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. Steve Keen says:

    That may happen through a Wall Street Journal blog tomorrow barry. The journalist referred me to Krugman’s paper and asked for my comments.

    I’ll be writing a blog on it shortly with the working title of “Krugman walks the dog: a neoclassical Minsky model”

  2. RRN says:

    Hi Steve, Watched your site for a long time now and want to alert all to the recent news the our banks appear to be convincing Gillard and Swan to allow them to issue “covered” bonds to raise cheaper international funding and hence, cheaper mortgages and further holding the house price bubble in tact. I’m sure you know that this weakens the security/status of domestic depositors in the event of an insolvency. Thin edge of a wedge where the common man will wear the eventual pain.

  3. Steve Keen says:

    Thanks RRN,

    Doesn’t surprise me of course: at the same time as they are publicly denying any prospects of failure, they are teeing up contingency plans for when it happens that distribute the risk and consequences from themselves to the broader community.

  4. ned says:

    Hey mahaish,

    Remember our discussion about how you think the Fed is all powerfull and can control interest rates? What’s gone wrong man? The ten year (and 5 and 30 too) seem to be going in the wrong direction since QE2!! What’s up with that??

  5. mfo says:


    Chances are in 12 months time this story could be reprinted in Australia word for word. The only changes required is replacing Ireland with Australia.

  6. mahaish says:

    early days ned early days,

    one months worth of data doesnt make a summer or is it autumn there 😉

    lets remember, the fed is in buying mode re Longer term maturity securities . not selling, but buying

    they want to drive the price up and lower the yield. is 600 billion enough to drive down yields . thats up for debate given the size of the market. but i suspect market psychology may be on feds side if enough people see the US as a sovereign risk. so the fed may get all the sellers it wants in the medium term and hence drive down yields

    but lets not forget the fed has infinitely deep pockets. if someone wants to sell a treasury, the fed just types in the increased balances at the sellers reserve or bank account.

    the fed can create money out of thin air, the private owners of treasuries cant , and as long as there are enough sellers it can drive the yield down.

    we’ll see if there are enough rats wanting to jump off the good ship USA

    and look at the longer trend line in your graph. we may just be crossing a little hill as we walk down to the valley floor.

    we’ll see what the picture looks like in about 6 months when that extra 600 billion in credit easing works throught the system.

    the beers on me if im wrong, and that may be the case if it turns out 600 billion isnt enough

    all the best

  7. barrythompson says:

    Regular readers will know that Steve is considering adding government-created fiat money to his model, to study the effects of fiscal stimulus via deficit spending. An issue here has been the uncertainty over the mechanism by which deficits create money.

    There is now a new article that appears to make it possible to reconcile the chartalist/MMT school of thought with the circuitist/new-keynesian school of thought. Stephanie Kelton argues very clearly that all government bonds are initially bought with newly created bank credit. Thus, deficits add newly created deposits, plus newly created bonds to the economy.


  8. mahaish says:

    actually ned,

    in speaking of walking all the way down to the valley floor,

    its interesting to note that 10 year treasury yields have been falling ever since the very early 70’s.

    QE or no QE, there are deeper forces at play driving the long term bond yield

    we could have a very interesting discussion as to what those forces might be

  9. mannfm11 says:

    I find a bunch of justification for a lot of actions being taken. One is the QE2, which I believe is nothing but an effort to hide bank fraud. The reason rates are going up on bonds is they aren’t a supply and demand item, but a risk and return item and inflation expectations and default risk have to be a part of the equation. QE didn’t work in Japan, for if Japan couldn’t get off the carpet with a rest of the world rapidly inflating prior to the GFC, when was it going to get off?

    US banks and brokers, from what I undersand, are going to get paid $120 billion. That is like a 1% tax on the economy. The banking system is insolvent. QE is putting the money in the banks to convert to the bankers and add to the bill we are going to get down the road. They call it talent, as in Clyde Barrow, Baby Face Nelson or John Dillinger. That is justification for the high pay.

    I don’t believe neo-classical economics is anything but a banker devised sham to allow looting of the population. QE doesn’t put any money into accounts as it is done and if it did, they would still be liabilities of the banking system, which is insolvent.

