Video of Whitlam Institute Talk

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Last month I spoke at a sem­i­nar on the finan­cial cri­sis organ­ised by The Whit­lam Insti­tute, in reply to a speech by Pro­fes­sor John Quig­gin. Guy Debelle, the Assis­tant Gov­er­nor (for Finan­cial Mar­kets) of the Reserve Bank of Aus­tralia, was the other discussant.

The Insti­tute has put together a very pro­fes­sional video of the dis­cus­sion, which has been picked up by SlowTV, a free inter­net TV chan­nel run by The Monthly, an Aus­tralian mag­a­zine of com­ment and analy­sis which, amongst many other things, pub­lished Aus­tralian Prime Min­is­ter Kevin Rudd’s lengthy essay on the Global Finan­cial Cri­sis in which he explic­itly cri­tiqued neoliberalism.

Australian Shareholders Association Investor Hour Talk

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I’m speak­ing at the Aus­tralian Share­hold­ers Asso­ci­a­tion Investor Hour next Tues­day (August 18) at 12pm with the topic “The Mar­ket Crash: Ori­gins and Prospects”.

I’ll take a long view of the finan­cial data–going back to 1890–and explain the booms and crashes of stock mar­kets as symp­toms of debt bub­bles and their burst­ing. From that point of view, this is the largest asset-price bub­ble in the last 120 years–and prob­a­bly in all of his­tory. The prog­no­sis for the mar­ket is there­fore grim, despite the cur­rent rally.

Site Overload

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This is mainly a post for my active dis­cus­sants, who are now suf­fer­ing from the vol­ume of debate here with 399 posts on the pre­vi­ous topic, and my own work­load right now that is mak­ing writ­ing a new post impossible.

I had hoped to post a new sub­stan­tive col­umn on Mon­day about recent eco­nomic and hous­ing mar­ket data, but with the new sub­ject I’m teach­ing (Behav­ioural Finance) plus other work com­mit­ments there’s no way I’m going to get there.

Rudd’s essay is on the money

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Aus­tralian Prime Min­is­ter Kevin Rudd has fol­lowed up his cri­tique of neolib­er­al­ism with a new essay in the Syd­ney Morn­ing Her­ald on the causes of the cri­sis, and the poli­cies needed after recovery.

With one excep­tion, his key expla­na­tions for the cri­sis are the same as those iden­ti­fied by myself and the hand­ful of other econ­o­mists who pre­dicted this cri­sis before it hap­pened:

Australia in the Red

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I will be a pan­elist at Aus­tralia in the Red, a forum on debt organ­ised by The Daily Reck­on­ing & Money Morn­ing, to be held at the State Library of Vic­to­ria on Fri­day July 31st from 7pm-11pm. The evening includes a panel dis­cus­sion on debt–with Dan Den­ning, Kris Sayce, Phillip Ander­son and Gabriel Andre as well as myself–followed by the screen­ing of “I.O.U.S.A.”.

The fol­low­ing infor­ma­tion is taken from their pro­mo­tion for the event, tick­ets for which are lim­ited and cost $199–click here for the online book­ing form. The “I’ll” below is Dan Denning.

Whitlam Institute Series on the Financial Crisis

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The Whit­lam Insti­tute is con­duct­ing a series of talks on the finan­cial cri­sis. The third of these will be held this com­ing Thurs­day (July 23rd) at the River­side The­atre com­plex in Par­ra­matta (on the cor­ner of Church and Mar­ket Streets). The keynote paper is being given by Pro­fes­sor John Quig­gin, with myself and Guy Debelle, the Assis­tant Gov­er­nor (Finan­cial Mar­kets) of the RBA as discussants.

Pro­fes­sor Quig­gin will present his paper “After the Cri­sis” for about 30–40 min­utes, after which there will be a 20 minute ques­tion and answer ses­sion with the audience.

No-one saw this coming?” Balderdash!

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The widely believed propo­si­tion that this finan­cial cri­sis was “a tsunami that no-one saw com­ing”, and that could not have been pre­dicted, has been given the lie to by an excel­lent sur­vey of eco­nomic mod­els by Dirk Beze­mer, a Pro­fes­sor of Eco­nom­ics at the Uni­ver­sity of Gronin­gen in the Netherlands.

