ABC Radio’s premiere current affairs program PM asked me to debate the causes and implications of last week’s market sell-off with Chris Caton, from BT Australia. Click below to hear the debate.
The transcript is below (and here on the ABC site). As is usual with such things, the transcript is wildly ungrammatical at times.
MARK COLVIN: The underlying fact about the global economy is that there’s still a huge discrepancy between what the economic historian, Niall Ferguson, calls Planet Finance and Planet Earth.
After the global financial crisis, he told this program that the true GDP of Earth was 10 times less than the valuation that Planet Finance put on it. A couple of years later he said it was down a bit, but Planet Finance was still seven times overvalued. Another way of describing this is a bubble — and bubbles that aren’t properly pricked keep re-inflating.
Plenty of economists have been pointing this out over the last few years and this year with the US debt debate and the Euro crisis, people have been saying it ever more frequently. In some ways one of the few mysteries is why the markets have suddenly chosen this time to listen.
I’m joined in the studio by Steve Keen, associate professor in economics, from the University of Western Sydney, and on the phone Chris Caton, chief economist of the BT Financial Group.
Chris Caton, you watch the markets, why now, I mean why not three weeks ago or three weeks from now?
CHRIS CATON: Well there isn’t a good reason. I suppose the catalyst, well we’ve had two catalysts, certainly in the US.
Number one, the agonising about the debt ceiling, would it be raised? Was there a chance of default? Was there a chance of downgrade? That’s catalyst number one.
And catalyst number two, there has been just a rapid-fire series of very weak economic data points: the GDP reports for the second quarter, the purchasing managers survey that covers manufacturing, and news about real consumption growth in recent months. And of course on top of that, you know, renewed rumblings about eurozone debt.
This could have happened at some other stage, but to me those were the catalysts. Catalysts don’t cause things, they just bring them on if you like.
MARK COLVIN: And some of it is just sentiment, as they call it in the market, in other words a sort of skittishness I suppose?
CHRIS CATON: Absolutely, whenever these things start they always continue essentially because, well you can call it panic, you can just call it people trying to get out, but yes panic sets in.
MARK COLVIN: Steve Keen is this the beginning of another global financial crisis?
STEVE KEEN: It’s the continuation of the last one. I mean Chris is quite right to say that there are catalysts and there are causes, and he’s identified a couple of important catalysts as to why it happened now.
But the real cause is what’s happening with private debt. This is being ignored in all the ballyhoo over the level of government debt in America right now but this is always been a crisis caused by private debt, which fuelled the biggest stock-market bubble in history, beginning back around 1994, and going right to 2000.
MARK COLVIN: What do you mean by private debt? Just explain what private debt consists of.
STEVE KEEN: Borrowing by households and corporations and that’s what…
MARK COLVIN: So we’re all in it, I mean this is about our mortgages too?
STEVE KEEN: Yeah mortgages actually drove up the level of house prices obviously. But equally financial-sector borrowings and lending to marginal loans and stuff like that, actually drove up the stock market as well. And to have a rising set of asset markets, you don’t just need rising debt you need accelerating debt.
And that’s what’s been going on in America for the last 20 years and it’s been completely ignored by the Federal Reserve. They actually, and now the deceleration is what actually set the financial crisis in train.
MARK COLVIN: Is there a housing bubble in South-East Asia as well, or in Asia generally?
STEVE KEEN: I think Asia had its huge crisis back in 97/98 and…
MARK COLVIN: I’ve just seen stuff in recent days suggesting that…
STEVE KEEN: There seems to be a yeah. Every time the finance sector gets away with a particular explosion in debt, as you said with Niall Ferguson’s work, it gets back to it again if you don’t completely put them back inside their boxes.
And not only did we not put them back inside the box, we put them in the governing seat and spent most of our time trying to rescue the financial sector that caused the trouble in the first place.
MARK COLVIN: Chris Caton is this the extension of the global financial crisis?
CHRIS CATON: It’s the hangover after the drunken binge in my view. So yeah, it is still essentially caused by everything that brought the GFC on.
MARK COLVIN: A hangover you can get over, can we get over this in, obviously not in a day or two which you can with a hangover, but the global equivalent?
