process to trans­fer deposits to equity.

    My prob­lem is its does not de-lever (or elim­i­nate cap­i­tal) at a very past pace.

  • mahaish

    hi bb,

    how much of that cap­i­tal has a debt oblig­a­tion attached to it,

    may be the issue is not too much cap­i­tal,

    but, impaired nett worth /equity

    fur­ther­more the value of cap­i­tal is being erroded by lack of full capac­ity util­i­sa­tion, hence high unem­ploy­ment, lead­ing to lower nett present value of future earn­ings from that cap­i­tal which effects stock equity, which errodes the value of cap­i­tal

    you’ve got a lot to answer for bb, start­ing this dis­cus­sion, hope i dont catch the dis­ease,;)

    always a plea­sure, im always enlight­ened by these dis­cus­sions

    and much obliged vk

  • bb


    how much of that cap­i­tal has a debt oblig­a­tion attached to it”

    All of it (the way I see it).

    When SK says pri­vate debt/ GDP is 165% (US), then he is also say­ing pri­vate cap­i­tal / GDP is 165%.

    Since GDP is a known quan­tity, the amount of return avail­able for the grow­ing pool of cap­i­tal has to be lower over time (as debt increases).

    This comes about by entre­pre­neurs put­ing more cap­i­tal to work, increas­ing pro­duc­tive capac­ity whether the econ­omy needs it or not. The result is con­tin­ued excess capac­ity. leaing to lower prices and defla­tion.

    We have seen this in Japan…hence my chart.

    Just for fun I am going to post it again.

  • bur­rah

    Inter­est­ing posts. As a non-econ­o­mist, I hope you don’t mind if I make a few com­ments to clar­ify in my mind where you are com­ing from. Your spec­u­la­tions remind me, for all the world, of John Law’s spec­u­la­tions 300 years age. Laws was the proto-Key­ne­sian, prac­ti­cally all his sug­ges­tions were pop­u­larised by Keynes in a more mature form.
    His major the­o­ret­i­cal fail­ing was to believe that stocks were liq­uid and a near sub­sti­tute for money.
    Next issue is the use of the term “pri­vate cap­i­tal” for bank lia­bil­i­ties. It is too close to finan­cial cap­i­tal which is bor­rowed from the banks for the pay­ment of the fac­tors of pro­duc­tiv­ity, which as ak points out is good debt, Per­sonal bebt on the other hand can

  • bur­rah

    That post took off on its own 🙂
    Per­sonal debt on the other hand can be ephemeral, from the pur­chare of flat screen t.v’s to the pay­ment of med­ical bills.
    Finally how does your the­ory fit in with this arti­cle:
    Bond­holder ‘Diplo­matic Immu­nity’ to Losses Chal­lenged as Irish Bail Banks?

  • Jason Mur­phy

    In the Aus­tralian con­text you guys would be famil­iar with the APRA role and the Pru­den­tial Stan­dards num­bers it runs. The base clause is a Pru­den­tial Capi­tol Ratio [PCR] of 8% being Capi­tol Base to Total Risk Weighted Assets.


    Credit Risk — Stan­dard:–12-12–07-Final.pdf
    Credit Risk — Inter­nal Rat­ings:

  • bb

    HI bur­rah

    Thanks for the art­cile.

    I’m not sure how I can relate the art­cile to my thoughts, but here it goes.

    Irish Bond hold­ers seem to face two poten­tial issues — liq­uid­ity and sol­vency.

    Wrt liq­uid­ity, they could seek redemp­tion from the bonds at matu­rity. The investors would then have liq­uid funds (Cash) to buy other bonds and stocks. The sell­ers of these stocks would then have the liq­uid­ity to buy the newly issued irish bonds which replace the old bonds.

    No mat­ter what hap­pens, there is enough liq­uid­ity in the sys­tem to solve the prob­lem so long as investors are com­fort­able with the sec­ond issue — sol­vency.

    If the Irish bank is insolvant (lia­bil­i­ties > assets), the junior senior bond hold­ers become equity (if the losses are large, senior bond hold­ers become equity). The old equity is extin­guished along with the bad loans. The result is delever­ag­ing. It is the same eco­nomic effect as indi­vid­u­als pay­ing down debt — except for the uncom­fort­able fact that a major finan­cial insti­tu­tion is col­laps­ing.

    Under this sce­nario, the sys­tem is still in bal­ance. Assets = lia­bil­i­ties.

    My con­cern is there still remains a huge amount of cap­i­tal in the sys­tem and will remain so for quite some time.

  • Aac

    ak at 76 wrote:

    So what?”

    Thank you for point­ing out that cor­rup­tion has always been a prob­lem. What would you do ak if you came across a bur­glar rob­bing your neigh­bours? Would you say “So What” its hap­pened before or would you act. 