Beze­mer did an exten­sive sur­vey of research by econ­o­mists or finan­cial mar­ket com­men­ta­tors, look­ing for papers that met four criteria:

Only ana­lysts were included who:

  1. pro­vide some account on how they arrived at their conclusions.

Debtwatch 36 July 2009: It’s the Deleveraging, Stupid

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Steve Keen’s Debt­watch No. 36 July 2009
It’s the Delever­ag­ing, Stupid
Gen­tle­man, you have come sixty days too late. The depres­sion is over. — Her­bert Hoover, respond­ing to a del­e­ga­tion request­ing a pub­lic works pro­gram to help speed the recov­ery, June 1930
“The past may not repeat itself, but it sure does rhyme”  Mark Twain
In the last six months, the phrase “Green Shoots of Recov­ery” has entered the eco­nomic lex­i­con. It appeared to some observers that the global reces­sion was com­ing to an end, while Aus­tralia itself was likely to barely feel its impact.
I would be as pleased as any­one if these “green shoots” were true har­bin­gers of a gen­uine end to the eco­nomic downturn–not because I would enjoy being wrong for the sake of it, but because my expec­ta­tions for the future are so bad that I’d pre­fer to see them not come to pass.
Unfor­tu­nately, on cur­rent data I expect that “green” is a bet­ter descrip­tion of the knowl­edge level of those mak­ing the opti­mistic pre­dic­tions, than of the colour of any bud­ding eco­nomic recovery.
Of course, it could be argued to the con­trary that many of those mak­ing such opti­mistic fore­casts are highly trained pro­fes­sional econ­o­mists, and not merely mar­ket com­men­ta­tors who migh have a vested inter­est in putting a pos­i­tive spin on the news. This is true–but far from being a rea­son to trust these fore­casts, it is yet another rea­son to be scep­ti­cal of them.
Almost every holder of a PhD in eco­nom­ics who works for a for­mal eco­nomic body like the Trea­sury, the RBA or the OECD has been deeply schooled in “neo­clas­si­cal” eco­nom­ics, often with­out know­ing that there is any other way of think­ing about how the econ­omy func­tions. They think they are sim­ply “econ­o­mists”, and any­one who objects to their analy­sis or mod­els must be une­d­u­cated about eco­nomic theory.
In con­trast, vir­tu­ally all Uni­ver­sity Depart­ments of Eco­nom­ics con­tain at least one econ­o­mist who rejects neo­clas­si­cal eco­nom­ics, and instead sub­scribes to a rival school–like Aus­trian, Marx­ian, Post Key­ne­sian, or Evo­lu­tion­ary Economics.
These con­trar­ian aca­d­e­mic econ­o­mists often dis­agree amongst them­selves, some­times vehemently–you couldn’t get two more opposed points of view than Aus­trian and Marx­ian eco­nom­ics, for example–but they tend to be united in regard­ing neo­clas­si­cal eco­nomic the­ory as pompous drivel.
There are prob­a­bly many rea­sons for this dichotomy between Uni­ver­sity eco­nom­ics depart­ments which almost always have a hand­ful of dis­si­dents, and offi­cial eco­nom­ics bod­ies like the OECD and Trea­sury that are almost exclu­sively staffed by neo­clas­si­cal econ­o­mists. But I sus­pect the main rea­son is tenure: uni­ver­si­ties offer it, while for­mal eco­nomic advi­sory bod­ies don’t.
As a result, aca­d­e­mic econ­o­mists who “turn feral” and reject neo­clas­si­cal eco­nom­ics can still teach and pub­lish and hang on to their jobs, even if their neo­clas­si­cal Depart­ment Heads wish they would go away. OECD and Trea­sury econ­o­mists who do the same thing prob­a­bly find their employ­ment com­ing to an end–because they don’t have tenure.
So any­thing pub­lished by a for­mal eco­nomic body like the OECD will be the prod­uct of a neo­clas­si­cal eco­nomic model–and there­fore, in my opin­ion and that of a siz­able minor­ity of aca­d­e­mic econ­o­mists, dri­vel (there was one exception–the Bank of Inter­na­tional Set­tle­ments [] while Bill White [], a sup­porter of Hyman Minsky’s “Finan­cial Insta­bil­ity Hypoth­e­sis”, was its its Eco­nomic Adviser).
Of course, dis­putes between aca­d­e­mic econ­o­mists don’t mat­ter in the real world, and most news­pa­pers report the announce­ments of bod­ies like the OECD as state­ments of wis­dom about the future–until, that is, a cri­sis like the Global Finan­cial Cri­sis makes a mock­ery of the OECD’s neo­clas­si­cal fantasies.
And what a mock­ery. This was the OECD’s fore­cast for the world econ­omy in June 2007:
In its Eco­nomic Out­look last Autumn, the OECD took the view that the US slow­down was not herald­ing a period of world­wide eco­nomic weak­ness, unlike, for instance, in 2001. Rather, a “ smooth”  rebal­anc­ing was to be expected, with Europe tak­ing over the baton from the United States in dri­ving OECD growth.
Recent devel­op­ments have broadly con­firmed this prog­no­sis. Indeed, the cur­rent eco­nomic sit­u­a­tion is in many ways bet­ter than what we have expe­ri­enced in years. Against that back­ground, we have stuck to the rebal­anc­ing sce­nario. Our cen­tral fore­cast remains indeed quite benign: a soft land­ing in the United States, a strong and sus­tained recov­ery in Europe, a solid tra­jec­tory in Japan and buoy­ant activ­ity in China and India. In line with recent trends, sus­tained growth in OECD economies would be under­pinned by strong job cre­ation and falling unem­ploy­ment. (OECD Eco­nomic Out­look, Vol­ume 2007/1, No. 81, June 2007, p. 7)
Yeah, right. Instead the global econ­omy was already well into the great­est eco­nomic cri­sis of the last 60 years. The next two years tore the OECD’s 2007 fore­casts to shreds.
One might hope for some soul search­ing as a result of this–and hope­fully some is occur­ring behind closed doors. But in a clear sign that the OECD hopes to see “Busi­ness as usual” restored in its mod­el­ling approach as well as the actual econ­omy, its cur­rent Eco­nomic Out­look dis­cusses the process of recov­ery from an eco­nomic cri­sis that it com­pletely failed to foresee:
OECD activ­ity now looks to be approach­ing its nadir, fol­low­ing the deep­est decline in post-war his­tory. The ensu­ing recov­ery is likely to be both weak and frag­ile for some time. And the neg­a­tive eco­nomic and social con­se­quences of the cri­sis will be long-lasting. Yet, it could have been worse. Thanks to a strong eco­nomic pol­icy effort an even darker sce­nario seems to have been avoided. But this is no rea­son for com­pla­cency; the need for deter­mined pol­icy action remains across a wide field of policies…
In sum­mary, it looks as if the worst sce­nario has been avoided and that OECD economies are now near­ing the bot­tom. Even if the sub­se­quent recov­ery may be slow such an out­come is a major achieve­ment of eco­nomic pol­icy. But this is no time to relax — ensur­ing that the recov­ery stays on track and leads towards a long-term sus­tain­able growth path will call for major pol­icy efforts going for­ward. (OECD Eco­nomic Out­look, Vol­ume 2007/1, No. 81, June 2009, pp. 5 & 7)
With its utter fail­ure to see this cri­sis com­ing, why does any­one still take the OECD seri­ously? Prob­a­bly for the same rea­son that peo­ple still gen­er­ally obeyed the Cap­tain of the Titanic after it had struck the ice­berg: author­ity counts for a lot in a cri­sis, even if the per­son in author­ity actu­ally caused it.
But it’s also because it takes repeated fail­ures before some­one who asserts author­ity is rejected–one fail­ure alone won’t do. So rather like Napoleon in exile in Elba, the OECD is still taken seri­ously by eco­nomic commentators–as with Peter Martin’s report (“Late in, early out of the down­turn”, SMH June 24th 2009):
AUSTRALIA is set to soar out of its eco­nomic down­turn sooner and more sharply than fore­cast in the bud­get, accord­ing to fore­casts from the Organ­i­sa­tion for Eco­nomic Co-operation and Devel­op­ment under­stood to have the back­ing of the Aus­tralian Treasury.
The OECD says the local econ­omy should shrink 0.3 per cent this year, less than any other OECD econ­omy and far less than the con­trac­tion of 1 per cent that under­lies the fore­casts in the May budget.
Next year the econ­omy should roar back 2.4 per cent, also above bud­get fore­casts and more than any other OECD econ­omy apart from those recov­er­ing from col­lapse in 2009.
The Trea­surer, Wayne Swan, greeted the fore­casts released overnight in Paris as evi­dence Aus­tralia was “out­per­form­ing every other advanced econ­omy in the face of the recession”.
The fore­casts show Australia’s unem­ploy­ment rate reach­ing 7.9 per cent late next year rather than the 8.25 to 8.5 per cent range assumed in the budget.
