Every bear has his day and this is Steve Keen's. The associate professor in economics and finance at the University of Western Sydney has been warning against the debt bubble for years, in print (with his book Debunking Economics) and with his Debtwatch Report podcast and Debunking Economics website.
At conferences and seminars here and overseas, he has pointed out that the ratio of private debt to GDP is now more than double the levels that triggered the Great Depression. "I thought, 'There has to be an enormous financial crisis and somebody has to raise the alarm,"' he says.
Keen's outspoken views have made him a controversial figure in a profession dominated by those who believe in the essential equilibrium of capitalism. So does he feel vindicated in witnessing the subprime disaster and its fallout? "It's nice to be right but when what you're right about is saying that there's going to be a serious catastrophe that will damage the lives of hundreds of millions of people, it's very hollow ... You don't want to win like this."
He thinks many in the industry, including reserve banks around the world, should have foreseen the crisis but chose not to.
Keen was born in 1953 - in a time of low debt, he points out, when the nation was bent on building up industries. His father was a bank manager whose only debt was a mortgage ("at 3 per cent") on the family home.
. . . . . .
Keen then went on to write Debunking Economics. Called as an expert witness in a court case involving multiple loans to a couple who could not afford the repayments, Keen made "a throwaway line" about how debt-to-GDP ratios in Australia were rising exponentially. Knowing he "could not rely on hyperbole as an expert", he examined the data more closely.
"My jaw just hit the floor," he says. "The ratio of private debt - like household and business debt - was about 145 per cent of GDP. That was in 2006. It's now 165 per cent."
Just before the Great Depression began in 1929, the ratio was 80 per cent. Today, he says, Australia's debt is about the fourth or fifth-worst in the world: "We're slightly below America, way below England, and the Netherlands is scary."
So how did we get into this position? Most economic theory, he says, is based on "bad mathematics" that should have been consigned to the scrap heap two centuries ago. And he thinks capitalism has become unhealthily focused on speculation and greed.
Keen makes a distinction between speculation and investment.
"Investment which involves a certain amount of a gamble is thinking, 'This might work as a product.' Speculation is thinking, 'The price of the company that makes this is going to go through the roof.' If you have too much of the latter driving the economy, then what will most certainly happen is leveraged speculation. The debt levels grow and you get to the stage where the financial burden on the economy becomes as it is now: unsustainable."
THE BIG QUESTIONS
Biggest break Choosing to read Hyman Minsky's book John Maynard Keynes in my Masters. That gave me a perfect explanation of the chaos we've got ourselves into.
Best investment My education. I'm not a good person for finance. I am, in that sense, conservative.
Worst investment My ex-wife, who is a good friend, worked for a telecommunications company that wanted to do an IPO to employees. She wanted to buy $3000 worth of shares. She said, "They're undervalued compared to the market." The price-to-earnings ratio was 40 to one. I said, 'That's crazy. We shouldn't buy them ... but well, OK, we can afford to lose $3000." They went down to 300 bucks.
Biggest regret Probably not getting in at the beginning of this speculative bubble in housing when I first moved out to rent in the 1970s. If I'd wanted to be financially comfortable, I should have done that. I didn't buy a house until 1989. I didn't believe the bubble could go on for as long as it did.
Personal philosophy We've turned capitalism into a kleptocracy. It should get back to being capitalism again.
Basically Steve is right about what underlies the problem, but not the effects. There will be no pop in the Sydney and Melbourne. It will just deflate with time. Steve also does not make enough mention of the demographics driving the economics and often forget that bears, like Rav, will not sell their HOME....the sociology is just as important as the economics and demographics.
I am just finishing reading Agequake and it seems to me that many saw the GFC coming as far back as 1999.
Interesting that the author is a Rothschild bot.....
It seems to me that banking overall has done quite well out of the GFC.....when really a major credit crunch of the scale we had, should have seen more go out backwards.......now it seems like the govts are failing like Greece, rather than the lending banks.......
i think there will be pockects of bad performing areas, Probably areas that are not tied to large employment areas ... the areas of syd, melb may deflate slowly, or not see price movement, ut inflation and interest affecting results.
Starting to see prices be "reduced" north of Sydney...
It’s not getting any smarter out there. You have to come to terms with stupidity, and make it work for you - Frank Zappa
The ultimate Neo-Keynesian and the ultimate Post-Keynesian are trading blows on their respective blogs right now.
