Home > crisis > The Crisis in 1000 words—or less

The Crisis in 1000 words—or less

from Steve Keen

URPE–The Union for Radical Political Economics–is holding a Summer School for the Occupy movement, and as part of that invited papers that explained the crisis in 1000 words or less (so that they can be printed on one double-sided sheet). Here’s my effort in somewhat less than 1,000 words (though with 2 figures). In the interests of URPE’s objective in this exercise, here’s the PDF of this blog post for general download.  

Both the crisis and the apparent boom before it were caused by the change in private debt. Rising aggregate private debt adds to demand, and falling debt subtracts from it. This point is vehemently denied on conventional theoretical grounds by economists like Paul Krugman, but it is obvious in the empirical data. The crisis itself began in 2008, precisely when the growth of private debt plunged from its peak of almost 30% of GDP p.a. down to its depth of minus 20% in 2010. The recovery, such as it was, began when the rate of decline of debt slowed. Across recession, boom and bust between 1990 and 2012, the correlation between the annual change in private debt and the unemployment rate was -0.92. 

The causation behind this correlation is that money is created “endogenously” when the banking sector creates loans, and this newly created money adds to aggregate demand—as argued by non-orthodox economists from Schumpeter through to Minsky. When this debt finances genuine investment, it is a necessary part of a growing capitalist economy, it grows but shows no trend relative to GDP, and leads to modest profits by the financial sector. But when it finances speculation on asset prices, it grows faster than GDP, leads obscene profits by the financial sector and generates Ponzi Schemes which are to sustainable economic growth as cancer is to biological growth.

When those Ponzi Schemes unravel, the rate of growth of debt collapses and the boost to demand from rising debt becomes a drag on demand as debt falls. In all other post-WWII downturns, growth resumed when debt began to rise relative to GDP once more. However the bubble we have just been through has pushed debt levels past anything in recorded history, triggering a deleveraging process that is the hallmark of a Depression.

The last Depression saw debt levels fall from 240% to 45% of GDP over a 13 year period, and the ensuing period of low debt led to the longest boom in America’s history. We commenced deleveraging from 303% of GDP. After 3 years it is still 10% higher than the peak reached during the Great Depression. On current trends it will take till 2027 to bring the level back to that which applied in the early 1970s, when America had already exited what Minsky described as the “robust financial society” that underpinned the Golden Age that ended in 1966.

While we delever, investment by American corporations will be timid, and economic growth will be faltering at best. The stimulus imparted by government deficits will attenuate the downturn—and the much larger scale of government spending now than in the 1930s explains why this far greater deleveraging process has not led to as severe a Depression—but deficits alone will not be enough. If America is to avoid two “lost decades”, the level of private debt has to be reduced by deliberate cancellation, as well as by the slow processes of deleveraging and bankruptcy.

In ancient times, this was done by a Jubilee, but the securitization of debt since the 1980s has complicated this enormously. Whereas only the moneylenders lost under an ancient Jubilee, debt cancellation today would bankrupt many pension funds, municipalities and the like who purchased securitized debt instruments from banks. I have therefore proposed that a “Modern Debt Jubilee” should take the form of “Quantitative Easing for the Public”: monetary injections by the Federal Reserve not into the reserve accounts of banks, but into the bank accounts of the public—but on condition that its first function must be to pay debts down. This would reduce debt directly, but not advantage debtors over savers, and would reduce the profitability of the financial sector while not affecting its solvency.

Without a policy of this nature, America is destined to spend up to two decades learning the truth of Michael Hudson’s simple aphorism that “Debts that can’t be repaid, won’t be repaid”.

  1. Steve Hummel
    July 24, 2012 at 6:54 pm

    A modern debt jubilee is wisdom. And its echo in the form of a universal individual Dividend and a general price discount to consumers (which is calculated only after the normal price discovery is done and outside of the cycle of production through to retail sale and thus is not actually price control) is the sane and honest solution to economic stability in perpetuity.

  2. July 26, 2012 at 7:23 pm

    I thought I’d posted a comment a couple of days ago. It was linking the $21trn hiding in tax havens (now subject of another blog) to problem of debt. Couldn’t we just do a bit of daylight robbery?

  3. July 30, 2012 at 10:56 am

    It’s almost unbelievable to anyone but an experienced Georgist like me that the author would correctly blame the housing crisis for the origins of the crisis, but then fail to prescribe the correct solution to the problem: Site Value Reclaim. Without claiming back the value of location – a vlue which came from the commnity, not from anything the landowner did, we will continue to have more Land Bubbles, as we have had about every 18 years, going back hundreds of years to the rise of capitalism in Western Europe. No regulation, agency, appeal to Man’s “better nature” or Change-agent elected official can fix this, unless we restructure the economy to account for the proper role of Land (meaning ALL of nature’s resources in Classical Economics, but in the present case, mostly locational values) in economcs. Treating Land as just another form of capital – when its qualities make it nearly the opposite of Capital – will guarantee more bubbles, crashes, pain and poverty forever.
    OTOH, get this right and we can have smooth economies, with gradually rising living standards for all, an end to vast wealth inequities based solely on rent seeking behavior, new opportunities for true entrepreneurs and workers, and a tiny fraction of the corruption at every level of government. This has been known since Henry George, and even before, going back to biblical times, and is perhaps the most proven economic theory there is in what is otherwise rightly called the “dismal science.”

  4. Michael Monterey
    August 2, 2012 at 12:02 am

    :D LOL!!! That’s a “Lesson” for Occupy? I think they will understand Manfred Max-Neef, C Eisenstein, and I much better. Even the neo-Marxian cartoon on capitalism via the RSA Youtube video will do more for the untutored Occupiers. But “The Secret of Oz” and Joseph’s Zeitgeist history of “Money – The Movie” may work best… Dontcha think?

  5. Tim Rez
    August 2, 2012 at 12:53 pm

    The first chart shows a positive correlation (between debt and unemployment), while the text claims a negative correlation. Am I misunderstanding, or is that a discrepancy?

    After looking again, I see that the data has two vertical scales, in opposite directions. Perhaps that could be made more clear?

  6. August 4, 2012 at 3:48 pm

    Every loan created by a bank creates enough Principal to pay off both the loan and, by recycling the interest as spending, the interest as well. So why does de-leveraging result in vast numbers of defaults and economic collapse? If Keen’s single-cycle “endogenous money” model were correct, de-leveraging need not result in any defaults whatsoever.

    Nowhere in Keen’s (or anyone else’s model I am aware of), does he take into account that money created as one loan gets lent again and again as existing money. Try paying off $300 in Principal debt with only $100 of Principal in existence. Now you get a rash of mathematically inevitable defaults.

    Here is a NEW 9-minute explanation in cartoon form.

    • August 8, 2012 at 10:00 am

      A major part of the problem is that collateral is over-estimated to begin with. House, really: Land, is particularly subject to this over-estimate. That’s why Land should be taxed to prevent bubbles and to raise revenues, and loans should only be made on actual houses, like car loans. 80% of what banks lend is for mortgages – derivatives multiply the problem exponentially. A Land Value Tax would prevent all major bubbles.

      • August 8, 2012 at 8:18 pm

        Even realistically collateralized, and WITHOUT any interest being charged, the dynamic I am describing still makes the full repayment of Principal impossible, and perpetual growth of the money supply imperative.

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