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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  • 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”

  • RRN

    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.

  • 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.

  • ned

    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??

  • mfo


    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.

  • mahaish

    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

  • bar­ry­thomp­son

    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.


  • mahaish

    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

  • 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.

  • soho44

    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.

  • soho44

    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.

  • mahaish

    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

  • BH

    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.

  • mahaish

    ah ha, i see,

    ive miss con­strued, mutch obliged bh,

    and yes agree with your sen­ti­ment

  • noah cross

    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?

  • 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”.

  • soho44

    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?

  • mahaish

    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.

  • ferb
  • Fred

    What are these if not exactly the same as cov­ered bonds?

  • Fred

    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.

  • John Pren­tice

    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.

  • cja

    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?

  • cja

    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.”

  • 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.