A lit­tle scep­ti­cism in this report would have been appre­ci­ated, given the OECD’s track record–and if a polit­i­cal jour­nal­ist had writ­ten the report, that might well have occurred. But it was writ­ten by an eco­nom­ics cor­re­spon­dent, and most of them have–like the OECD’s economists–been schooled only in neo­clas­si­cal eco­nom­ics, and don’t know how flimsy the the­ory itself is (there are excep­tions here, like Brian Tookey whose book Tum­bling Dice is an excel­lent cri­tique of neo­clas­si­cal eco­nom­ics). So we get a report like this trum­pet­ing good times and green shoots, with no irony (Peter Mar­tin was far from the only one to present the OECD’s views with­out any scepticism–see also “Earth-destroying bomb defused — just” by Michael Pas­coe [–just-20090625-cxj7.html] or Glenn Dyer at Crikey “That’ s no green shoot, that’ s Aus­tralia in full bloom: OECD” []).
Clearly it will take a few more eco­nomic fail­ures before the OECD faces its Waterloo.
To be fair, offi­cial eco­nomic bod­ies and their uncrit­i­cal fans were not the only source of “green shoot” eupho­ria. A large part of this feel­ing that the worst was over also came from the global expe­ri­ence of a recov­ery in stock mar­kets from their recent lows. In addi­tion, Aus­tralia had a near unique dose of green­ery when unem­ploy­ment remained remark­ably benign, and it avoided the pop­u­lar def­i­n­i­tion of a reces­sion by record­ing growth in real GDP in the March 2009 quar­ter (real GDP rose by 0.4%, hav­ing fallen by 0.5% in the pre­ced­ing quarter).
Let’s look first at the Stock Market.
The Dow has indeed had an impres­sive rally, from the low of 6547 on March 9 to the peak of 8799 on June 12–a rise of 34% in under a quar­ter of a year. This has led to many of the usual sus­pects pro­claim­ing that the bear mar­ket is over, and a new rally is under­way. Com­par­isons with 1929 are, of course, unjustified…
On closer inspec­tion, reports of the death of the bear mar­ket are some­what exaggerated.
Firstly, though the index has ral­lied by 34% from its low, it is still down 40% from the all time peak of Octo­ber 2007.
Sec­ondly, ral­lies like this came and went ad nau­seam in the early 1930s, until the mar­ket hit rock bot­tom at 41.22 points on July 8th 1932–89% below the Sep­tem­ber 3rd 1929 peak of 381.17.
The biggest such rally occurred very soon after The Crash in 1929, start­ing on Novem­ber 13th 1929 when the mar­ket was down 48% from its Sep­tem­ber peak. It then rose almost 50% from its low in under 6 months–and it was this recov­ery that inspired Hoover’s Oval Office gaffe.
But the mar­ket had only recov­ered half of what it had lost when the rally ran out of steam–a 50% fall fol­lowed by a 50% recov­ery still leaves you 25% below where you started from–and the inex­orable slide of the Great Depres­sion dragged the mar­ket down with it.
This cur­rent rally took a lot longer to start than its 1929 cousin, though it began from a com­pa­ra­ble bot­tom (55% below the peak ver­sus 48% below it in 1929), and it still has to go on for much longer and drive the mar­ket much higher to match its antecedent–let alone to pro­claim the 2007 Bear Mar­ket is over (note also that Eichen­green and O’ Rourke, using global data, argue that the cur­rent decline is far worse than in the Great Depres­sion, with global mar­kets down 50% on aver­age 12 months after the cri­sis ver­sus just 10% down after 1929–see Fig­ure 2 in
Mean­while, in the Real World…
Though the stock mar­ket was pro­vid­ing some good cheer in the USA (at least until last week), the real econ­omy con­tin­ued to dis­ap­point. To get an idea of just how bad the down­turn has been, and how lit­tle inkling of it that con­ven­tional econ­o­mists had, con­sider the Eco­nomic Report of the Pres­i­dent, pre­pared by the US President’s Coun­cil of Eco­nomic Advis­ers (]), in 2008 ( and 2009 (
The 2008 Report made the fol­low­ing forecasts–note in par­tic­u­lar the “fore­cast” that unem­ploy­ment would be below 5 per­cent between 2008 and 2013.
The 2009 Report, sub­mit­ted to Con­gress and the incom­ing Pres­i­dent in Jan­u­ary of this year, made a mock­ery of the 2008 Report but still dras­ti­cally under­es­ti­mated the sever­ity of the down­turn: it fore­cast that unem­ploy­ment would peak at 7.7% in 2009, growth would remain pos­i­tive for the next five years.
Despite the fre­quency with which numer­ous econ­o­mists who failed to antic­i­pate the Global Finan­cial Cri­sis con­tinue to report sight­ings of “green shoots of recov­ery”, the actual eco­nomic data con­tin­ued to be grim­mer than even their most pes­simistic revised forecasts.