    Karl Den­ninger has doc­u­mented the fraud bet­ter than any­one else and if any­one is in any doubt that this is all about fraud then please read the lat­est that I found ref­er­enced on Dinninger’s site; 

    Econ­o­mist Joseph Stiglitz: Put Cor­po­rate Crim­i­nals in Jail

  • John Pren­tice

    Cor­rup­tion has always been a problem.….……since the begin­ning. Cor­rup­tion is always a prob­lem.

    How­ever I sus­pect when you pull the tide out and delever, we will find the west as been gut­ted and stuffed. Leav­ing me under­stand­ably aware that even politi­cians who were against the eco­nomic order of the last 30 years, scared for their polit­i­cal career and hence didn’t push through anti-cor­rup­tion mea­sures that would dampen “growth”.

  • bb, for­give me for jump­ing in but your time­line needs to include oil pro­duc­tion in it or it sim­ply doesn’t reflect the future accu­rately. I’ve just returned from the Asso­ci­a­tion for the Study of Peak Oil and Gas 2010 Con­fer­ence in D.C. and I will attempt a short syn­op­sis.

    Despite high oil prices, oil pro­duc­tion has not increased since 2004 i.e. we are on a pro­duc­tion plateau. (See slide 5 of–8-2010_aspousa_KeynoteEnergyMess_Hirsch_R.pdf)

    The giant and super­giant oil fields, which pro­vide ~60% of world oil, are declin­ing at 6.7% per year (, p. 43).

    The var­i­ous oil megapro­jects data­bases, which cat­a­log future oil pro­duc­tion accu­rately within a six-year hori­zon (the time it now takes for a new oil project to pro­duce first oil since all the easy oil is already in pro­duc­tion) indi­cate that sur­plus capac­ity will be exhausted by 2012. We could face a 10 mil­lion bar­rel per day short­fall by 2015 (U.S. Joint Forces Com­mand 2010 Joint Oper­at­ing Envi­ron­ment Report).

    Net exports fall faster than top line pro­duc­tion by a fac­tor of 3. Peak Oil Ver­sus Peak Net Exports–Which Should We Be More Con­cerned About?.

    Oil com­prises ~35% of the world pri­mary energy sup­ply (IEA 2007). As oil declines, the world econ­omy will con­tract at roughly a 1 to 1 ratio dis­count­ing debt effects. Mit­i­ga­tion of max­i­mum world oil pro­duc­tion: Short­age sce­nar­ios, Hirsch, 2008.

    Accord­ing to the recently leaked Ger­man mil­i­tary report:
    “The above men­tioned chain of events shows clearly that the energy sup­ply of the eco­nomic cycle must be assured. The energy sup­ply must be suf­fi­cient to allow pos­i­tive eco­nomic growth. A shrink­ing econ­omy over an inde­ter­mi­nate period presents a highly unsta­ble sit­u­a­tion which inevitably leads to sys­tem col­lapse. The risks to secu­rity posed by such a devel­op­ment can­not even be esti­mated (p. 50).

    Putting the Bun­deswehr report in con­text

    I encour­age you to inves­ti­gate the sit­u­a­tion with oil and include it in your fore­casts. The pub­lic agency mod­els are com­pletely wrong. For instance, we have dis­cov­ered only 1/3 of the oil the United States Geo­log­i­cal Sur­vey pre­dicted we would by now back in 2000 but the agen­cies have not revised their fore­casts to reflect that. 

    Just as the gen­eral econ­o­mist should lis­ten to Prof. Keen, so too should peo­ple be lis­ten­ing to the ana­lysts at the Asso­ci­a­tion for the Study of Peak Oil.


  • BH

    I don’t know how to rec­on­cile the loans cre­ates deposits view with the com­ments made by bankers regard­ing their fund­ing. Can any­one help here on this?

    For exam­ple in the arti­cle hur­rah linked above I read…
    “It’s very hard to wipe out the bond­hold­ers because they are the source of fund­ing to keep the banks going,” said Philip Hamp­ton, chair­man of Royal Bank of Scot­land Group Plc, whose Edin­burgh-based bank received 45.5 bil­lion pounds ($71.5 bil­lion) in the biggest bank bailout in the world dur­ing the finan­cial cri­sis.

  • bb


    I don’t know alot about peak oil. My sense is that peak oil is a two dimen­sional proble. “peak oil at a cer­tain price” seems to be a more appro­pri­ate descrip­tion.

