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 

| Open Player in New Win­dow

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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  • Hawkeye_Pierce

    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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  • Tom Shaw

    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.

  • Tom Shaw

    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.

  • 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…

  • Tom Shaw

    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).

  • Tom Shaw

    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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  • Tel

    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.

  • Rogue­Dave

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

  • 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.

  • Rogue­Dave

    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?

  • 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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  • Stama­tis Kav­va­dias

    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.

  • Stama­tis Kav­va­dias

    … 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.