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The Bear in a Bull Market | BTalk Australia


Steve Keen

Steve Keen

(Episode 319; 22 minutes 15) Steve Keen has been arguing for years that excessive debt levels would bring the world economy crashing down. When the global financial crisis hit people started to listen. Now we're starting to hear about green shoots in the economy. The Aussie share market has risen by 40% since March. With these positive signs some people are starting to doubt his predictions.

Yet Keen argues that it's the high level of government intervention has helped in the short term, but the underlying problem remains. A huge amount of debt that needs to be wiped out before the economy will stabilize. Right now, if you remove the government stimulus the economy will slide.

This graph, from Steve Keen's Debtwatch blog, shows the ratio of debt to GDP. It seems like a good measure --- the ratio of how much you owe against how much you make. Keen says the ratio is unsustainable. You can see how long he predicts it will take to pay off that debt based on previous peaks during the Great Depression and the late 19th century. Doesn't that mean now is a bit early to be talking about green shoots?

Steve Keen's Debtwatch
So how can we help the process of removing excessive private debt? What does the government need to do next?

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  • Transcript
Phil Dobbie: Hello, I'm Phil Dobbie. Welcome to BTalk Australia. Today, green shoots; positive indicators of bullish share market. We're hearing a lot about the path to recovery. Is it real or a false hope? Well, Steve Keen has absolutely no doubt.

Is the global financial crisis over? Are we on the path to recovery? If so, we hardly felt a thing, didn't we? We didn't even go into recession here in Australia, officially we're told, anyway. Well, Steve Keen is a professor in economics at the University of Western Sydney. He's been describing recently on his Debtwatch blog how it's hard to be a bear right now. Well, the market is certainly pretty bullish, isn't it? Steve, we've spoken a couple of times before.

You predicted the next Great Depression, driven by excessive debt. You said the bubble would burst, unemployment would run rampant. Commodity prices would nose dive. Did you get it all wrong?

Keen: Well, not internationally; I remember that the American unemployment's gone through the roof. We're now approaching 10 percent and I really expect that's going to happen; that will be the second worst recession if it gets to that level since the Second World War. So a serious downturn has occurred. What's also occurred is that this was something which I saw coming some time ago and was warning about it and, certainly when Australia Reserve bank was completely ignoring it and fetishising about the rate of inflation. In America, they were reducing interest rates across that whole time, but Bernanke; you might remember about a year and a half or two years ago, said that the total impact of this sub-prime's life was between $100 billion and $300 billion. Well, $2 trillion later they really thought: oh, my God, the second Great Depression is coming. And, the scale of the government action that's been thrown out to counteract that has been gigantic.

Kevin Rudd gave the best metric on that that I've seen at the international level and they said that over the three-year period from when the crisis was beginning, which is September 2007 to the September 2010, the aggregate spending by governments around the world is equivalent to 18 percent of global GDP.

Dobbie: So, has that worked? Has it stopped us getting into ---

Keen: Yes, it does. If you have spending collapsing because people are starting to delever, and that's becoming very obvious in the United States, for instance.

And if you throw in a huge amount of government spending in the other direction, you can counteract that deleveraging for that period of time.

Dobbie: Alright. So in other words, you're almost shifting that debt, aren't you? You're taking the debt away from private and making it state debt.

Keen: Yes, that's right, the government's spending could be fine just by maybe printing money. It could just simply, the government could sell bonds to the reserve bank; the reserve bank hangs onto the bonds and gives the government money, and the government then spends the money. There's no need for the government to go into debt to the public sector to the private sector to do that, but nonetheless, that is what they are doing. And, of course, that will work for that period of time, but every time you do it, you're still stuck unless the private sector is deleveraging and you're balancing the deleveraging all the way down. The private sector is still stuck with that level of debt, which it is trying to reduce. And, if you look at the Australian economy and look at how fast we delevered in 1890 and in 1930; the rate in 1890 you could call sort of an endogenous rate of deleveraging because there was no policy driving the reduction in debt then. We reduced it at about 4 percent per annum, and it started at just about 100 percent of GDP. So effectively, 4 percent of GDP was being used to reduce debt levels, which of course is a 4 percent deduction from spending, so the aggregate amount falls by four percent.