It all started two weeks ago when Steve Keen published claimed that Paul Krugman didn't understand Hyman Minsky and his warnings about debt. They've exchanged half a dozen posts since then, but we'll skip to the latest insults.
KEEN: Reading what Paul Krugman is saying about banking feels like reading a Ptolemaic Astronomer describing sunrise today as if that’s actually what’s happening. He is dismissive of the view that banks can “create credit out of thin air”—so dismissive in fact, that anyone unacquainted with the empirical evidence might be fooled into believing that his case is so strongly supported by the facts that it’s not even worth the bother of citing the empirical data that backs it up.
KRUGMAN: Oh dear. Nick Rowkrugmane sends me to Keen’s latest... Nick uses a four-letter word to describe this; I can’t, because this is the Times.
KEEN: In just a couple of days I’ve gone from the privilege of being acknowledged by Krugman to being misread by him, in a way that would have any student failed in a multiple choice exam. In a passage where I specifically referred to DSGE models–which includes both “New Classicals” and “New Keynesians” he interpreted me as referring to New Keynesian models only...
Since I don’t work for The Times, I can and will use a four letter word to describe your poor comprehension here Paul: FAIL.
Biggest regret'Probably not getting in at the beginning of this speculative bubble in housing when I first moved out to rent in the 1970s. If I'd wanted to be financially comfortable, I should have done that. I didn't buy a house until 1989. I didn't believe the bubble could go on for as long as it did.'
I wonder if a past mistake such as this, a mistake looked back on as one's greatest ever regret, could drive a person towards an irrational and ultimately futile crusade against the perceived 'bubble' that damaged his wealth to such an extent? Could it make a person obsessive in their attempt to 'prove' the existence of this bubble, to prove that the 'bubble' must burst? Could it cause a person to overlook or dismiss evidence contrary to their objective? Could it result in an unbalanced and biased analysis of the available data?
Keen seems to be saying here that the bubble began in the 1970s, and that he didn't buy until 1989. Surely, if he had kept the home he bought in 1989, he should have it paid off by now, and it would be worth a lot more now than he paid for it?
His claim here that the bubble began in the 1970s is at odds with his previous claims that the bubble began in 1964, 1983 and 1988...
In light of this recent revelation, that the bubble began in the 1970s as well as beginning in 1964, 1983, and 1988, I have added item 12 to my list...
In light of this recent revelation, that the bubble began in the 1970s as well as beginning in 1964, 1983, and 1988, I have added item 12 to my list...
I first moved out to rent in the 1970s. If I'd wanted to be financially comfortable, I should have done that. I didn't buy a house until 1989. I didn't believe the bubble could go on for as long as it did
Keen's in his 60s?? Waiting 40 years, all his adult life, for the bubble to pop -- gotta feel sorry for the guy!!
CHRIS BECKER NOW NEUTERED "There are two kinds of people in this world: ones that fiddle around wondering whether a thing's right or wrong and guys like us." (Hugo to Gagin in Ride the Pink Horse)
Lauren Lyster’s Capital Account covers probably what has been the biggest economists bust up since Hayek v Keynes and has caused something of an internet sensation.
The argument is between Professor Paul Krugman, Noble Prize Winner and undoubtedly the worlds most famous economist through his outspoken NYT column and blog, and Professor Steve Keen – who until recently was a marginalised and little known figure based in Australia. Keen had one major claim to fame though, he was only one of a tiny handful of economists who predicted the great financial crisis of 2007 to today (and Krugman didnt) and the only one to do so with a mathematical model.
Now both figures are progressives and critics of the neo-conservative austerity ‘consensus’ that somehow we will get out of this great depression by austerity which is and will make matters worse. So why have daggers been drawn? Well the reason is that Krugman and some of his more conservative colleagues such as Greg Mankiw and Robert Lucas all share the same underlying theory of economics – the neoclassical synthesis. This approach of course failed to predict the crisis and is used to justify austerity economics. However over a number of years the dissatisfaction with this approach has been growing. Because progressive Neo-Classicals – the so called New Keynesians, have been unable to lend a clear blow on austerity economics, either to show why we had the great depression, to prove that it does not work and present a clear policy alternative, many have concluded that they are an active impediment to a change in thinking about economics. But the austerians can point to progressives supporting the foundations of their own economic theory it must be right mustn’t it. The New Keynsians have become the ideological prop to the status quo. A potemkin village to be pointed at by neo-cons to critics of economics. YankeeFrank on Naked capitalism sums it up
Actually, I would argue that Krugman and his Rubinite sponsors are our worst enemies. They provide many of the theoretical underpinnings for our current lemon socialist/crony capitalist system. Krugman, as far as I recall, has still refused to utter the words “fraud” or “crime” in relation to the misdeeds of our bankster overlords.