    Unfortunately I don’t have a model, a name or an education, because I started writing about this during the NASDAQ bubble implosion myself. One of my first posts, I described pretty much what happened in 2008. Most people don’t realize who was exposed in 2008. Literally every major financial institution in the US and Europe was shown to be insolvent. The dominos are lined up.

    The US needs a $25 trillion liquidation and replacing the $25 trillion with government spending won’t work. We have too many artificial prices and too many constraints to do what should be done, a huge haircut and maybe some prosecution. Plus, interest rates would have to rise if we were to take a haircut. Stimulus could come afterwards, not before. The idea of privatizing gains and socializing losses is something that is going to have to come to an end. The US has put itself in the same boat with Ireland, in that much of the mess is financial guarantees.

    The problem is how do you model a depression and a recovery from one. As I said, Japan has proven the current solution doesn’t work. Steve has put out a good model to show where aggregate demand falls short through credit contraction, but the way that kind of depression could be stopped would be to amp the credit creation up another notch. We all know that would lead to total collapse, but that seems to be the solution. Something tells me to clean this out, we need to go to the bottom, as we are talking not only about a debt liquidation, but an entirely different price structure. Plus AD has to be based on a less explosive amount of debt accumulation.

    One thing Steve has pointed out that I figured out several years ago was the banks created the credit,then looked for the reserves. The Fed might buy treasury securities, but that didn’t mean the banks sold them. Cash doesn’t pay a return. This being the case, I realized more than a decade ago that the real reserves of a bank was its capital base. Guess what. It isn’t there and the reserves aren’t going to do any good, because all they do is paint both sides of the balance sheet with an equal number at best. At worst, they turn an interest bearing asset into a non-interest bearing one. I believe the story I was told in money and banking was a wives tale and have believed that for 10 years or more.

    Being that the idea of what I call socialist economics is to maximize AD, where do we go from here? Seems the hocus pocus of broad credit expansion is their pet gorilla. What is called capitalism, which is generally banking and rampant speculation, has very little to do with capitalism. Banking and speculation are linked to each other and from what I can tell, the only large bubble in modern history that didn’t take place in a bank credit bubble was the Tulip Mania. That happened due to a large amount of gold being coined in the Netherlands, but I would compare it more to a Beany Baby craze, as it was a fast and unsustained bubble that arose and collapsed in a few months.

    A depression is a different animal. I think concentration of wealth is just a symptom of a depression, as it is the counter party, concentration of debt in the speculative rich and the lower middle class that represents much of that wealth. It is not by chance that this process was called wealth creation. But, isn’t true wealth real and not imagined? The idea that the structure of asset values is going to be supported on a pile of bad levied on the very group that supplies the demand for products that support asset prices is not going to work. Even if there is debt forgiveness, there is still the absence of the demand that was provided by excessive credit. Remaking the system based on excessive credit, which turns to excessive bad debt isn’t going to work and I doubt replacing private investment with public investment is going to work either.

    The World War II experiment worked, not because it was war, but because there was forced savings. Americans came out of the war with money in their pockets. They also came out with a huge market for capital goods, as Europe had been ravaged. The world has run on American credit since and that is coming to an end.

    So, the end goal is pretty much stated, reflate the lower end of the economy and clear out its debt. The debt is pretty much declaring a spade a spade, as the debt, the demand and the support of these people cannot be maintained in the status quo. It was clearly a mistake to give these people the means to enjoy an unsustainable lifestyle, which is the other problem. Aggregate demand included the unsustainable credit. It is also clear the millions of people in this class can’t live in a high income country and have their wages compromised by the use of labor that is paid a dime on the dollar. What to do about this problem is just as important on the developed nation side of the equation as the emerging market and it has more to do with so called wealth creation that can’t be sustained than the workers themselves.

    I think there is more to Says Law (I may have the wrong theory) than meets the eye. This pile of debt is all based on the idea we can have more if we invent more money. The debt is also based on the idea it is collectible and in sum it is never collectible. In fact, the more there is, the greater percentage isn’t collectible and enforcement of it becomes societal debt peonage. It is this debt peonage that depresses aggregate demand more than anything. I can see it in my job of managing properties.

  10. soho44 says:

    Speculation’s still rampant about how big the Irish Bailout will be. Understandably, these are happening:

    National pride is at stake.
    The govt. is blatantly spinning this and it’s not working.
    Does the opposition have enough support to force the govt. to call an election? I don’t think so.
    Odds are, the total bailout amount will be way more than the govt. amount quoted.