If we did that now, we'd be cutting aggregate down by 6 percent. Now, what Rudd is telling us, he's spent more than 6 percent, because the Australian spending was above the international average. We've spent more than 6 percent of the government GDP over a one year period. The government spending has been more than 6 percent of GDP over one year, plus also the impact of interest rate cuts and so on. That's a huge stimulus. Now, courtesy of that, we've just had about a zero growth.

Dobbie: But are we deleveraging? I mean is private debt going down?

Keen: The private sector, you'll have to look at what's happening at private sector and again, the government's manipulated this to some extent with what I call the first time vendor's grant.

Dobbie: Yes.

Keen: And that is that they, the business sector is cutting debt at a radical rate, so last month the business debt fell by a billion dollars. Now, that's pretty substantial at a deleveraging.

Dobbie: For one month?

Keen: In one month. At the same time, mortgage debt rose by $9 billion. Personal debt fell by about half a billion, so overall there was about a $300 to $500 million increase in private debt in one month. Now, if you maintained that for a year, you'd get about a $4 billion increase. Compare that to calendar year 2007, when the increase in private debt that year was $260 billion.

Dobbie: So when you look at that, and this has been said a lot hasn't it; the first home buyers grant is a bit of a nonsense then, isn't it? I mean, we're deleveraging everywhere, but it's creating a bubble in this one sector of the economy.

Keen: It's creating a bubble and it's basically saying that the only way to get out of this trouble is to go back toward the unsustainable path we were on previously.

I think that is just crazy. And in fact, I've only just realised about the impact, courtesy of some anecdotes from friends of mine in the media and in real estate, is that the first time vendor's grant as I call it, has actually boosted prices not just for the sub $500,000, which is where the first time buyers come in; but right up to about the $1 to $1.5 million house price range. The mechanics are simple. When that first time buyer gets that, say extra $7,000, they'd lever that to let's say $50,000 more in terms of what they'd spend to buy somewhere, and it's gone virtually right through the price. Let's say 40 grand goes through the prices, then that $40,000 turns up in the accounts of the person selling that house.

As raw cash, no debt attached whatsoever. They then take that and go to the bank and lever that say, to a factor of $200,000 and use that to buy the next place.

Dobbie: This has got a familiar ring to it, hasn't it?

Keen: It has. It's the sub-prime crisis all over again. Running in Australia with government providing the finance to the sub-primes.

Dobbie: Yes.

Keen: So, when that money is withdrawn, it won't just affect the sub half million dollar range; it'll affect prices right up to the $1.5 million level as well, because people who've been expecting second home buyers to come through or third home buyers to come through and fork out $1 million or more to buy somewhere, are going to find those people short a couple of hundred thousand dollars.

Dobbie: Now, things do look as though they're going in the right direction, though. I mean, you're saying the government grants --- let's ignore housing for the moment. But otherwise, the government policy seems to have been working, If you invested in the share market in March, you'd be smiling now. We've got a long way to get back to 2007, late 2007 levels.

Keen: Uh-huh.

Dobbie: But, I mean, the all ordinaries has gone up about 40 percent since March.

Keen: Yes, I think that means it's a good time to get out. A large amount of the money's gone back into what it was doing before and it was just speculating on rising asset prices. Both in the share market and in housing. And some of that money has gone into local production, but not a great deal.

We're still seeing the anomaly of manufacturing arms like the vehicle components unit that went bankrupt in Tasmania recently, coinciding at the same time with a burning stock market. There's something strange going on when those sorts of patterns occur where the indicators of domestic production aren't looking so crash hot, but the markets are burning. And, I think the government stimulus has certainly worked.