CHRIS CATON: Yes. It’s my belief, and this is where I think Steve and I will probably disagree, yes you can get over it, but you get over it only slowly.
And yeah I must admit it’s difficult looking forward to see anything other than, you know, fiscal austerity and consolidation around the world, slow growth for a long time. So the hangover’s going to last a long time, but to me we’re not, mixing metaphors just slightly, we’re not about to fall off another precipice.
MARK COLVIN: Do you agree with Kenneth Rogoff, the professor of economics at Harvard University, who says that the world is just basically still grossly over-leveraged?
CHRIS CATON: I don’t see it quite that way, but I’m sure that Steve would have a different opinion. I think that a lot of that…
MARK COLVIN: He’s nodding vigorously and he’ll come in in a minute.
CHRIS CATON: (laughs) I think a lot of that has gone away. But, yeah, it is quite clear there are still some stupendously wrong valuations, if you like. I don’t see that, incidentally, in the equity market which of course is where we’re seeing a lot of action lately.
Over to Steve …
MARK COLVIN: Steve Keen.
STEVE KEEN: (laughs) Well in terms of the level of debt we’re in, if you go back to the beginning of the post-war period in America, America’s private debt to GDP ratio was 45 per cent. It peaked out in 2009 at 300 per cent, so more than six times as much debt compared to income as when the Second World War ended.
And that’s now turned around, you’ve fallen from 300 per cent of GDP as the private debt level to 260 per cent, which is a pretty huge fall, but it still leaves America with more debt than it had at the absolute peak of the Great Depression.
MARK COLVIN: Doesn’t Professor Rogoff give a tipping point of 90 per cent?
STEVE KEEN: He’s talking about government debt.
MARK COLVIN: Right ok.
STEVE KEEN: I’m talking about private debt.
MARK COLVIN: So where are we on that?
STEVE KEEN: Government debt we’re hitting about the 100 per cent level again.
MARK COLVIN: So they’re 10 per cent over his tipping point?
STEVE KEEN: But it wouldn’t matter if it wasn’t for the level of private debt. The American government began with a higher debt to GDP ratio than 100 per cent after the Second World War, but the private sector was at, you know, a trivial level of debt, frankly, for America’s debt-carrying capacity. So it was quite possible for the private sector to boom, and with the booming private sector the government to gradually reduce its debt level by running surpluses.
MARK COLVIN: So this does go back to the previous global financial crisis, it does go back to that period where there were those companies that were over-leveraged, and people trying to make a nest-egg for their retirement were investing in firms like Lehmans, and so forth, and also investing in CDOs (collateralized debt obligations), those terrible instruments which really basically were instruments of…
STEVE KEEN: Mass destruction.
MARK COLVIN: …instruments of mass destruction, but what they represented was mortgages that were never, ever going to be paid back. And all that still hasn’t washed out of the system?
STEVE KEEN: It still hasn’t washed out. There’s still, I mean there’s level of derivatives peaked at something like $530 trillion, about three to four times the size of the global economy, that people say that’s a gross position rather than net. But fundamentally that only works if you can rely upon your counterparty not going bankrupt. Well so much for that particular reliance.
MARK COLVIN: Chris Caton, the counter argument?
CHRIS CATON: Can I just say that in the long run there’s no magic constancy between debt and GDP. For a start what you’re doing is dividing a stock…
STEVE KEEN: Oh please Chris don’t hit me with that one, that’s a silly comment because the people did the same thing about government debt and nobody ever whinges about that. It’s a blind spot neoclassical economists have about the level of private debt because they believe the private sector’s always rational, they’ve been through the biggest irrational bubble in history.
MARK COLVIN: Let’s Chris …
CHRIS CATON: All I’m saying Steve is, you can make your same point if you like another way, but to me you really have to look at the level of debt and the level of assets.
STEVE KEEN: Level of assets have got three letters at the front ASS. I think we should take them importantly. Assets can collapse in value overnight, as we’ve seen today, you’re liabilities remain there, and it’s liabilities that are driving this debt crisis.
They’ve got totally out of hand, and you, mate there may not be a magical level of debt, but when you have it going from 45 per cent of GDP to 300 per cent that is a runaway exponential growth process that can’t be sustained. And when it broke that’s what caused the financial crisis.