The clear­est evi­dence here is that the Fed­eral Reserve’s “stress tests” for its Super­vi­sory Cap­i­tal Assess­ment Pro­gram assumed that even under an adverse sce­nario, unem­ploy­ment would be below 9 per­cent by mid-2009. It is cur­rently 9.4 per­cent (see
The taper­ing process that is built into neo­clas­si­cal eco­nomic fore­casts (see is not evi­dent in the data to date.
Delever­ag­ing and Eco­nomic Breakdown
The rea­son that most econ­o­mists con­tinue to under­es­ti­mate this down­turn is because (a) the down­turn is being dri­ven by delever­ag­ing from lit­er­ally unprece­dented lev­els of pri­vate debt, and (b) the neo­clas­si­cal the­ory of eco­nom­ics, which dom­i­nates aca­d­e­mic and mar­ket eco­nom­ics alike, ignores the role of pri­vate debt in the economy.
The rea­son that I antic­i­pated this cri­sis four years ago is that I reject the main­stream “neo­clas­si­cal” approach to eco­nom­ics, and instead analyse the econ­omy from the per­spec­tive of Hyman Minsky’s “Finan­cial Insta­bil­ity Hypoth­e­sis”, in which pri­vate debt plays a cru­cial role. In our credit-driven econ­omy, demand is the sum of GDP plus the change in debt. If debt is low rel­a­tive to GDP, then its con­tri­bu­tion to demand is rel­a­tively unim­por­tant; but if debt becomes large rel­a­tive to demand, then changes in debt can become THE deter­mi­nant of aggre­gate demand, and hence of unemployment.
That is man­i­festly the case in Amer­ica today. Under the stew­ard­ship of neo­clas­si­cal eco­nom­ics in the per­sonas of Alan Greenspan and Ben Bernanke, the growth in pri­vate debt has not merely been ignored but has actively been encour­aged, in the dan­ger­ously naive belief that the pri­vate sec­tor is being “ratio­nal” when it borrows.
This appar­ent indict­ment of the pri­vate sec­tor as there­fore “irra­tional” is in fact really an indict­ment of neo­clas­si­cal eco­nom­ics for abuse of lan­guage. What neo­clas­si­cal the­ory means by the word “ratio­nal” is “able to cor­rectly antic­i­pate the future”–which is the def­i­n­i­tion, not of ratio­nal­ity, but of prophecy.
There is noth­ing “irra­tional” about being unable to pre­dict the future–it is fun­da­men­tally uncer­tain, while mod­ern eco­nomic the­ory hides from this real­ity just as Keynes’s con­tem­po­rary eco­nomic rivals did in the 1930s when he wrote that:
I accuse the clas­si­cal eco­nomic the­ory of being itself one of these pretty, polite tech­niques which tries to deal with the present by abstract­ing from the fact that we know very lit­tle about the future. (Keynes, “The Gen­eral The­ory of Employ­ment”, Quar­terly Jour­nal of Eco­nom­ics 1937)
Instead, in the uncer­tain world in which we live, the pri­vate sec­tor nec­es­sar­ily spec­u­lates about the future–and some of those spec­u­la­tions will be wrong. The role of reg­u­la­tion and gov­ern­ment eco­nomic pol­icy should be to con­fine those spec­u­la­tions, as much as is pos­si­ble, to pro­duc­tive pur­suits rather than gam­bles about the future path of asset prices–a past­time that has always in the past led to Ponzi asset bubbles.
This time, with gov­ern­ment pol­icy dri­ven by neo­clas­si­cal eco­nom­ics and its deluded atti­tudes towards the future, pol­icy has actu­ally encour­aged  the pri­vate sec­tor to bor­row to indulge in two giant Ponzi Schemes–the stock mar­ket and (belat­edly) the hous­ing mar­ket. It has gam­bled with bor­rowed money that share and house prices would always rise faster than con­sumer prices.
That gam­ble worked for some decades, but it then failed–in 1987–89. Had the Greenspan Fed not inter­vened then to “res­cue” Wall Street, there is every pos­si­bil­ity that the US would have expe­ri­enced a mild Depres­sion then–mild because the level of debt was lower then that at the time of the Great Depres­sion (165% in 1989 ver­sus 175% in 1929), and cru­cially because the rate of infla­tion then was high (5% in 1989 ver­sus 0.5% in 1929).
The lower level of debt would have meant that less delever­ag­ing would have been required to return to a pre­dom­i­nantly income-financed econ­omy in 1989 than was required in the 1930s, while high infla­tion would have meant a lower like­li­hood of defla­tion dur­ing the Depres­sion itself, and pos­si­bly that infla­tion alone could have eroded the debt bur­den. It still would not have been pretty–certainly it would have been worse than the 1983 reces­sion, when unem­ploy­ment as it is cur­rently defined peaked at 10.8 percent.