There's one thing which it actually does is kick out of the water yet another concept of neoclassical economics, which is this thing they call the policy or relevance hypothesis, a load of garbage saying that the private sector would always react to counteract whatever the public sector did to try to manage the economy. That's clearly not the way the world works. But I'll certainly concede the government reaction has attenuated the impact of the beginning of deleveraging and maybe even slowed down the process of deleveraging in Australia for a while, but it still hasn't eliminated what caused the crisis.

The reason I saw it coming before any other economist in Australia did, and most in the rest of the world, was because I focused on debt. And now, I'm saying rising debt caused the boom; the ending of the rising debt caused the crisis. The debt's still there. We've done nothing to address the actual causes of the problem, so I still think we're going to find that this is going to be; deleveraging will be a permanent millstone of the government and rather than simply doing a temporary stimulus, and being able to get out of the way and let the economy take over. It's going to find every time it withdraws a stimulus to try to let the economy take over, the economy will tank again.

Dobbie: Right. So, the government needs to play a part in this for what, for a decade?

Keen: Well, Japan's been doing it for two decades now. Again, we've got a little experiment called Japan we can take a look at. And, Japan had a double economy that burst in 1990. The government tried to do standard, what they call canes, even though it's not really canes. This comes more from a guy called John Hicks; the stimulus' to the economy, which were debt financed. And, when it began in 1990, Japan's public debt was about 50 percent of GDP. Private debt was gigantic; it was at least three times GDP. They had a huge debt finance bubble as well. The public sector tried to spend its way out of trouble, and in the process it went from having a public debt of 50 percent of GDP, to 200 percent. Now, of course, across that whole 20-year period now virtually, Japan has been stumbling along. They've gone nowhere over that whole period, living at low growth, rising unemployment, a dramatic change in the structure of unemployment in Japan, which has really quite seriously changed the social dynamics in that country; many, many more part-time, insecure jobs for the young. And yet as soon as the rest of the world fell down a hole, Japan collapsed. The reason being, the one thing that kept their system going is the capacity to export to the rest of the world; with a bubble that's still going on, they'd buy Japanese goods.

With the rest of the world; Japan could be picked up by the rest of the world and the failing in its policy papered over that way. There is no rest of the universe that's going to shop from the world when the world's in the same situation Japan once was.

Dobbie. Yes, because I was going to make the point that we're obviously the same as Japan. We've got an export market on our side, but it's not much good to us if China stops buying.

Keen: Yes, and China, again there's been an enormous stimulus attempts around the world, including China. These things will work for a while, but they don't address the underlying problem of excessive levels of debt. And, as long as you leave excessive debt there, then when the stimulus goes, I think the spending will go as well, and it will slump back down. So, people talk about a W, a V shape versus a U shape versus an L shaped. I think we're going to see lots of W's with the ups coming when government stimulus gets thrown in and heading back down again as soon as the government stimulus is removed, because they haven't addressed; you know, it's suppressing the private sector and that's the level of debt that it's in.

Dobbie: You've mentioned that it's been a focus for a lot of business. I mean, businesses realise times are tough. We need to get those debt levels down and every single business is concentrating on that now. Aren't consumers doing the same thing? Everyone's going: oh, my God, we've got to get our credit card down. If we've got a spare house, let's sell it. I think there is, and it could be that we've learned from this and we might be a long way off on equilibrium, but we might slowly glide towards that equilibrium.

Keen: Hopefully we are, but the trouble is, of course, when you do that, you reduce aggregate demand. And that's the real story. Our economy is demand driven; if the dollars aren't there to buy the goods, the goods don't get out the door, and then of course we reduce our capacity to produce the goods in response to that. This is the part that the conventional economists completely missed because they don't analyse the economy either dynamically or as a credit system, so they missed the rising debt that has to increase demand. So, I see demand as being the sum of GDP plus the change in debt and when we had the debt driven economy, that change in debt was positive and adding to demand. When we start to reduce debt that debt will be a negative and it will reduce the level of demand. And, if we delever it the way we did back in the 1930's, which averaged 8 percent over the whole period, including the benefit of the little public policy called the Second World War, that would still take us about 15 years to get back to the level that we had back in 1980.

