Home > Uncategorized > Why China had to crash: Part 1

Why China had to crash: Part 1

from Steve Keen

In this post I consider the economy in general: I’ll cover asset markets in particular in the next column, but you’ll need to understand today’s post to comprehend the stock and property market dynamics at play. Having said that, the Shanghai Index fell another 7.5% on Tuesday, after losing 8.5% on Monday, and is now down over 45% from its peak—so I’ll try to write the stock-market-specific post by tomorrow. In this post I’ll show, very simply, why a slowdown in the rate of growth of private debt will cause a crisis, if both the level and the rate of change of debt are high at the time of the slowdown.

Engineers should find this argument easy to understand and informative, but tedious to read because the logic is so obvious. Economists are probably going to find it almost impossible to comprehend, clearly wrong, and they will probably be enraged by it.

So who should you trust if you’re neither? Firstly, think of how often you successfully trust engineers every time you operate a domestic appliance, hop in your car, drive over a bridge, or fly between continents. Then think how often you have unsuccessfully trusted economists (when I’m asked socially what I do for a living, I describe myself as an “anti-economist”—before I elaborate that I am a Professor of Economics but regard the dominant school of thought in economics as dangerously deluded).

Finally, work out which profession you’d rather trust if the two groups disagree—even when we’re talking just economics.

OK, preliminaries over. Now for the logic.

Demand is strictly monetary: there is some barter, but in the vast majority of cases, purchases of both goods and assets requires money. And there are two main private sources of money: you can either spend money you already have, or you can borrow from a bank. When you borrow from a bank, you increase your spending power without reducing anybody else’s: the bank records a new asset on one side of its ledger (the debt you now owe to the bank) and a new liability (the additional amount of money in your deposit account). When you spend that borrowed money, it becomes income for someone else. So total expenditure and income in our economy is the sum of the turnover of existing money, plus the change in private debt (I’m leaving the government and external sectors out of the argument for now).

Mainstream economists will already be screaming at this point, because they believe in a fallacious model of money called “Loanable Funds” in which banks are just intermediaries and lending is a transfer of money between savers and lenders. They continue to believe this model even though the Bank of England has said very loudly that it is wrong. Engineers should be waiting for stage two of the argument (the full mathematical argument will be published in the Review of Keynesian Economics in October).

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Cover of Developing an economics for the post-crisis world

Developing an economics for the post-crisis world

by Steve Keen

1. Economists have no ears
2. Mad, bad, and dangerous to know
3. Debunking the theory of the firm
4. Economic growth, asset markets and the credit accelerator
5. The Return of the Bear
6. The fiscal cliff – lessons from the 1930s
7. A bubble so big we can’t even see it
8. Secular stagnation and endogenous money

  1. Paul Schächterle
    August 27, 2015 at 3:03 pm
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