To say that debt can be “modeled out”, or banks can be ignored, in our understanding of the financial system is exactly how the devil gets in….
Krugman’s answer to our problems is the typical limousine liberal response, and it amounts to pretty much the same thing as the republican response: charity for the “losers” in our economy. The main difference is who should provide it, the government or private donors.
Sure Krugman wants “money drops”, but insists the current system is sustainable if we just do that. He in no way calls for real reform of finance, banking or industrial policy. But that is because he’s spent his career pushing the policies we now live under. …So yes, Krugman is the enemy. The idea that he is an ally just shows us how far from any real solutions this nation is; which is why we’re going to have another, much more massive and destructive, collapse before the ideas discussed on … truly progressive sites get the airing and support they deserve.
The alternative school has emerged from the ‘post Keynesian’ school. This school grew out of Keynes closest associates and was based on the idea that the key issue in economics is that of disequilibrium. That is when different markets are out of sync with excess/under supply, such as of course lack of demand for labour – unemployment, or excess demand for money, inflation. This group held that what was important about Keynes was that it was a disequilibrium theory. Whereas in America the synthesis in the neoclassical synthesis squeezed Keynes into a more conventional ‘equilibrium’ box where economies are stable and markets stabilising and things tend to settle down except where there are external ‘shocks’, or where prices are ‘sticky’ – like – heaven forfend – when people don’t automatically drop their wages if their is a bad week. The Post Keynsians attacked the foundations of this view, but for many years were a small group. They achieved a few notable victories, notably from economist Piero Sraffa who for a time seemed to shake the whole foundations of economics with results neo-classicism couldn’t explain and which even the giants of the time such as Paul Samuelson admitted defeat on. But it didn’t go anywhere. It was a Pyrrhic victory. The results were dismissed as being abstract and of no practical importance.
Have the heirs of Wyne Godley and Hyman Minsky begun to defeat neoclassical economics?
Everything carried on as before and heterodox figures were confined to a small club. There was a reason for this – money – or rather lack of a theory and model of money and banking. In the last 20-30 years however to fill that that huge gap, a theory of money, credit and banking, developed. It was known as the French circuitist school. Its ideas were actually very similar to ideas which were dominant before the second world war, that an expansion of money is based on credit, which is founded on profits in the future funding loans and creating monetary expansion today, through profits funding interest on loans, as opposed to investments created through savings, which is not monetary expansion as it is simply spending deferred until the future – the monetary stock does not change. A second breakthrough came with the work of Wyne Godley, who incidentally is the model for the St Michael defeating the Devil on the side of Coventry Cathedral. He took this approach toward money and modelled how it flowed between bank accounts and the economy. This approach became known as stock-flow consistent economics. The other key figure was Hyman Minsky – again a fairly marginal figure in his lifetime but a cult figure now – since who set out a model of financial instability – how a boom in credit could create a financial crash and recession. Steve Keen was the figure who brought these ideas together and more importantly created a dynamic computer economic model – which he used to predict the 2007 crash, and further more the risk of a further ‘double dip’ which we have actually now begun to see.
Although Steve Keen launched frequent attacks on the neo-classical citadel Krugman seemed to ignore Keen. Until last week, and then it all kicked off. Exactly what the issues were and how they were argued will have to wait till another day as it deserves a more through treatment in terms people can understand without jargon and maths. In short though Krugman attacked a paper of Keen’seven though he professed not to really understand the ideas behind it. The reaction on the internet was instant, the comments on Krugman’s blog made it clear that Krugman should learn this stuff and moreover most felt Keen was right. The reaction of Krugman was to lash out accusing Keen and his critics of mysticism. This simply unleashed a torrent of criticisms on the web, which to my eyes were about 20:1 in favour of Keen. The problem was that Krugman seem to express some very naive and out of date ideas on how money works. If you want to follow the arguments here is Krugmans follow up and a third post. To which Keen replied here, and then here.
