The Crisis in 1000 words—or less

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URPE–The Union for Rad­i­cal Polit­i­cal Economics–is hold­ing a Sum­mer School for the Occu­py move­ment, and as part of that invit­ed papers that explained the cri­sis in 1000 words or less (so that they can be print­ed on one dou­ble-sided sheet).  Here’s my effort in some­what less than 1,000 words (though with 2 fig­ures). In the inter­ests of URPE’s objec­tive in this exer­cise, here’s the PDF of this blog post for gen­er­al down­load.

Both the cri­sis and the appar­ent boom before it were caused by the change in pri­vate debt. Ris­ing aggre­gate pri­vate debt adds to demand, and falling debt sub­tracts from it. This point is vehe­ment­ly denied on con­ven­tion­al the­o­ret­i­cal grounds by econ­o­mists like Paul Krug­man, but it is obvi­ous in the empir­i­cal data. The cri­sis itself began in 2008, pre­cise­ly when the growth of pri­vate debt plunged from its peak of almost 30% of GDP p.a. down to its depth of minus 20% in 2010. The recov­ery, such as it was, began when the rate of decline of debt slowed. Across reces­sion, boom and bust between 1990 and 2012, the cor­re­la­tion between the annu­al change in pri­vate debt and the unem­ploy­ment rate was ‑0.92.

The cau­sa­tion behind this cor­re­la­tion is that mon­ey is cre­at­ed “endoge­nous­ly” when the bank­ing sec­tor cre­ates loans, and this new­ly cre­at­ed mon­ey adds to aggre­gate demand—as argued by non-ortho­dox econ­o­mists from Schum­peter through to Min­sky. When this debt finances gen­uine invest­ment, it is a nec­es­sary part of a grow­ing cap­i­tal­ist econ­o­my, it grows but shows no trend rel­a­tive to GDP, and leads to mod­est prof­its by the finan­cial sec­tor. But when it finances spec­u­la­tion on asset prices, it grows faster than GDP, leads obscene prof­its by the finan­cial sec­tor and gen­er­ates Ponzi Schemes which are to sus­tain­able eco­nom­ic growth as can­cer is to bio­log­i­cal growth.

When those Ponzi Schemes unrav­el, the rate of growth of debt col­laps­es and the boost to demand from ris­ing debt becomes a drag on demand as debt falls. In all oth­er post-WWII down­turns, growth resumed when debt began to rise rel­a­tive to GDP once more. How­ev­er the bub­ble we have just been through has pushed debt lev­els past any­thing in record­ed his­to­ry, trig­ger­ing a delever­ag­ing process that is the hall­mark of a Depres­sion.

The last Depres­sion saw debt lev­els fall from 240% to 45% of GDP over a 13 year peri­od, and the ensu­ing peri­od of low debt led to the longest boom in Amer­i­ca’s his­to­ry. We com­menced delever­ag­ing from 303% of GDP. After 3 years it is still 10% high­er than the peak reached dur­ing the Great Depres­sion. On cur­rent trends it will take till 2027 to bring the lev­el back to that which applied in the ear­ly 1970s, when Amer­i­ca had already exit­ed what Min­sky described as the “robust finan­cial soci­ety” that under­pinned the Gold­en Age that end­ed in 1966.

While we delever, invest­ment by Amer­i­can cor­po­ra­tions will be timid, and eco­nom­ic growth will be fal­ter­ing at best. The stim­u­lus impart­ed by gov­ern­ment deficits will atten­u­ate the downturn—and the much larg­er scale of gov­ern­ment spend­ing now than in the 1930s explains why this far greater delever­ag­ing process has not led to as severe a Depression—but deficits alone will not be enough. If Amer­i­ca is to avoid two “lost decades”, the lev­el of pri­vate debt has to be reduced by delib­er­ate can­cel­la­tion, as well as by the slow process­es of delever­ag­ing and bank­rupt­cy.

In ancient times, this was done by a Jubilee, but the secu­ri­ti­za­tion of debt since the 1980s has com­pli­cat­ed this enor­mous­ly. Where­as only the money­len­ders lost under an ancient Jubilee, debt can­cel­la­tion today would bank­rupt many pen­sion funds, munic­i­pal­i­ties and the like who pur­chased secu­ri­tized debt instru­ments from banks. I have there­fore pro­posed that a “Mod­ern Debt Jubilee” should take the form of “Quan­ti­ta­tive Eas­ing for the Pub­lic”: mon­e­tary injec­tions by the Fed­er­al Reserve not into the reserve accounts of banks, but into the bank accounts of the public—but on con­di­tion that its first func­tion must be to pay debts down. This would reduce debt direct­ly, but not advan­tage debtors over savers, and would reduce the prof­itabil­i­ty of the finan­cial sec­tor while not affect­ing its sol­ven­cy.

With­out a pol­i­cy of this nature, Amer­i­ca is des­tined to spend up to two decades learn­ing the truth of Michael Hud­son’s sim­ple apho­rism that “Debts that can’t be repaid, won’t be repaid”.

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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.