The revolt of (part of) the top 1% of the top 1%

from Steve Keen

What are your preconceptions about the author of a book with the title The Next Economic Disaster: Why It’s Coming and How to Avoid It? Academic? Leftist? Anti-capitalist? Anti-banker certainly?

Prepare to drop them all, because the author is none of the above. Taking the last first, the majority of his career has been in banking — and as a founder and CEO.

To put it in his own words:

“Starting in 1978, I came up the career ladder in the consumer division of a Texas bank. When that bank got into trouble through oil and gas loans in the mid-to-late 1980s, a colleague and I took our division private in a leveraged buyout in 1989. We named it First USA, took it public in 1992, and sold it to Bank One in 1997 for almost $7 billion. It was the top-performing financial stock on the NYSE during our tenure, returning almost 100 per cent per annum to its shareholders.

In 1999, in conjunction with former colleagues, I started a de novo credit card and internet bank called Juniper Financial, which we grew successfully and sold to Barclays in 2004. (That’s when the story I told you occurred.)

In 2007, I started yet another business with former colleagues, this time an energy business called Energy Plus that focused on electricity and natural gas. That business was quite successful and grew to almost $400 million in sales in four years — and we sold it to NRG in 2001.

As for my wealth, I make a point of never giving the details, but I have been very fortunate. I started with essentially nothing, could have retired at 40, but remain busier than ever because of a love for the areas in which I am active.

Currently, as you mention, in addition to my work on private debt, I have two main areas of focus. The first is venture capital, where along with several terrific associates, we focus on very early stage companies — the most creative part of the new economy. Thus far we have investments in fourteen companies and are continuing to grow. My second area of focus is charity — and within charity, I have focused most specifically on both cancer research and the arts. I have the good fortune of being associated with the University of Pennsylvania’s Penn Medicine division, where very recent and truly revolutionary research may have uncovered the cure for leukemia and holds the promise of the same for other types of cancer. I also am a strong supporter of the arts—especially the efforts of young artists creating new, world-class work today.”

So what is someone who established banks, initiated credit card companies, and is clearly in the top 1 per cent of the top 1 per cent of America doing writing a book that warns of the dangers of private debt?

That relates to ‘the story I told you’, which he refers to above. As CEO of Juniper Financial, he became extremely concerned at the rising level of mortgage debt, because he felt this could mean that his credit card customers might be unable to pay their debts.

He sought professional advice about the dangers, but all the economists he spoke to were unconcerned, because house prices were rising at the same time. The chief economist of Barclays Bank noted that yes, while his customers’ liabilities were rising, so were their assets — and “that’s a trade that I’d take any day”.

Richard Vague decided to take the other side of that trade, and sold Juniper Financial to Barclays, three years before the crisis that he feared finally occurred. Having been advised that this crisis was highly improbable, be began a long empirical journey to being a sceptic, not of capitalism, but of the conventional economic theory about how it operated.

As he notes in the conclusion to this book: “How could we have known back then [in the late 1970s] how wrong almost everything we were taught would turn out to be?”

What was most wrong was the reassurances he received from conventional economists that the aggregate level of private debt wasn’t a problem, and nor was its rapid growth in the early 2000s. Painstaking empirical research, which is detailed in this book, instead led him to the conclusion that the aggregate level of private debt and its rate of growth were probably the most important economic indicators of all.

After collecting the data on 22 major economies, he concluded that economic crises were almost inevitable when aggregate private debt exceeded 150 per cent of GDP, and when that level had grown by 18 per cent or more (say from 150 to 168 per cent) over five years or less. This rule of thumb applied in every economic crisis across the globe, while there were only two countries which ever met those rules and did not have a crisis: Australia and South Korea in the 2007 crisis. His explanation for why these countries did not have a crisis is instructive:

“The remaining instances were Australia and South Korea, which in the late 2000s were carried along by the ongoing lending boom in their much larger neighbor China.”

This is the most topical part of Richard’s book: his prediction (with reservations) that China will have a serious crisis in the next 2-5 years because it fulfils in spades his two basic criteria:

“China … has 54 percent growth in five-years in private debt to GDP and 182 percent overall private debt to GDP, and … I therefore deem to be ‘at risk’.”

His reservations here are its enormous foreign capital reserves, low government debt (meaning that it can afford to bail out its banks) and its capacity to control and restructure its banks in a way that no Western government has been willing to even contemplate. But given those reservations, he still expects a serious economic slowdown in China driven by these private debt excesses, with extreme flow-on consequences for economies that are dependent on China.

There is much else of merit in this short book, and I highly recommend buying it and studying both its data and its analysis. I’ll cover more of this myself in future columns, but in this column I’ll focus on the phenomenon of someone who has benefited enormously from financial capitalism nonetheless calling for its serious reform. Here, he is not alone: the ‘zillionaire’ Nick Hanauer, who was the initial non-family investor in Amazon, recently penned “The Pitchforks Are Coming… For Us Plutocrats”, in which he warned that unless inequality was reduced, then:

“The pitchforks are going to come for us. No society can sustain this kind of rising inequality. In fact, there is no example in human history where wealth accumulated like this and the pitchforks didn’t eventually come out. You show me a highly unequal society, and I will show you a police state. Or an uprising. There are no counterexamples. None. It’s not if, it’s when.”

When the poor and the dispossessed complain about inequality, it’s only to be expected. But when part of the top 1 per cent of the top 1 per cent complain about it, it is truly time to worry — and preferably to act.