Why credit money fails

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I’ve given several talks on this general topic recently–at the ASSA (Academy of Social Sciences of Australia) annual symposium “Family fortunes in the aftermath of the global financial crisis“, The Gold Symposium, the Australian Investors’ AssociationBulls vs Bears” Symposium, and finally at the Local Future 2010 Conference on Sustainability: Energy, Economy & Environment in Grand Rapids, Michigan.

I was given one and a half hours to present at the Local Future event, which gave me the opportunity to present a comprehensive treatment of the dynamics of credit money and the “Global Financial Crisis” (to use the Australian moniker for it) or “Great Recession” (as economists in the US refer to it). At the other talks, I had to skip over substantial parts of my argument to fit within shorter time slots.

I’m still at the Grand Rapids conference, and scheduled to give two more talks today (one on using QED, the other on Debunking Economics–I’m writing a second edition for publication early next year), so I’ll make this a brief post and let the screen capture video below speak for itself.

Aaron Wissner’s introduction

Steve Keen's Debtwatch Podcast


Video capture of my talk (with audio)

Steve Keen's Debtwatch Podcast 

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Recording of the discussion

Steve Keen's Debtwatch Podcast


MP3 recording of my speech

Steve Keen's Debtwatch Podcast


I make extensive use of the program QED (which has been developed for me by a collaborator who wishes to remain anonymous for now), and the program is embedded as a zip archive in slide 17 in my Powerpoint Presentation. To run it, right click on the icon on the slide, save the ZIP file to somewhere on your computer, unzip the contents, change to the subdirectory and double click on QED.EXE. I hope to be able to do a screen capture of my demonstration of the program at the conference today, which should make it easier to work out how to drive it.

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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67 Responses to Why credit money fails

  1. Hawkeye_Pierce says:

    To Steve & others

    Does anyone know of any specific academic literature that tackles the thorny question of Credit Quantity versus Credit Quality.?The current assumption is that debt can keep growing because there is no perverse incentive to mis-price the risk.

    Here is an excerpt from a paper I recently submitted to the UK’s Independent Commission on Banking:

    “The crux of the model is that the aggregate quantity and quality of credit issuance within a market is inversely related (Warburton 1999 Debt & Delusion, p47, p49). Rationing of credit is believed to result in an overall improved status of portfolio quality, whereas an increase of total credit issuance is connected with worsening quality. In an Originate & Distribute (Securitisation) environment, rising quantity of credit issuance is feasible by accepting (potentially mis-priced) declines of credit quality, assisted on the part of the issuer through the practice of risk transfer.

    Rather than provide a valuable risk reduction function for society, it seems that modern banking practices such as securitisation disguise the underlying levels of risk and pass the problem along the food chain. Therefore, permitting risk transfer practices (in the form of securitisation) is tantamount to condoning sub-optimal lending activity. ”

    Are there any other people (other than Peter Warburton) who think along these lines?

    See page 5 of the pdf report:


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  3. Tom Shaw says:

    Here’s my thought-bubble solution to Minskian instability as you’ve described it.

    There are two goals:
    * Converge debt/NNP (net national product) to a target level
    * Continue to allow credit impulses to grow the economy

    These goals sound contradictory but I believe they can be solved by correctly aligning incentives. The trick is (a) to remove excess accumulated credit from the economy in a way that does not subtract from demand and (b) dampen the positive feedback for lenders.

    Step 1. Govt establishes a debt/NNP target.

    Step 2. Govt unilaterally cancels a proportion of all existing debt to match target and guarantees to do so again in future. Basically: a law directs the courts that they can only enforce e.g. 50% of loan amounts existing at the time of the change.

    Step 3. Banking industry exempted from some aspects of competition regulation to allow them to maximise industry profits. Given debt/NNP is now fixed, the only way to maximise industry profits is to grow NNP (or increase fees – but this can still be controlled through competition).

    Banks would then favour:
    * Loans for building new property over buying existing property
    * Loans for new businesses over loans to buy existing shares
    * Loans for productive investment over consumption
    * Loans for local products over international products

    Basically, you’ve short-circuited the asset price bubble process.

    Of these steps, Step 2 is probably the most controversial. However, I believe it would be more popular than bank bailouts (and produce fewer moral hazards), and less protracted and damaging than inflation. Note that it is morally equivalent to controlling the inflation rate, which is widely accepted by economists.

    As I said this is just a thought-bubble, so I’m keen to hear if it makes sense or if there are obvious flaws that would pop it.

  4. Tom Shaw says:

    The flaw would be that the loan asset shortfall would need to be recovered somehow, probably by capital injection from the government, effectively nationalizing the banks. Bank shareholders would bear the brunt of the dilution. Maybe not a bad thing if excessive lending was the cause of the problem, but as I said, controversial.

    I guess I’m thinking out loud trying to find a solution with the same basic outcome as years of inflation – but faster and with lingering positive incentives, rather than moral hazards. Clearly I need to think some more.

