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.