Saturday, 6 February 2016

Debts, Wits and Crappy Economics

About a week ago, while I was still rushing through beautiful New Zealand, this BBC interview with Economics Professor Steve Keen emerged and quickly got shared by predominantly leftist people. Keen, recently accepted a position at Kingston University, had his call to fame by predicting the financial crisis in 2008, an achievement shared by largely peripheral economists.
In the interview, Keen points out what he's been repeating for decades that banking systems matter, that they create money and that this money influences the economy. This is a prime example of where the peripheral schools of thought in Economics teaching broadly agrees with one another against the dominant mainstream view, albeit with vastly different implications and details of that perspective.

Keen's work, based on Hyman Minsky, concerns debt - and especially private debt levels - in comparison to GDP, which he mentions by saying the following:
"in global terms, you've got highest level of debt compared to GDP in the history of humanity."
Because he believes debt is so dangerous, his generic solution is a QE for the people, essentially debt-relief by vastly expanding the money supply. While I agree with his intention to equalise the treatments of Main Street with Wall Street, this solution is outright stupid. Let's take a look at why.

The most obvious mistake, which economists and journalists often make in regards to housing prices, is conflating stock and flow. GDP is a flow, created in each period by investments, business and individuals acting and consuming. Debt is stock, a financial contract of payment between two parties, quite unrelated to GDP. As such, comparisons to GDP become quite nonsensical. Debts correspond to assets, because that's what they intend to finance or create; in other words, having massive debts is not an issue as long as there is assets to back them up - think Oil Tankers or Airlines, with incredibly large asset-purchases to finance, with equally large debts. Of course, there is a relationship between assets/debts and incomes that is a flow: interest rates. But unless professor Keen somehow failed to notice, debt is cheap these days thanks to imprudent central banks, interest rates being artificially low (lowest in "history of humanity"?), and so financing the same amount of assets is much cheaper - or equivalently, the same amount used to finance debt in the past can now finance so much more debt, without jeopardising the ability to carry that debt. Hence, prima facie we should expect debts to be much higher than before.

Besides, a quick dive into the numbers suggests less reason to worry:

Or, at least it suggest that perhaps private debt is no cause for anxiety, as opposed to the almost doubling of public debt as share of GDP over the last 15 years.

Moving on to Keen's suggestion of QE for the people. As we've seen, high private debt-to-GDP is a red herring and not a problem. But for the sake of argument let's ignore that and see what follows from his solution.

First of all, by massively expanding the money supply, Keen circumvents the sole reason the Fed's trillion-increases in Base Money has not yielded the widespread inflation many Economists warned about: that banks are simply sitting on the money or parking it at the Federal Reserve earning interest rather than making loans. The money is not in the real economy, pushing up prices the way Austrians feared, nor bumping spending the way new-keynesians such as Bernanke or Krugman hoped for. Aggressively circumventing this, as Keen suggests, would release both those forced very quickly; GDP figures and employment would ramp up, prices for already-scarce resources would jack up, capital goods would pretty instantly become more expensive and the lovely inflation would return. Probably, depending on the size of the QE, it might be the out-of-control version we've been afraid of. But why would that matter, Professor?

Secondly, since the reason people held so much debt in the first place (low interest rate-policy and propped-up housing markets) are not dealt with, it's likely that people take on new debt once the old one is paid off by this Keen injection (or made redundant by price inflation lowering the real burden of debt). After all, houses are still expensive and debt is still cheap. When these people take on new debt, we rode a very bumpy and expensive merry-go-round, only to return to where we started, Professor - oh, expect for the fact that you sincerely screwed up monetary systems and incentives along the ride.

Thirdly, incentives. What happens to the mindset, the risk aversion and idea of debt when Keen gives everyone a massive debt relief? If someone else pays for my debt when they become too high, what will I likely do in the future? Essentially, in his quest for cosmic justice Keen extends the damaging problems of moral hazard in the banking system to every system, increasing risks all around, likely ramping up even more debt later on, since it is now rational to assume that parts of it won't be mine to repay.