  5. Steve Keen says:

    Yes, but your starting point is a good one Tom. However consider the political situation that would need to apply for the government to set such targets and enforce them. I doubt that there’d be any representatives of Goldman Sachs advising the President in such a situation…

  6. Tom Shaw says:

    Interesting point. That’s another positive feedback: those who benefit from the system will tend to be powerful enough to perpetuate it.

    It reminds me of reading Erik Reinert. His position is that Europe’s dynamic growth came from the economic competition between nation-states, and the copying of successful policy innovation across borders. I don’t remember if Reinert said this, but “us v them” at a state level would also be a great way to align incentives within a state.

    So perhaps the meta-solution, at least politically, will come from not wanting to fall behind internationally. Or the US could foster this internally by devolving power from the federal to the state level (see the growth of the Tea Party movement).

  7. Tom Shaw says:

    PS You can see this effect in action even now. Krugman wrote an essay a few days ago comparing Iceland’s policy response to Ireland’s. I can’t judge if he’s right or wrong – time will tell – but you can be sure other countries and whole populations are watching the outcome closely.

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  9. Tel says:

    “Question: how does Cameron sell this to the public when a lot of them despise the EU?”

    He would probably start his speech with the words, “Too bad, so sad” and finish up along the lines of, “Ha, Ha, who you gonna vote for? More Labour?”

    But Lisbon got pushed through by completely ignoring the democratic rights of the European people, so the EU leaders are working on a principle that votes are irrelevant… and maybe they could turn out to be right.

  10. RogueDave says:

    Have you updated your model/presentation for policy efforts such as the Fed’s QE.2?
    Thank you,

  11. Steve Keen says:

    Not yet RogueDave,

    But my perspective is that QE2 is more of a dinghy than an ocean liner. This is supposed to be $600 billion over 12 months, when QE1 was over $1 trillion in only 5 months. I expect it to be a damp squib.

  12. RogueDave says:

    Thanks for the reply Steve. After posting I thought through my question more completely, and realized the generic question of QE.1,2,3,4,5,x should have been posed.

    Further, as the model looks at the US economy in isolation, do you anticipate adding non-US elements?

  13. Steve Keen says:

    Not in a short time horizon RD. At a technical level that means multi-economy modeling, and that’s something I might leave to PhD students to develop.

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  16. Stamatis Kavvadias says:

    Prof. Steve Keen,

    Currently, both the video and the introduction of Aaron Wissner to your talk in this page cannot be found! Please restore the missing links, because this is, I believe, a very interesting talk.

    A have a question that is rather involved… You go to great lengths in this talk, to explain a common fallacy that the money to pay interests “do not exist in the system of debt-based money”. You explain that the flow of money is supposed to be adequate to pay the interest and create revenues, in addition to paying down the debt. The answerback to this argument is that in the present monetary system and regulation worldwide, *there is nothing* to force lenders to spend their income gained from interest payments! Lenders (e.g., those getting dividends from bank profits) can save their income, or even *lend it again*, requiring the existence of money, to pay additional interests! This can be true both for banks and especially for other non-official sector lenders.

    Further, even without the issue of recirculation of interest-derived revenues, the existence of interests in a world of wealth concentration (I call it capitalism, though I am not an economist) should be causing a similar problem. If the money from interests are spent in the economy, but go to the hands of savers (or even the wealthiest organizations in the world, in concert, start collecting on debts owed to them but do not pay down their obligations), then the money to pay some of the interests may start to be missing! If money saved are lent again, additional need for money to pay interests will emerge.

    Both situations above, inevitably lead to the requirement of re-financing their debts, and this time the interests will be higher.

    ***** If the situation persists, the interests that mount up will require an ever increasing productivity from the borrowers. ***** (my question/request refers to this)

    This may seem as a reasonable situation to a capitalist, but consider that, in the globalized economy we live in, this may also happen to sovereign states (if politicians tends to have the state borrowing instead of the private sector, as in the case of Greece)! I view this as a complementary fact to your detection of the unconstrained bank lending.

    Now to my question/request. I think your model needs refinement, to include savers and investment/re-lending. It is clear that the largest fraction of the wealth is concentrated to the hands of few, and there are statistics on that, and it is clear that the wealthiest spend a significantly small fraction of their income, and invest a lot of it. Of course, this inequality needs to be taken into account in the model of savers and re-lending. Further, the only way to address such an issue is redistribution of wealth, usually done through taxation. I am kind of scared of the implications this may have on a global scale, where redistribution of wealth is not possible, but this could alert as of coming wars, and urge us to take action! I would add another parameter to the discussion: the velocity of money circulation calculated by your modeling that includes savers and re-lending. This approach, applied in global scale, would allow for a reasonable measure of when a sovereign economy cannot handle its borrowing costs: when the required velocity of money significantly exceeds the one observed in the economy.

    Do you think this would be worth the effort and could be done in a scientific way? Maybe there is already significant research on the issue. I would be very interested in such results, or any answer on the issue.

  17. Stamatis Kavvadias says:

    … On second thought, my comment on when a sovereign economy cannot handle its borrowing costs, may further need integration of debt re-financing dynamics, which is a common situation with sovereigns. Anyway.

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