So, with that length of time, at the beginning of the whole process, if we actually started at that really high level of deleveraging, we'd see a 12 percent hit to aggregate demand.

Dobbie: But we have to see that through, don't we, to reach some sort of equilibrium? We were spending too much. We were consuming too much.

Keen: If you try to reduce the debt by people actually deliberately using their income to pay their debt down or by organisations going bankrupt and the bank's being forced to reduce the debt, that takes forever. And it's a process which is literally every reason to call it a depression. If you actually say: look, that's debt that should have never been issued, we're going to slash it by 50 percent, which is what I'd be arguing in favour of across the board, and then the banks go under because you've nationalised the banks and the banks caused the trouble in the first place, and then re-privatise them at a later stage. Do the sort of reorganisation the Americans should have had. You can get through the debt much more rapidly. But, this of course, is political and I can't see it being done, but I'm going to continue promoting it because I think once we find ourselves with a permanent debt anchor around our ankles, and the economy trying to stumble forward, and you do it for 10 to 15 years as the Japanese have been doing, ultimately you've got to realise that you have to really go back and change the game.

I think we're still caught in a bit of a fool's paradise in believing that the previous pattern of the economy booming along nicely can be restored simply by the government papering over and then getting out of the way. As soon as the government gets out of the way, I think we're going to be back down the hole again.

Dobbie: Now, of course, we went through a government that was satisfied that if they balanced the federal budget then everything was fine, irrespective of what was happening to the household budget. Do you look at Malcolm Turnbull, who's now giving Kevin Rudd a hard time, obviously for what he's saying is building up massive debts for the next generation? That looks a little bit one sided, doesn't it? He seems to be blinkered in that old way of thinking.

Keen: Yes, there's no depth to it. Actually I must say Rudd's essay, which I got my hand on was quite a good essay. And certainly, he actually targeted what caused the problem and he talked about the danger in the future being deleveraging and deflation. And he was the first government leader I've seen actually make those statements, so Rudd is more sensible. Malcolm is just ---

Dobbie: Well done, by the way, for getting to the end of that essay. That was quite an achievement.

Keen: That's a short read for an academic man.

The Malcolm stuff and banging on about the level of government debt; that's the same old, bloody hobby horse that Costello and Howard used back before they got elected. And they ignored the rise in private debt, and that was what gave us the trouble we're now in. So you can't ignore private debt levels because again, from the real world and from my theoretical point as well, rising debt levels based on asset speculation are a recipe for ultimate disaster. And balancing the government books, actually man-handing money across to people who then use that to go and speculate on asset markets and drive up their own levels of debt far, far higher than government debt ever got to be. It's quite bizarre when you graph government debt against GDP versus private debt against GDP, government debt's been maximum of about 15 to 20 percent of GDP and trending down to zero. Private debt was a minimum 25 percent and trending up to 165 percent.

Dobbie: Yes.

Keen: It's just absurd that one was focused and the other was ignored.

Dobbie: Yes, look at the two together and treat them as one.

Keen: The one to control, this is where we went wrong in government policy and why I blame Ben Bernanke and Alan Greenspan for causing; not causing the depression, but making it far worse than it needed to be, is that they ignored the role that private debt plays when people borrow money to speculate on rising assets.

Dobbie: So, if you were in Kevin Rudd's shoes now, obviously you'd get rid of any support for the housing sector, certainly, and for the first home buyer's grant. But, aside from that, what would be your next step? You were saying we still need more government intervention; what should they be doing now?

Keen: Well, and my policy won't be tried until such time as it's obvious it is now with the policy, and that'd be abolishing about 50 percent of the debt, writing it off overnight, nationalising the banks in the process.

Dobbie: Yes.

Keen: Forcing them to lend to firms so that they maintain working capital and firms don't go under, and then trying to reindustrialise the country, which has been de-industrialised in the last 20 years.

Dobbie: You're right. It's going to take a lot for that to happen.