Lastly, it's ironic how Keen criticize mainstream economists like former fed chairman Bernanke, when Keen's own "solution" is copying good old Helicopter Ben's hypothetical solutions from way before the crisis. It was ludicrous then, it's ludicrous now.

I'm glad such a public figure as Steve Keen speaks up about the monetary system and creates some diversity in an otherwise pretty homogeneous(ly wrong) discipline. And I'm incredibly happy that he's speaking at Glasgow Economic Forum in March (You should all go, btw!).

But boy are his ideas wrong. Spectacularly incorrect, hysterically unsuitable and outright dangerous. Not that it ever stopped statists before, did it.


  1. This comment has been removed by the author.

  2. Three points. Firstly debt may well be a stock but debt repayments are a flow. And the more debt, the more debt repayments.

    Secondly the issue with debt is that it has to be repaid with money. It's all very well saying that debts match assets, so everything is great, but the trouble is that when it is time to pay your lender you need to pay with cash, not with some portion of the asset. If you have to sell the asset in order to get money to pay the loan, you have a problem. If you discover that you can't get enough money to make the repayment by using the asset to earn an income, or even by selling it, you have a big problem. So the flow of money in circulation has to be large enough to at least match the flow of debt repayments, no matter how well the stock of assets might match the stock of debt.

    Thirdly, Steve Keen's proposal is not a helicopter money proposal; it is a debt reduction proposal. Helicopter money can be spent by its recipients on anything from rent, to consumer goods, to interest payments, to debt reduction. As such it would very likely have the results you predict. In contrast Keen's proposal prioritises debt principal repayment with the aim of reducing future debt repayments. As a result it would not inject money into circulation to nearly the same extent as the standard helicopter money would do.

    1. Thanks for stopping by, guys.

      1)/2): Ok, fair enough, this Minskyate 'speculative' debt levels where cash flow is barely sufficient to pay interest, and so repayments become an impossibility is a valid point. Now, consider this; in an economy where central banks do everything in their power to constantly push down yields and interest rates (ie, companies can constantly refinance at lower rates), instead of pursuing lower interest rates, they could agree on longer maturity. And so any business with a functioning calculator could figure out a sustainable combination of interest & debt repayments. My point still stands; looking at debt charts and crying "wolf" is quite silly.

      Secondly, it matters what this increase in debts you're so afraid of is doing. If it's taken out and consumed by households like pre-crisis Home ATM strategies, I agree we're in big trouble. If it's invested in factories, business expenditure, successful start-ups etc (and shale gas boom of few years back seem to suggest it was..) debt is mostly harmless.

      3) ok, maybe I exaggerate the Helicopter Ben analogy, but his suggestion still puts you guys in a very awkward situation: either it runs into incentive/moral hazard problems where people simply jack up their debt levels as soon as the reduction has kicked in - or the deflation of credit and de facto contraction of money supply sends prices falling. And so we see widespread deflation. Not that I mind, but last time I checked, Keen's camp of economists normally wants to jack CPI inflation UP - not down.

    2. With Helicopter Money, jacking up debt levels is perfectly possible, so your point about the moral hazard of jacking up level of debt is perfectly good. But with Keen's proposal it's not, because anyone with debt must first use the money to pay down principal under the terms of his scheme. Sure, anyone who doesn't have debt could use the money to jack up debt. But if they wanted to do that they would have done it already. That kind of person is more likely to invest the cash. So moral hazard isn't an issue for Keen's proposal.