    My (very une­d­u­cated) thoughts are

    1. We heard about peak oil in 2008 when the price of oil was US$150 per bar­rel. The price has halved since then which would be incon­sis­tent with peak oil the­ory

    2. If you pick up any annual report of a major oil pro­ducer it is clear the aver­age cost of pro­duc­tion per bar­rel of oil is about US$30–40 per bar­rel. It would be weird if all of the fian­cially viable oil was priced at such a low level. Surely at $80–90 per bar­rel, more sites become prof­itable. Of course this could take years to come on line.

    just my 2c

  • bb


    Banks cre­ate deposits the moment they make a loan. So on day one, they are fully funded. Assume this orig­i­nal loan comes from, say, Bank A.

    Day 2, when the per­son who received the loan spends the money, one of three things hap­pen.

    1. The money is spent on domes­tic con­sump­tion (eg: build a house, etc). The providers of this prod­uct (ie Builders)recieve the money and put it in bank A. There­fore Bank A remains fully funded.

    2. The money is spent on domes­tic con­sump­tion (eg: build a house, etc). The providers of this prod­uct (ie Builders)recieve the money and put it in the bank (say Bank B). Since this is dif­fer­ent to Bank A, Bank B will have a cash sur­plus equal to the amount Bank A has a cash deficit. Bank B will tend to lend money to Bank A in the money mar­kets to get an ade­quate return on their cash sur­plus.

    This trans­ac­tion rep­re­sents “overnight cash”. Very risky for Bank A to Fund itself with short term cash, so from time to time it may issue longer term bonds to repay the short term loans from B. The cash from the bonds comes from the depositers of B who are look­ing to make an invest­ment in Bank rated papaer. B’s depositers decline, but thats ok, its short term loan from A just got repaid.

    So far the sys­tem remains in bal­ance. Its just banks may have dif­fer­ent bal­ances and need to lend to each other to cover deficits or put excess cap­i­tal to work.

    3. The money is spent on for­eign con­sump­tion (eg: Plazma TV from Japan). The buyer sells $A and buys Yen to pur­chase the TV.

    The buyer of the $A has a prob­lem. Where do I put this money I just bought?

    They may buy an office tower, or shares, a house or iron ore. No mat­ter what they do, the seller of the Office tower / shares / house / iorn ore has to put the money some­where. Either Bank A (bank A remains fully funded) or Bank B (and we go back to point (2) above).

    So you need to look at all of the banks in total to come to a con­clu­sion that the banks are self fund­ing. At an indi­vid­ual level some banks may have deficits and some may have sur­pluses.

  • Philip

    That was an inter­est­ing arti­cle about Stiglitz in the Dai­ly­Fi­nance.

    One group of peo­ple who are never held account­able are econ­o­mists. The econ­o­mists in the cen­tral banks, trea­suries, reg­u­la­tory agen­cies, uni­ver­si­ties, etc. have got away free like the bankers.

    I would rec­om­mend that econ­o­mists be sub­ject to fir­ing, fines and impris­on­ment, if eco­nomic dis­as­ters occur on their watch.

    Fur­ther­more, as the U.S. is one of the last West­ern coun­tries to employ the death penalty, if the rich demand that cor­po­ra­tions have the right of per­son­age, then cor­po­ra­tions should also be sub­ject to exe­cu­tion.

  • Hi bb,

    It’s worth research­ing King (really, his first name was King) Hub­bert, an oil engi­neer who first devel­oped the con­cept of Peak Oil. It’s a math­e­mat­i­cal propo­si­tion derived from the fact that there is a finite amount of oil that we began exploit­ing pretty much in the 19th cen­tury. Given that there was a set amount to begin with and no more is being pro­duced (cer­tainly not on a human time scale, though it may be being gen­er­ated on a geo­log­i­cal one), if we con­tinue using it then at some stage we will exhaust it. The sim­plest rela­tion for the remain­ing amount of oil at any point in time is an inverse sig­moid (which reflects an expo­nen­tial increase in ini­tial min­ing when it’s all vir­tu­ally sur­face level when it’s easy to exploit, and decrease towards zero as we taper to hav­ing no oil left), and the dif­fer­en­tial of this spec­i­fies the rate of flow of oil at any point in time.

    The dif­fer­en­tial is effec­tively a bell-shaped curve, hence “Peak Oil”.

    Using this for­mula and fit­ting it to US data in the mid-1950s, he pre­dicted that the US would hit its own Peak Oil in 1970. He was derided for his pre­dic­tion at the time (I know the feel­ing), and was proven cor­rect when US oil pro­duc­tion peaked in the 1970s.

    There’s a lot more to it than that, but that’s the begin­ning. On the price issue, con­sider the fol­low­ing:

    [T]here is a dif­fer­ent and more fun­da­men­tal cost that is inde­pen­dent of the mon­e­tary price. That is the energy cost of explo­ration and pro­duc­tion. So long as oil is used as a source of energy, when the energy cost of recov­er­ing a bar­rel of oil becomes greater than the energy con­tent of the oil, pro­duc­tion will cease no mat­ter what the mon­e­tary price may be.”