Keen: Indeed, and I'm not trying to put forward policies that the only effective policy means one that's reduced private debt levels. But if you reduce private debt levels through the usual mechanisms of the market, then you will have a long, drawn out depression, and that's what I'm trying to avoid. So I'm saying the only way to do that effectively is to abolish large slabs of the debt, which was irresponsibly lent in the first place.

Dobbie: Right.

Keen: But I know, of course, if I did that, you'd suddenly expose a gaping hole in the economy that's really built over about a 20- or 30-year period, because we de-industrialised Australia. We substituted those industrial jobs to jobs in finance, insurance, real estate and retail. Well, you know, who needs those services anymore, when we're dealing with jobs generated by people who have tried to increase debt levels. When you pull it away and say we're going to employ those people, we don't have the factories for them anymore. So, there is not just the financial problem being generated by this whole bubble, there's a structural problem as well in the economy, which will be exposed as time goes on.

Dobbie: Right. So, perhaps there needs to be more investment in the public sector, which is actually going to create public sector jobs as well.

Keen: To some extent, but also I'd want to get back to the stage where we actually try to have an industrial culture in this country. We've denigrated real engineers and exalted financial engineers; well, look where that's got us.

There are lots of people who are good at manipulating pieces of paper and artificially inflating the value of assets and charging enormous fees in the process, and nobody knows how to design a light bulb.

Dobbie: Now, nationalising banks, what would that really achieve? It's unlikely to happen right now. Because, of course, we keep on getting told what a great job the banks are doing in Australia.

Keen: Yes, I know. One of my favourite movies is The Philadelphia Story where Denzel Washington, defending Tom Hanks, prosecuting his firm for sacking him and the firm claimed they didn't sack him because he was homosexual, but because he was incompetent. And all the way through, Denzel was saying prove to me in words that show and understand why that particular action wasn't homophobic rather than about incompetence. And the same story; if our banks are so much more responsible, then why is it that household debt in Australia, from 1990 to 2009, rose three times as fast as household debt from America.

And with the beginning of that period, household debt in Australia was half the American level, it's now equivalent.

Dobbie: Right.

Keen: I think that the aggregate figure just points out our banking sector was just as good as pumping out debt to the household sector as the Americans were, and just as good at inflating a house price bubble, as the Americans were. The difference was they didn't focus; they were lending entirely on the very bottom echelons of the economy and it spread through the entire economy.

Dobbie: Do we need to nationalise them? Can't we just put more controls in place?

Keen: Ultimately I don't think you can control banks. I think you have to control the borrowers and make the borrowers less willing to take debt on. So, ultimately, what I'd like to see is a change to the way financial assets are defined. It means it is no longer feasible to make a large amount of money by borrowing and gambling on rising asset prices. That's my ultimate objective; is to get a change in how we value houses and a change in how we define shares, so that you don't have that prospect for gigantic gains with leverage asset price speculation. But, in this current situation saying if it wasn't for the over-inflated value of housing and if it wasn't for the over-inflated asset markets in America, our banks would be bankrupt and the American banks, as we know, are really effectively already bankrupt.

Dobbie: Yes.

Keen: I'm not saying if they go bankrupt, what do you do? And in the American situation, what they've done is keep alive the zombie banks. Now that is exactly what they criticised the Japanese for doing back in 1990. So we're repeating the same mistakes the Japanese have made, and I think we're likely to see the same course for the global economy as Japan had, only without the benefit that Japan had, where Japan could export to the rest of the world. Export demands aren't all that great. We can't rely on that much demand to make up for the stuff up that we've made of the world in over-encumbering it with debt. So I think we're going to find that it is even more intractable from when the Japanese found their own situation.

Dobbie: Hey, Steve, maybe that is the answer. Maybe we just need to find an alien race who's going to buy from us, but otherwise ---

Keen: Yep, that's it. If we sell it, will they come?

Dobbie: Well, let's wait and see. Steve Keen, pleasure as always to talk to you. Whenever I talk to you, by the way, I always feel the urge to get off the phone to you, call up my bank and make sure I've paid off my credit card.

Good to talk to you. Talk to you again soon.

Keen: OK, mate. Bye, bye.