And we’re now in a permanent stage of deleveraging until we get back down to similar levels, about 100 per cent of GDP.
MARK COLVIN: Incidentally, since we’re talking about valuing assets, to what extent are the ratings agencies at the centre of this, as they were back in 2007 Chris Caton?
CHRIS CATON: They, well I guess the ratings agencies didn’t distinguish themselves.
STEVE KEEN: (laughs) I think they did.
CHRIS CATON: Well perhaps they did, but for the wrong reasons, during the GFC, and it may be that they’re a bit trigger happy right now and hence not helping matters either. For example, this overhanging threat to downgrade the US government debt anyway, despite the, well despite what has been done there.
Now, you know, maybe US government debt does deserve to be downgraded, but there’s something like 17 other nations that have Triple‑A debt and when you look at them, you think, well surely if the US, and maybe here again Steven might come in with this, surely if the US deserves to lose its Triple‑A status, then all of the other 17 do too. There’s not, nobody there whose debt should be more highly ranked than that of the US.
STEVE KEEN: Well I think the reason the USA gets away with it because it’s the reserve currency for the globe.
CHRIS CATON: Mmm.
STEVE KEEN: And of course also it’s got a captive central bank. So if it runs a deficit and it can’t sell the bonds the Federal Bank, the Federal Reserve, necessarily underwrites it. The reason we’re getting a debt crisis, a genuine one, in Europe, rather than America, is because they don’t have a captive central bank. In fact, frankly, they don’t really have a central bank at all.
MARK COLVIN: Alright, let me, we ought to wind up gradually.
Chris Caton, what do you think are the chances of avoiding stagflation and what should we do about it?
CHRIS CATON: Well there’s no inflation to be stagflation. The…
MARK COLVIN: In Australia, what about the world?
CHRIS CATON: Well the issue is avoiding …
STEVE KEEN: Deflation, debt deflation.
CHRIS CATON: …I would say we’re 80 per cent likely to avoid a double-dip recession in, well either in Europe, or the US, or the world in general. It is clear this is a period that the world economy has lost a lot of momentum. My suspicion is that this is a temporary thing it’s going through.
MARK COLVIN: Steve Keen?
STEVE KEEN: I think it’s permanent until the debt levels are paid down. We’re in a debt deflation where deleveraging by the private sector is going to reduce aggregate demand below aggregate supply and will slowly grind down.
MARK COLVIN: And the question of what we do about it?
STEVE KEEN: We have to abolish the debt. The debt should never have been issued in the first place and the financial institution that issued should go bankrupt.
MARK COLVIN: And for Australia, the ramifications and what we should do?
STEVE KEEN: Similar sort of thing. We had equally a bigger housing bubble, house debt bubble, than America had, and that debt should never have been issued, so we have to get that debt reset otherwise we’ll face the same sort of grinding future America has.
MARK COLVIN: And you’ll be on top of Mount Kosciusko again?
STEVE KEEN: No, no, I’ll be showing Rory Robertson how to run.
(Chris Caton and Mark Colvin laugh)
MARK COLVIN: Chris Caton your prescriptions?
CHRIS CATON: Well I thought I just basically, I mean I think we will get through this very, but get through it very slowly and I just wonder…
MARK COLVIN: I mean for the government, what would you be advising the government on how to buckle up for this one?
CHRIS CATON: Well prayer I guess would be the first thing…
(Steve Keen and Mark Colvin laugh)
MARK COLVIN: Prayer, right…
CHRIS CATON: … and also …
MARK COLVIN: We’ll call in Cardinal Pell and Archbishop Jensen.
CHRIS CATON: Australia has no endemic problem here, we’re looking a paragon compared with everybody else.
STEVE KEEN: Not with our private debt levels.
CHRIS CATON: And we’ve also got more flexibility…
STEVE KEEN: That I’ll agree.
CHRIS CATON: …certainly in monetary policy than the rest of the world does. But we are not immune to what happens elsewhere, we know that, so yeah, if the worst outcome were to come about elsewhere then we would be affected, through loss of wealth, through consumer sentiment, etc.
MARK COLVIN: Thank you both very much.
Chris Caton, chief economist of the BT Financial Group and Associate Professor Steve Keen from the University of Western Sydney.