      As for debt being harmless, the story is more complicated. Debt creation puts money into circulation, debt repayment takes money out of circulation. So whether debt is good or bad depends upon the balance between debt creation and debt repayment. If debt creation dominates, the result is inflation as new money floods the economy; if debt repayment dominates the result is deflation as money disappears from circulation; if the two are roughly balanced, there's no problem. So how harmless/harmful the debt is depends on how far from balance the loan issue/repayment situation is. But when debts are large, either interest rates need to be low or loan issues need to be high in order to maintain that balance. And when people don't want to borrow money that causes a problem because it may be impossible to push down interest rates far enough to restore a balance between money creation from loan issue and money destruction from loan repayment. In such a situation, having the government create money without debt may be the only way to break out of a debt spiral. The good news is that in that situation, the extra money is not going to jack up inflation; instead it's going to jack down deflation because if we don't do it deflation is going to get really bad. And by really bad I mean bankruptcies, unemployment and cheaper (but less affordable) goods. All symptoms which we are already beginning to see...

    3. First of, you're missing the point. Afaik, Keen's proposal doesn't including a permanent ban on certain debt levels, right. Meaning that when Average Joe with credit cards debts or massively leveraged Business B get this Keen money, it is true that they are forced the pay down debt; what I'm saying is that AFTER that, they have every incentive to take out new debt. Why? They took on these debts for a reason (stupidity, imprudency, low interest rates, propped housing market whathave you), and Keen's proposal is not targetting those. That is, even if what you're saying is true, it's only painkillers for a cancer patient.

      Ok, maybe. Problem is: by intervening in markets via QE stimulus, the losses from the housing market crash are kept aside. Since -09 the Fed has effectively bought up toxic assets rather then let them default so the economy can recover. Instead, we're stuck in this never-ending circle of slow-growth and only slowly over time take those losses. What we need IS a negative balance between debt creation and repayment. New debt just prolongs the crisis..
      Shoving dirt under the rug doesn't make it go away..

      Here we go again with the "omg deflation is horrible". Funny how generally left-wing economist rely so much on Friedman & Schwartz...There's no compelling reason why generally falling CPI numbers should be a cause for concern.

  3. As Derek points out, the logical fact that the total of debts equals the total of assets buys you absolutely nothing, either literally or theoretically.

    If it had any purchase in the real world there would, for example, be no credit-checking industry.

    It is a sign of the dogmatism of mainstream economics and its fantasy barter world that the difference between claims to wealth and real wealth is not recognised.

    Joakim's misconceptions are the result of his mainstream teachers' refusal to engage with other perspectives, and in particular the horror with which the mainstream regards the teaching of the history of economic thought

    It is now well over 100 years since Marx introduced the concept of fictitious capital -- "money that is thrown into circulation as capital without any material basis in commodities or productive activity" -- or in other words paper claims to wealth and income streams, as distinct from from money capital on the one hand, and real capital invested in productive assets on the other.

    1. See my response above; it does.

      That's a non sequitur; and that industry does exactly what I was talking about - measure ASSETS on the one hand vs DEBTS on the other. Outcome and riskiness of Same loan with same interest is very different if posting 0 collateral or LARGE collateral.

      Hm, I like to think that my understanding of HET and diversity of economic ideas is slightly more sophisticated than your average mainstream professor. Besides, there's a difference between knowing your HET (which I claim I do) and accepting validity of former economists claims, in present as well as past life (which I don't).

  4. This is Prof R. Werner's suggestion.

    "Importantly for our disaggregated quantity equation, credit creation can be disaggregated, as we can obtain and analyse information about who obtains loans and what use they are put to. Sectoral loan data provide us with information about the direction of purchasing power - something deposit aggregates cannot tell us. By institutional analysis and the use of such disaggregated credit data it can be determined, at least approximately, what share of purchasing power is primarily spent on `real' transactions that are part of GDP and which part is primarily used for financial transactions. Further, transactions contributing to GDP can be divided into `productive' ones that have a lower risk, as they generate income streams to service them (they can thus be referred to as sustainable or productive), and those that do not increase productivity or the stock of goods and services. Data availability is dependant on central bank publication of such data. The identification of transactions that are part of GDP and those that are not is more straight-forward, simply following the NIA rules."


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