  • ak


    I have no doubts that the finan­cial sec­tor (espe­cially in the US but not only there) has been involved in com­mit­ting a sys­temic fraud by push­ing debt to peo­ple which they can­not repay (and a few other lit­tle things). 

    The fraud has been com­mit­ted in the name of “free mar­kets”, “com­pe­ti­tion” and “effi­cient resource allo­ca­tion”. Every­thing sci­en­tif­i­cally proven by Mil­ton Fried­man and the oth­ers.

    We should be thank­ful that this hap­pens as the alter­na­tive would be much more worse for (some of) us: state reg­u­la­tion and inter­ven­tion, maybe even nation­al­i­sa­tion of banks or print­ing money. There would be actu­ally peo­ple respon­si­ble for mak­ing deci­sions. Now “an invis­i­ble hand” is steal­ing wealth from us. Free mar­kets and cor­po­ra­tions. This is way bet­ter than the old Soviet Com­mu­nist Party. Nobody is respon­si­ble for any­thing. A cor­po­ra­tion can sue and ruin an indi­vid­ual or bend the law but there is no way a cor­po­ra­tion can be brought to crim­i­nal jus­tice as they are all super­hu­man. You can­not sue gods and you can­not put bankers in jail.

    The man­agers? “I was only clean­ing up the office here, I don’t know any­thing”.

    Oh and the British Trea­sury has “objec­tively” run out of money and they are shut­ting down the state. Bad luck, noth­ing else can be done about it. 

    We tried feu­dal­ism, cap­i­tal­ism, Stal­in­ism, “real social­ism”. Now it’s time for lit­tle masochism.

  • BB, Steve has it cor­rect. And I can under­stand why he feels like Hub­bert! Hub­bert was even­tu­ally vin­di­cated in his life but it took sev­eral years past the peak of U.S. pro­duc­tion before peo­ple gen­er­ally acknowl­edged that pro­duc­tion was in ter­mi­nal decline and no amount of tech­nol­ogy or money thrown at the prob­lem was going to change that fact.

    It turns out that your think­ing is com­mon, that higher prices will bring more pro­duc­tion, and that is often true but only within the bounds of the bell-shaped curve. I’ll attach the curve for con­ven­tional oil to this post. 

    It’s impor­tant to dis­tin­guish between con­ven­tional, liq­uid crude and uncon­ven­tional oil. The dis­cov­ery of con­ven­tional oil peaked in the early 60’s. Since then each decade has found less oil than before. We will con­tinue to find oil but cur­rently we are using between 3 and 4 bar­rels for every bar­rel we dis­cover. In other words, we have been draw­ing down our oil inher­i­tance since the 80’s when pro­duc­tion exceeded dis­cov­er­ies.

    If you begin to fol­low this story, you will hear that there are tril­lions of bar­rels of oil in the Alberta tar sands or off the coast of Brazil. But it’s not only the quan­tity of oil we are con­cerned about: it’s the flow rate. If it takes 10 years to add another 1 mil­lion bar­rels per day of tar sand pro­duc­tion, that really doesn’t help if the liq­uid crude is declin­ing at 4 mil­lion bar­rels each and every year. Same with Brazil’s oil. The remain­ing oil is really dif­fi­cult to get, really expen­sive and sim­ply won’t come online quickly enough to stop us from falling off the plateau we are on.

    The oil fields to watch are the giants and super­giants, which pro­vide 60% of world pro­duc­tion. A col­league of mine at the Global Energy Sys­tems Group in Upp­sala Uni­ver­sity stud­ied them in depth. Just 20 fields pro­vide 25% of world pro­duc­tion. In other words, as they decline, it pretty much doesn’t mat­ter what we do with all the smaller fields: world oil pro­duc­tion will decline sim­ply because they make up such a high por­tion of over­all pro­duc­tion.

    Unfor­tu­nately, most econ­o­mists (not Steve!) under­stand only the price mech­a­nism and thus think that a higher price will always bring more oil to mar­ket. Because they do not under­stand the geol­ogy of the prob­lem, they are gravely incor­rect. The price mech­a­nism must work within the phys­i­cal bounds of the prob­lem.

    Prob­a­bly the best expla­na­tion is the report by The UK Indus­try Task Force on Peak Oil and Energy Secu­rity. How­ever, a report to the New Zealand Par­lia­ment that was released a cou­ple weeks ago is a very good, much shorter syn­op­sis.

    The con­sen­sus by the petro­leum geol­o­gists as this con­fer­ence was that we fall off the pro­duc­tion plateau we are on between 2 and 5 year from now. Then world oil pro­duc­tion declines at 2% to 4% per year for­ever. This will, under­stand­ably, rearrange the world econ­omy.


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