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

Bernanke an Expert on the Great Depression??

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Note: This post has been mod­i­fied ni the light of com­ments that the ini­tial ver­sion quot­ed Bernanke out of con­text.

A link to this blog from a US legal advi­so­ry web­site the Prac­tis­ing Law Insti­tute’s In Brief ( “DEFLATION IN THE REAL WORLD”) remind­ed me of  Bernanke’s book Essays on the Great Depres­sion, which I’ve been aware of for some time but have yet to read. I’ll make amends on that front ear­ly this year; for­tu­nate­ly, an extract from Chap­ter One is avail­able as a pre­view on the Prince­ton site (I could­n’t locate the promised eBook any­where!; in what fol­lows, when I quote Bernanke it is from the orig­i­nal jour­nal paper pub­lished in 1995, rather than this chap­ter).

The World’s Biggest Ponzi Scheme?

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Two days ago the FBI indict­ed Bernie Mad­off, prin­ci­pal of Bernard L. Mad­off Invest­ment Secu­ri­ties LLC, on secu­ri­ties fraud. Though the case has yet to run, in the indict­ment the FBI report­ed that Mad­off con­fessed that his was “basi­cal­ly a giant Ponzi Scheme”  that may have lost some extreme­ly high net worth indi­vid­u­als over US$50 bil­lion.

Mad­of­f’s firm was famous for return­ing con­stant pos­i­tive results, even on a month by month basis, for decades. As Hen­ry Blod­get on Yahoo’s Tech Tick­er reports below, many Wall Street pro­fes­sion­als were incred­u­lous of these results, but invest­ed in his firm anyway–because they thought his returns must be com­ing from him exploit­ing his “mar­ket mak­er” role on the Nas­daq to do insid­er trad­ing.

DebtWatch No 29 December 2008

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What’s Real­ly Going On? or…

Why Did I See it Com­ing and “They” Did­n’t?

Part 2: The Mod­els

But this long run is a mis­lead­ing guide to cur­rent affairs. In the long run we are all dead. Econ­o­mists set them­selves too easy, too use­less a task if in tem­pes­tu­ous sea­sons they can only tell us that when the storm is long past the ocean is flat again.” (Keynes, A Tract on Mon­e­tary Reform, 1924)

In last mon­th’s Debt­watch, I explained why the data side of why the “Finan­cial Insta­bil­i­ty Hypoth­e­sis” enabled me to pre­dict this cri­sis, long before con­ven­tion­al “neo­clas­si­cal” econ­o­mists had any idea it was approach­ing.

DebtWatch No 28 November 2008: What is Really Going On?

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2nd Anniver­sary Issue…

Why Did I See it Coming and “They” Didn’t?

The finan­cial cri­sis is wide­ly accept­ed as hav­ing start­ed in August 9 2007, with the BNP’s announce­ment that it was sus­pend­ing redemp­tions from three of its funds that were heav­i­ly exposed to the US secu­ri­ti­sa­tion mar­ket (click here for the BNP August 9 2007 press release).

Just three months before­hand, the OECD released its 2007 World Eco­nom­ic Out­look, in which it com­ment­ed that:

Debtwatch 27 October 08: The Failure of Central Banks

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Just two years ago, Cen­tral Banks appeared tri­umphant. Infla­tion, the scourge of the 1970s and 80s, appeared dead, the finan­cial cri­sis of the Tech Wreck had been con­tained, economies world­wide were boom­ing, and stock mar­kets and house prices were spi­ralling ever upwards.

Then along came the Sub­prime Cri­sis, and we received a rude reminder of why Cen­tral Banks were cre­at­ed in the first place: to ensure that the world would nev­er again expe­ri­ence a Great Depres­sion.

SBS Dateline tonight with George Negus

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George negus is inter­view­ing me and Peter Schiff on Date­line tonight. The top­ic is the attempt­ed res­cue of Fan­nie Mae and Fred­die Mac, and what that may mean for the glob­al econ­o­my and Aus­tralia in par­tic­u­lar.

Date­line goes to air tonight (Wednes­day) at 8.30pm. It is also acces­si­ble on the web, the day after the pro­gram goes to air.

In oth­er news, the pod­casts are cur­rent­ly not func­tion­al, but I hope to fix them up tomor­row.

Debtwatch No. 25: How much worse can “It” get?

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Last month closed with some far from com­fort­ing news about the state of the US hous­ing mar­ket (sales and prices still falling), US finan­cial insti­tu­tions (Fan­nie Mae and Fred­die Mac in need of res­cue), Aus­tralian banks (NAB’s 90% write-down of its US CDO port­fo­lio). Then ABS fig­ures showed that retail sales had fall­en “unex­pect­ed­ly” by one per­cent in June. The recent ral­ly in stock mar­kets came to a sud­den end, and after a brief peri­od of renewed con­fi­dence, the ques­tion “how much worse can “It” get?” is once again doing the rounds.

My answer is: a lot worse. The empir­i­cal grounds for this assess­ment are:

DebtWatch No 11 September 2007: Why didn’t they see it coming?

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I expect–and hope–that the tenor of dis­cus­sion at this mon­th’s RBA Board meet­ing will be very dif­fer­ent to last mon­th’s. In August, I imag­ine, the com­mu­ni­ty mem­bers of the Board lis­tened sage­ly as the RBA’s econ­o­mists explained why the risk of future infla­tion had risen, why this jus­ti­fied a “pre-emp­tive strike” of rais­ing inter­est rates, and then reluc­tant­ly agreed to the rise.

I hope that this mon­th’s dis­cus­sion is more along the lines of “if you guys are the mon­ey experts, how come you did­n’t see it coming?”–it, of course, being the unfold­ing col­lapse of the US hous­ing mar­ket, and the result­ing extreme tur­moil on finan­cial mar­kets.