But what we face now will be far worse, because delever­ag­ing from the now unprece­dented debt level of almost 300% of GDP will drive Amer­ica into a Depres­sion that could eas­ily be deeper than that of the 1930s.
This is already becom­ing appar­ent in the data, as eco­nomic his­to­ri­ans Barry Eichen­green and Kevin O’ Rourke have pointed out (see “A Tale of Two Depres­sions” at
To sum up, glob­ally we are track­ing or doing even worse than the Great Depres­sion, whether the met­ric is indus­trial pro­duc­tion, exports or equity val­u­a­tions. Focus­ing on the US causes one to min­imise this alarm­ing fact. The “ Great Reces­sion”  label may turn out to be too opti­mistic. This is a Depression-sized event.
The com­par­i­son of unem­ploy­ment rates (which Eichen­green and O’ Rourke didn’t make) bear this out: using the cur­rent OECD def­i­n­i­tion of unem­ploy­ment, this down­turn is well ahead of the 1979 reces­sion even though unem­ploy­ment started from a lower level; and using the much broader U-6 def­i­n­i­tion (see;, which is more strictly com­pa­ra­ble to the NBER def­i­n­i­tion used dur­ing the Great Depres­sion, unem­ploy­ment now is as bad as at the same stage of the Great Depres­sion, and increas­ing as rapidly.
Delever­ag­ing is already extreme: the most recent flow of funds data shows that pri­vate debt is falling rapidly and there­fore sub­tract­ing from aggre­gate demand rather than adding to it. As noted in ear­lier Debt­watch Reports, in the mod­ern debt-dependent econ­omy, changes in the demand financed by changes in pri­vate debt are strongly neg­a­tively cor­re­lated with the unem­ploy­ment: when debt’s con­tri­bu­tion to demand falls, unem­ploy­ment rises.
The turn­around in debt growth in the USA is unprece­dented in the post-WWII period. Even dur­ing the 1980s and 1990s reces­sions, debt con­tin­ued to grow both in nom­i­nal terms and as a per­cent­age of GDP. Now debt is falling at arate of almost US$2 Tril­lion a year (which equates to 14 per­cent of GDP).
This is why the cri­sis exists, is so much worse than the offi­cial eco­nomic fore­cast­ers expected, and will con­tinue and be much deeper than they cur­rently believe: the cri­sis is being dri­ven by delever­ag­ing, and neo­clas­si­cal econ­o­mists do not even include pri­vate debt in their models.
As noted in ear­lier Debt­watch Reports, there is a very strong link between the rate of growth of debt and unem­ploy­ment: when debt grows more quickly, unem­ploy­ment falls; when debt grows slowly or falls, unem­ploy­ment rises.
This is not because debt is a good thing, but because our economies have become so debt-dependent that changes in debt now have a far stronger influ­ence on eco­nomic activ­ity than do changes in GDP.
The US Gov­ern­ment is attempt­ing to “pump-prime” its way out of trou­ble by public-debt-financed deficit spend­ing, which raises three fur­ther issues:
this so-called Key­ne­sian rem­edy can work when pri­vate debt lev­els are rel­a­tively low, and gov­ern­ment pol­icy to atten­u­ate pri­vate spec­u­la­tion is strictly adhered to (see my 1995 paper Finance and Eco­nomic Breakdown);
how­ever, in our ram­pantly spec­u­la­tive economies, this pol­icy has only worked when it has re-started the pri­vate debt binge, result­ing in ris­ing debt lev­els over time;
this can’t hap­pen this time around, because all sec­tors of the pri­vate economy–businesses both real and finan­cial, and households–are already debt-saturated. There is no “green­fields” group to lend to, as was pos­si­ble in 1990 when house­hold debt was a “mere” 60% of GDP, and the deriv­a­tives mar­ket in finance had yet to explode; and finally
the scale of the pri­vate debt bub­ble os just too big to be coun­tered by sub­sti­tut­ing pub­lic debt for pri­vate debt.
This last point is evi­dent in the data. Even though the US gov­ern­ment has thrown the prover­bial kitchen sink at gov­ern­ment spend­ing, the increase in pub­lic debt (which adds to aggre­gate demand) is more than coun­ter­acted by pri­vate sec­tor delever­ag­ing (which sub­tracts from aggre­gate demand):
Total US Debt is there­fore falling. Though in the long run this is a good thing–we must return to a non-debt-dependent econ­omy and once we have got­ten there, stay there–the tran­si­tion will be as pleas­ant as Cold Turkey is for a heroin addict.