    One thing that’s never been mentioned up until now? Name one country in the world that’s said no to the IMF? Answer: Brazil’s last president said no to the IMF offer of restructuring an loan. They then went on to pay it off , and now are doing ok.

    If Ireland says no to the IMF and EU, can they then be expelled from the EU? Can the other members impose sanctions against them (like it’s really going to do any good at that point)?

    Also, if they say no then what they’re doing is daring to go against the power of the States. Slightly off-topic: when rendition flights to torture people were taking place under Bush II, flights routinely went thru Irish airspace. Yet, the govt. never refused them entry.

    Why? Plausible deniability. We knew, but publically we denied it. We didn’t dare offend one of our biggest trading partners. What if a secret CIA prison was on Irish soil? Would you still deny it then?

    For a while, only the nutcase neocon fringe crowd was talking about the States being bankrupt. Now, if you do a search you’re starting to see more reputable sources saying the same thing. Most are still outside and only seen at night here in the States (on the “Overnight Global News” on CNBC or Bloomberg). But what they’re saying is essentially correct.

    If the IMF bails them out, my understanding is that the Irish govt. has no negotiating room. A schedule is set and reviews are conducted at times to make sure conditions are being met. If they’re not, then further funds are cut off. The Greek govt. has publically admitted that they can’t meet their bailout conditions without billions more.

    Where will the EU and IMF get further funds when almost everyone is debasing their currencies?

    Unfortunately the Irish public is guilty of the same apathy as the Stateside public. The govt. and banks are guilty of incompetence, global mismanagement, fraud and what else? Nobody’s being prosecuted. Despite all of this, most people that I’m seeing on the news are having a go at them on their favorite talk shows. And that’s going to solve the problem.

    Have you lost count of the parallels between Ireland and the States?

    Ireland’s new budget is voted in in December. My predictions?

    The govt. will stay in power.
    They also won’t have the nerve to stand up to the rest of the EU and the States.
    The initial bailout amount will probably be doubled once the govt. admits that it’s not enough.
    Then lots of other EU members will line up for bailouts as well.
    The vulture hedge funds will have a field day trying to play all the angles in this.
    Bernanke will continue with his idiotic soundbites.
    And finally, commodities will continue to go up as a hedge against the collapsing Euro.

  11. soho44 says:

    What’s a key criteria for becoming an EU member?
    “The existence of a functioning market economy as well as the capacity to cope with competitive pressure and market forces within the Union.” (stolen from Wikipedia).

    Now, time to split legal hairs. How do you define “functioning market economy”? Most reasonable people would probably say these.:

    A healthy GNP rate.
    A low inflation rate.
    Various growing economic sectors.
    A low corporate tax rate to promote investment (both at home and from abroad).
    A stable currency.

    If I’m the Prime Minister of a new country and want EU membership, does the EU come in and inspect all of the govt. financial records? If I’m notoriously corrupt (like many say the Greek govt. has been) and I’m accepted and then apply for a bailout, who’s responsible? My govt. or the EU for letting me in in the first place?

    The problem is that none of the EU members are adhering to the Maastricht Treaty. I’ve heard some rich and powerful market players say what do you expect? At that level, everybody knows this goes on. But nobody does anything.

    What the IMF should do is this. Make investigating, prosecuting and if necessary jailing everyone responsible for this meltdown in Ireland. If they don’t do it, then the EU loses market credibility (which could then collapse it). If they do enforce this, then the current Irish govt. stays in power. The EU doesn’t collapse. After that, the potential short profits from hedge fund speculators will be cut.

  12. mahaish says:

    “Hi Steve, Watched your site for a long time now and want to alert all to the recent news the our banks appear to be convincing Gillard and Swan to allow them to issue “covered” bonds to raise cheaper international funding and hence, cheaper mortgages and further holding the house price bubble in tact”

    hi rnn,

    the wholesale funding guarantee finished according to my knowledge in march this year.

    any new bank liabilities from that period do not have the government guarantee. perhaps the banks want the guarantee re introduced to cover any future anticipated funding problems, especially if their analysts are saying there may be a second wave of defaults coming in the US for instance

  13. BH says:

    “covered bonds” does not refer to a wholesale government guarantee but might have some interaction with the remaining depositor guarantee.

