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The crisis & building an ethical financial system Steve Keen University of Western Sydney www.debtdeflation.com/blogs www.debunkingeconomics.com Overview • Crisis caused by growth & collapse of biggest private debt bubble ever • Banks succumbed to inherent temptation to create excessive debt • Ethical system must break debt-asset price feedback – Break temptation of “unearned income” to borrowers • Relate debt to income of asset, not borrower • Reorient finance to support productive investment, innovation • “Modern Jubilee” needed to overcome current crisis • Conventional economics misunderstands debt & banking – New economics needed as well as new financial architecture Debt and Depressions • US Private Debt to GDP 1920-Now indicative of global phenomenon: US Debt to GDP 320 300 280 Private Public 260 Percent of GDP 240 220 200 180 160 140 120 100 80 60 40 20 0 1920 1930 1940 1950 1960 1970 1980 www.debtdeflation.com/blogs 1990 2000 2010 2020 Debt and Depressions • Global phenomenon – Schularick & Taylor: biggest debt bubble in recorded history Private Debt to GDP ratios 500 450 400 Percent of GDP 350 USA UK Australia Canada 300 250 200 150 100 50 0 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 www.debunkingeconomics.com Debt Dynamics & The Crisis • Crisis caused by reversal from rising to falling debt – Decline in income relatively mild… – But decline in debt change huge… USA GDP 7 210 7 1.910 7 GDP GDP + Debt Change BNP 1.810 7 US $ Million 1.710 7 1.610 7 1.510 7 1.410 7 1.310 7 1.210 7 1.110 7 110 6 910 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 www.debunkingeconomics.com Debt Dynamics & The Crisis • Empirical evidence on role of debt (theoretical analysis later) Change in Private Debt & Unemployment BNP 30 1 25 2 20 3 15 4 10 5 5 6 0 0 7 5 8 10 9 15 10 11 Unemployment Debt Change 20 25 30 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 www.debtdeflation.com/blogs Percent of GDP p.a. Percent of Workforce Unemployed 0 Debt Dynamics & The Crisis • Empirical evidence on role of debt Acceleration of private debt & change in employment, USA 15 10 Percent p.a. 5 0 0 5 10 15 20 25 30 1955 Acceleration of private debt Change in Private Employment 1960 1965 1970 1975 1980 1985 Year 1990 1995 2000 2005 2010 2015 Debt Dynamics & The Crisis • Empirical evidence on role of debt Mortgage Acceleration & House Price Change: USA 5 Percent of GDP p.a. 4 18 Mortgage Accelerator House Price Change 15 12 3 9 2 6 1 3 0 0 0 1 3 2 6 3 9 4 12 5 15 6 18 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Real Percent p.a. 6 Margin Acceleration & Change in Australian Shares • Acceleration of margin debt & change in Australian ASX 2 40 1.5 30 1 20 0.5 10 00 0 0.5 10 1 20 1.5 30 2 40 2.5 3 2001 Margin Acceleration Share Index Change 2002 2003 2004 2005 50 2006 2007 2008 2009 www.debunkingeconomics.com 2010 2011 2012 60 2013 Percent real change p.a. Percent of GDP p.a. Margin Debt Acceleration & Share Price Change (Corr = 0.81) Why was this allowed to happen? • Conventional economics ignores banks, debt & money – E.g., Paul Krugman on my analysis of the crisis • “Keen … asserts that putting banks in the story is essential. • Now, I’m all for including the banking sector in stories where it’s relevant; – but why is it so crucial to a story about debt and leverage?...” • Neoclassical “Loanable Funds” model ignores banks – “If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand.” – Sees level of debt as having no macroeconomic consequence… Neoclassical “Loanable Funds” • Patient lends to Impatient • • • • Patient’s spending power goes down Impatient’s spending power goes up No change in aggregate demand Banks mere intermediaries (ignored in analysis) • All the action on liabilities side of bank ledgers Post Keynesian “Endogenous Money” • Empirically-based “Endogenous Money” sees banks as crucial – Bank lending creates new money & demand • Bank grants loan & creates deposit simultaneously • New loan puts additional spending power into circulation • Aggregate demand exceeds demand from income alone • Structure of banking tempts banks to create excessive debt • Bank income rises if debt rises (relative to income) Temptation to create excessive debt • Increase in lending/decrease in repayments increases bank income Ethical Finance? • Primary role of finance should be supporting industry & community – Working capital for firms – Debt-financed purchase of long-lived consumption items – Developing infrastructure • But limited profits entice lending for asset speculation instead – Difficult to remove temptation for banks – Possible to remove temptation to debt for borrowers • In asset purchases, base lending limits on income of asset, not buyer – Now, if 2 people compete for the same house – The one with higher leverage wins – Proposal: “Property Income Limited Leverage” • Maximum loan 10 times imputed rental income of property • No possibility of higher leverage advantage for buyers • Buyer with higher savings wins – Proposal: Maximum borrowing for share purchase based on prospective dividend yield of shares Escaping the crisis • Fundamental cause of crisis excessive lending for asset speculation – Responsibility overwhelmingly lies with lenders, not borrowers • Far greater resources to analyze viability of loan • Lending based on trust: abuse of trust & fiduciary duty • Best way out of crisis to reduce debts – “Debts that can’t be repaid, won’t be repaid” (Hudson) • Best means a “Modern Jubilee” – Can’t just abolish debt as in Biblical Jubilee • Securitized debt means non-bank savers would suffer – Central Bank fund injection directly to public via bank accounts • Those in debt must repay debt • Those without debt keep cash injection – Bank debt reduced—bank income falls – Securitized debt holders lose: fall in value of & income from bonds • But compensated by debt injection – Deleveraging drag on aggregate demand eliminated Without deliberate action? • Deleveraging could dominate economy for 20 years… USA Private Debt to GDP 320 2027 300 280 260 240 Percent of GDP 220 200 180 160 140 120 100 Debt to GDP ratio 80 12.5% p.a. decline 9% p.a. decline 7.3% p.a. Extrapolated 80 60 40 20 0 1920 1930 1940 1950 1960 1970 1980 1990 www.debtdeflation.com/blogs 2000 2010 2020 2030
