The next Great Depression

1. The next Great Depression? Steve Keen University of Western Sydney Debunking Economics www.debtdeflation.com/blogs www.debunkingeconomics.com

2. The Scale: Biggest Bubbles in History

3. The Scale: Greatest Debt Level in History

4. The Scale: Greatest Debt Level in History But Australia�s different, right?...

5. The Ponzi Economy 72-74 & 84-92: debt-induced boom, bust, & recovery�

6. Back in the USA� Deleveraging-driven downturn�

7. Why hasn�t it happened here? Give it time�

8. Did (neoclassical) economists see this coming? �the current economic situation is in many ways better than what we have experienced in years� Our central forecast remains indeed quite benign: a soft landing in the United States, a strong and sustained recovery in Europe, a solid trajectory in Japan and buoyant activity in China and India. In line with recent trends, sustained growth in OECD economies would be underpinned by strong job creation and falling unemployment.� (p. 9) OECD Chief Economist Jean-Philippe Cotis in OECD Economic Outlook June 2007 Why so ignorant? Static modelling (equilibrium-assuming �dynamics�) Ignore role of credit & debt

9. Minsky�s �Financial Instability Hypothesis� A rival, time-&-debt-aware model: Economy in historical time (both ignored by conventional �neoclassical� economics) Debt-induced recession in recent past Firms and banks conservative re debt/equity, assets Only conservative projects are funded Recovery means most projects succeed Firms and banks revise risk premiums Accepted debt/equity ratio rises Assets revalued upwards� �Stability is destabilising� Period of tranquility causes expectations to rise�

10. The Euphoric Economy Self-fulfilling expectations Decline in risk aversion causes increase in investment Investment expansion causes economy to grow faster Asset prices rise speculation on assets profitable Increased willingness to lend increases money supply Money supply endogenous money, not under RBA control Riskier investments enabled, asset speculation rises The emergence of �Ponzi� (Bond, Skase�) financiers Cash flow less than debt servicing costs Profit by selling assets on rising market Interest-rate insensitive demand for finance

11. The Assets Boom and Bust Eventually: Rising rates make conservative projects speculative Non-Ponzi investors sell assets to service debts Entry of new sellers floods asset markets Rising trend of asset prices falters or reverses Ponzi financiers go bankrupt: Can no longer sell assets for a profit Debt servicing on assets far exceeds cash flows Asset prices collapse, increasing debt/equity ratios Endogenous expansion of money supply reverses Investment evaporates; economic growth slows Economy enters a debt-induced recession Back where we started...

12. Crisis and Aftermath Modelling Minsky Extension of Goodwin�s Growth Cycle to include debt 4 �stylised facts� Wages share grows if wage rises exceed productivity Employment rises if growth exceeds productivity + population increase Bank lend money to finance investment & speculation Speculation rises when growth rises Dynamics Borrow money to finance investment during a boom Repay some of it during a slump Debt/ Income ratio rises in series of booms/busts Eventually one boom where debt accumulation passes �point of no return��

13. Better dynamic, credit-aware model� Minsky�s �Financial Instability Hypothesis� more realistic�

14. Can Ben Bernanke (and others) �Do It�? Previous model without a government sector� In real world, huge stimulus packages undertaken: �On the fiscal front, governments from the world�s largest 20 economies are expected to collectively pump about $US5 trillion into their economies by the end of next year (or nearly 8 per cent of global GDP since the crisis began). Altogether, the measures are the equivalent of an extraordinary and unprecedented 18 per cent of global GDP.� (Kevin Rudd) Plus �quantitative easing� in the US & UK:

15. Can Ben Bernanke (and others) �Do It�? �If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.� (Bernanke 2002)

16. Can Ben Bernanke (and others) �Do It�? But money supply is expanding by less than increase in Money Base:

17. Can Ben Bernanke (and others) �Do It�? What�s going wrong with the money �printing press�? �Money multiplier� (ratio broad money measures to Base Money) collapsing as Bernanke expands Base�

18. Another interpretation: limitless lending Who�s in control of the money supply and debt? Economics textbooks The Government/Central Bank Central Bank creates �base money� Sets �money multiplier� Credit Money = Base Money / Money Multiplier Economic data �There is no evidence that either the monetary base � leads the cycle, although some economists still believe this monetary myth. � the monetary base lags the cycle slightly� The difference of M2-M1 leads the cycle by � about three quarters.� (Kydland & Prescott 1990, p. 15)

19. �Money from nothing, but your cheques ain�t free� Loan an asset of bank Simultaneously creates liability of money in firm�s deposit account:

20. �Money from nothing, but your cheques ain�t free� Full system (see �Roving Cavaliers of Credit� blog post) is:

21. �Money from nothing, but your cheques ain�t free� �Credit Crunch�: Economic downturn caused by change in credit alone Debt-deleveraging not an issue here�

22. What about a Government Rescue? Yes, But� Which gives more �bang for buck��rescuing bankers or debtors?

23. What about a Government Rescue? Yes, But� Rescue would work if only problem was �credit crunch� Stimulus �papers over pothole� Credit flows again, economy returns to steady growth But debt-saturation as well? Deleveraging looms�no-one else left to lend to:

24. What about the Market? Yes, But� An impressive rally�

25. What about the Market? Yes, But� An impressive rally�

26. What about the Market? Yes, But� An impressive rally� in 1930 too�

27. What about the Market? Yes, But� An impressive rally� in 1930 too�

28. What about the Market? Yes, But� Until it ran out of steam�

29. What About the Recovery? Yes, But� Turnaround in unemployment?...

30. What About the Recovery? Yes, But� Not a shallow recession�

31. What About the Recovery? Yes, But� Barry Eichengreen & Kevin H. O�Rourke, �A Tale of Two Depressions�: http://www.voxeu.org/index.php?q=node/3421

32. Prognosis & Remedies? Deleveraging-induced downturn inevitable Demand=Sum of GDP plus change in debt Falling debt reduces demand All post-WWII recoveries involved rising debt Deleveraging outweighs government stimulus E.g. 1st Rudd stimulus A$42bn (4% GDP) Aggregate private debt A$2 trillion 5% deleveraging�A$100 billion cut in demand Can�t solve debt-induced crisis with more debt But that�s what�s been happening� As it did in Japan 1990-2009� Public debt from 50%-200% Keeping �zombie banks� alive

33. Deleveraging and economic activity� What impact could deleveraging have?

34. Deleveraging and economic activity� What about the USA? Higher debt level means further to fall�

35. Alternative policies Across-the-board debt reduction Irresponsible lending caused the crisis Abolish large fraction of debt Guarantee bank deposits at same time A 21st Century Jubilee� Redefine capital assets to reduce Ponzi behaviour Time-limited Shares (like bonds) House valuation on imputed rent Maximum secured mortgage debt say 10 times annual rental Remove positive feedback between leverage and house prices Or we�ll be here again in 2070�

36. For Further Reading� www.debtdeflation.com/blogs