Gen­tle­man, you have come sixty days too late. The depres­sion is over.” - Her­bert Hoover, respond­ing to a del­e­ga­tion request­ing a pub­lic works pro­gram to help speed the recov­ery, June 1930

Green Shoots or Green Observers?

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Econ­o­mists have long had to endure being called “Dis­mal Sci­en­tists”, but really that’s not hard enough on them. With their pro­cliv­ity to invent trite phrases to describe com­plex issues, they deserve to be known as Dis­mal Poets as well.

The lat­est cliché off the eco­nomic jar­gon pro­duc­tion line is “Green Shoots of Recov­ery”. With gov­ern­ments hav­ing laid lib­eral amounts of fer­tiliser – in the forms of hand­outs, bud­get deficits, slashed inter­est rates and “quan­ti­ta­tive eas­ing” (another new piece of jar­gon for giv­ing good money to bad lenders in return for bad assets) – they now report signs of eco­nomic recov­ery sprout­ing like alfalfa everywhere.

Eichengreen and O’Rourke: A Tale of Two Depressions

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Eco­nomic his­to­ri­ans Barry Eichen­green and Kevin H. O’Rourke are using empir­i­cal data to com­pare this down­turn to the Great Depres­sion. I’ll be refer­ring to and adding to their com­par­i­son in the next Debt­watch (which will be pub­lished late next week, before the RBA’s July meet­ing), but the research is so good that it deserves to be high­lighted now.

Their con­clu­sion is compelling:

To sum­marise: the world is cur­rently under­go­ing an eco­nomic shock every bit as big as the Great Depres­sion shock of 1929–30. Look­ing just at the US leads one to over­look how alarm­ing the cur­rent sit­u­a­tion is even in com­par­i­son with 1929–30.