    “Australian financial institutions cannot sell covered bonds because domestic law requires banks to place depositors above all other creditors in their claims on assets. Covered bonds would subordinate depositors. They typically give the bond buyer recourse to both the issuer and the pool of mortgages or other secured collateral that stays on the bank’s books and “covers” the bond.”
    ( http://www.theaustralian.com.au/business/city-beat/australias-big-banks-renew-push-for-covered-bonds/story-fn4xq4v1-1225860365202)

    It seems like a poor idea that would just white-ant confidence in the banking system.

  14. mahaish says:

    ah ha, i see,

    ive miss construed, mutch obliged bh,

    and yes agree with your sentiment

  15. noah cross says:

    This won’t help weekend sales.
    Treasury warns against bubble.

    It will be intriguing to see the reactions of the Chris Joyes et al.
    Could they bet $100 million against Treasury; or ask that Treasury cease and desist?

  16. Steve Keen says:

    He won’t like how I’m doing it. I’m writing a post entitled “Krugman walks the dog”. It’s related to “the Fonz jumps the shark”.

  17. soho44 says:

    Here’s an angle on the Bailout that nobody’s publically mentioned.

    What happens if Ireland gets a bailout? Then, other EU members line up for bailouts as well. After that, the EU itself needs a bailout.

    If the EU is such a great stabilizing force globally, who’s going to save it?

  18. mahaish says:

    “If I’m the Prime Minister of a new country and want EU membership, does the EU come in and inspect all of the govt”

    not until well after the horse has bolted by the looks of it, soho44

    the greeks ran up budget deficits upto 3 times larger than allowed under maastricht

    “The problem is that none of the EU members are adhering to the Maastricht Treaty”

    the problem is soho44, maastricht is a nonsensensicle idea, and bad rules are meant for the breaking,

    from my understanding, EU monetary union architecture means the EU central bank sets the interest rate target, but each countries central bank controls currency issue. thats why the greeks were able to run up large deficits above the target range. and so they should in order to fight an economic downturn.

    insisting on adhearing to non sensicle deficit targets and imposing auterity measures on the population is only going to speed up the demise of the EU, once the political feed back comes through.

    EU policy makers need to understand this, or start dedicating a greater part of their budgets to hireing riot police.

  19. Fred says:

    Simple answer. Because they are a party to the fraud. Theft on a grand scale.

    Here’s some Christmas reading; “Confessions of an economic hit man” John Perkins, “Drugging America: A trojan Horse”, Webster Tarpley, and Michael Hudson, to name a few.

  20. John Prentice says:

    Soho, your mistake about the “FED” is that it cares about nominal rates. It does not. Matter of fact,a rising 30 year for example, would be a GOOD thing as it would be a indication of easement in “real” short term rates. That is the problem. Short term rates are to high in “real” terms and the rentier is over saving and not investing. Causing consumers to lose savings and spend less. So the Fed wants to steepen the “real” yield curve which also has the side effect of helping the banks to recap faster(surprise, surprise). To the FED it is win win for everybody.

    The whole goal of “QE” is slight of hand. Fake out the rentier to spend more into the economy while in all reality doing nothing in any signifigent terms. The real question comes if the market stops caring and forces the FED to nakedly print. Which is the REAL printing.

  21. cja says:

    There seems to have been a fairly significant fall off in Australian house auction clearance rates recently. Do you know if this is flowing onto private debt? I’ve also seen articles like recently. Do you know where we are with debt-financed demand currently?

  22. cja says:

    Debt, Deleveraging, and the Liquidity Trap by Eggertsson and Krugman.

    “…yes, it does suggest that the current conventional wisdom about what policy makers should be doing now is almost completely wrong.”

  23. Steve Keen says:

    It’s the other way round cja–the slowdown in debt is flowing through into auction clearance rates. The “credit impulse” from the household sector has turned negative now that the FHVB is over, and that is causing the reduction in demand for housing and hence the fall in clearance rates. On the other side, I expect that an increase in distress sales as rates rise is adding to supply. So there truly is a supply-demand imbalance now, hence the falling clearance rates and the increasing overhang of unsold stock on the market.

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