Keen responded by calling Krugman’s economics ‘ptolomiac’ as outdated as assuming the sun revolved around the earth. I chipped in a short piece explaining how Krugman’s economics weren’t even ptolomiac – as it was timeless so the earth didnt even spin. The piece went through Krugman’s ideas on how investment is funded and how money is created and tried to show some flaws in his approach. To my surprise Keen to whom I am just an acquaintance of and occasional correspondent with posted my piece in support and retweeted some of my more abtuse theoretical points. From his blog.
I’m rather lucky with the calibre of my blog members, and that’s been in evidence in the discussion over Krugman here in the last few days. One comment by Andrew Lainton simply has to be shared more widely…
Gulp. Krugman responding to the Ptolomiac criticism lashed out – but made a critical error, he quoted Keen selectively in order to make home look like some kind of unknowledgeable idiot. The blogoshere spotted this instantly and came down on Krugman like a tonne of bricks, the argument became for a time intemperate. Scott Fullweiller made a slam dunk intervention. Until suddenly, Krugman, seeing that many had considered he had made an idiot of himself withdrew from the field saying im right, the rest of you are wrong and im not taking part in the debate any more – he took his ball home. Though he did come back with the rather limp defence that the New Keynesian theories were somehow different and not the kind of ‘DGSE’ models that Keen has attacked and.
I’m all for listening to heretics when they offer insights I can use, but I’m not finding that at all in this conversation, just word games and continual insistence that the members of the sect have insights denied to us lesser mortals. Time to move on.
In terms of the argument the overwhelming view of the internet was the Krugman had lost the debate and this was one for the history books – perhaps even a turning point in the dominance of neolassical economics – or neo-con economics as I call it. As I said a few days ago ‘this week will be remembered as the end of the beginning of the end of neo-classical economics’.
Which the blogosophere immediately picked up on as hypocracy as New Kenynsian models are built on the mathematical foundation on DGSE and it was Krugman who was playing word games and refusing to engage with the criticisms of why they were wrong.
Ana -Berlin summed it up
What this latest Krugman post shows is a bad faith, not superior knowledge. I’ve read Keen’s blog and Krugman’s original posts along with all the readers comments and seems to me that 1) Krugman tried to debunk an opposing theory with a couple of coffee table talk remarks which is in itself a massive display of petulance. 2) Krugman constantly appealed to “authority” to disguise is inability to engage the opposing theory on scientific grounds (e.g. cannot go to Berlin due to more important engagements). 3) When hounded by readers who, correctly, point out that his arguments are fallacious and that he fundamentally misunderstands the role of banking, Krugman resorts to some third party opinion who, conveniently, misrepresents Keen’s points completely. 4) it all ends in a nasty tone, with Krugman insulting Keen, and here, one should note, that this is not a symmetric battle, you are talking about a Nobel prize winner, world wide known economist trying to diss and belittle a much lesser known professor out of spite. On a final note i would advise everybody to get acquainted with Keen, Krugman is not going to write economical history
Interestingly many of the key theoreticians in this new approach come from a non economics background, such a historians, traders, and engineers, so why should not even a town planner join in. Neo-classical economics had become so degraded that it needed to be torn down from the outside.
Neo-classical economics now has its wagons circled because there have been a number of attacks recently even from outside and inside the corral, from figures such as Eggertson and Kocherlakota which imply that disequilibrium is the norm and that you get this even when prices are fully flexible – so the defence that New Keynsianism is somehow immune to criticisms for its inclusion of ‘stickiness’ falls apart. These results if followed through imply that the foundational principles of neo-classical economics are incoherent and must be replaced by a dynamic disequilibrium alternatives on broadly the lines that Keen and others have suggested.
As Keen Said on Capital Account last night - video at top
Hey, your models didn’t predict the financial crisis, we can ignore your models….
[Y]ou can’t model the economy without including the role of banks, debt, and money. And Krugman’s part of the economic establishment, which for thirty or forty years has got away with arguing that you can model a capitalist economy as if it had no banks in it, no money, and no debt… You just don’t have a model of capitalism if you don’t include those components.
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