This article first appeared in Moneyweb.
One of the great economic questions of our age is what caused the Great Depression and can we avoid a repeat?
Steve Keen, self-proclaimed ‘anti-economist’ professor of economics at Kingston University in London, has applied himself to the question for four decades and believes he has the answer. Debunking Economics (Zed Books, 2001; revised and updated 2011) is the product of that exploration. It is also a frontal assault on mainstream economics for lacking the rigour demanded of other scientific disciplines.
Whether a great depression can happen again – or indeed is already underway – is important because the last such period was accompanied by genocide and fascism. The stakes are high and the current prescription of bailing out failed banks, rather than over-indebted consumers, is merely prolonging the day of reckoning.
Keen is merciless in his attack on neoclassical economists. They are not up to the task of steering the world economy and their intellectual ministrations are not only misguided, they are fatal, he says. Our current economic system is held up by matchsticks that will likely lead to two outcomes: starvation or emigration. Either we reform the current economic system, including its money, or we risk ending up in a Hunger Games hell.
There is an element of apocalypse fatigue surrounding our economic trajectory with so many depressing books exploring aspects of the subject, but to turn away from the signals is criminally negligent. The markers of economic catastrophe are all around us: the debt-to-GDP levels hit 300% of GDP in 2008 when the world’s biggest banks ran to their respective governments looking for bailouts. That was 1.7 times the levels reached in the 1930s. The Great Depression was deepened by the massive deleveraging that took place in the 1930s, as people raced to pay down debt. The result was deflation, falling economic output and massive job losses. Followed by war.
Deficits create surpluses
Keen deviates from many of his peers by focusing on private rather than public debt. The two sources of money in an economy are banks and government. Banks create money each time a loan is given out. Governments create money by running budget deficits, which is a debt to the government itself. To conflate the two sends out false signals. Where neoclassical economists get it wrong is in assuming government debt is a liability. No, says Keen, it is an asset, since this deficit is what creates surpluses in the private sector. A liability on the government’s accounts is matched by a corresponding asset in the private sector. Those private surpluses are for the overall benefit of the country. Government’s role is to create the stock of money that fuels the private sector economy. This runs counter to the Austrian economic model of commodity-backed currencies (such as gold), and the neoclassical attachment to austerity.
Like Michael Hudson, author of J is for Junk Economics, Keen sees no problem with governments running deficits so long as there is surplus labour and resources, in which case inflation will be subdued. This argument carries some weight if you consider that the US government has run an average deficit of 2.4% for the last 120 years.
Keen also proves that there is a correlation between growth in credit and unemployment. The lower the credit extended by banks, the worse the unemployment rate. Most bank lending in the US and UK goes to private individuals for the purchase of houses, creating bubbles. Hence there is a tight relationship between credit growth and housing prices. The problem came in the 1980s when commercial banks muscled out the building societies and started financing house acquisitions. Building societies did not have banking licences so were restricted in the manner in which they could accept deposits and lend money. Banks, on the other hand, are able to gear up their lending through fractional reserve lending.
When banks slow down the credit spigots, housing prices collapse – as they did by 40% over 15 years in Japan and as they will do in Australia, South Korea and many other countries currently lofted by housing bubbles.
Predict crashes is simple
It is therefore simple to predict when crashes will occur: when the rate of private credit expansion slows down. Countries that borrowed their way through the last financial crisis will become zombie economies, including China, Canada, South Korea, Australia and Belgium. These economies avoided a crash through heavy borrowing, but they cannot escape the guillotine for much longer.
There is another category of countries in even worse shape. Keen calls them the “walking dead of debt”. These include the UK, US, Japan, Spain, Portugal and Greece, which have already been through a crisis, but remain so highly indebted they will veer between negative and slightly possible growth.
When the world’s biggest banks faced collapse in 2008 and ran to the authorities for bailouts, this was neoclassic economics at its most insane. Banks were the recipients of more than $1.5 trillion (with a ‘t’) of freshly minted money from the Federal Reserve, and the hope was that this would trickle down to the man and woman on the street. This is how the money multiplier is supposed to work: deposit R100 in a bank account and the bank lends this out multiple times, eventually creating R1 000 in credit from a R100 deposit. That’s the beauty of having a banking licence. Only the trickle-down didn’t happen. In other words, banks took the bailout money but stopped lending. If an economic reboot was the goal of the bailouts, then handing the money straight over to over-indebted consumers would have worked far better. They bailed out the wrong people. We can thank the neoclassical economists for their bum advice.
Austerity versus prosperity
The neoclassical love of austerity, rather than returning countries to prosperity, actually destroys economies. Keen argues that government deficits are necessary to increase the money supply on which economic growth feeds. Austerity does the opposite.
“If we leave the development of economics to economists themselves, then it is highly likely that the intellectual revolution that economics desperately needs will never occur – after all, they resisted change so successfully after the Great Depression that the version of neoclassical economics that reigns today is far more extreme than that which Keynes [British economist John Maynard Keynes, 1883-1946] railed against seven decades ago. I concluded the first edition with the observation that economics is too important to leave to the economists. That remains the case today,” says Keen.
If change is going to come, it will be from the young, who have not yet been indoctrinated into a neoclassical way of thinking, and from those from other professions like physics, engineering and biology, who will be emboldened by the crisis to step onto the turf of economics and take the field over from the economists.