10 Jun 2012

Steve Keen: Why 2012 Is Shaping Up To Be A Particularly Ugly Year


Submitted by Chris Martenson
At the high level, our global economic plight is quite simple to understand says noted Australian deflationist Steve Keen.
Banks began lending money at a faster rate than the global economy grew, and we're now at the turning point where we simply have run out of new borrowers for the ever-growing debt the system has become addicted to.
Once borrowers start eschewing rather than seeking debt, asset prices begin to fall -- which in turn makes these same people want to liquidate their holdings, which puts further downward pressure on asset prices:

The reason that we have this trauma for the asset markets is because of this whole relationship that rising debt has to the level of asset market. If you think about the best example is the demand for housing, where does it come from? It comes from new mortgages. Therefore, if you want to sustain he current price level of houses, you have to have a constant flow of new mortgages. If you want the prices to rise, you need the flow of mortgages to also be rising.

Therefore, there is a correlation between accelerating and rising asset markets. That correlation applies very directly to housing. You look at the 20-year period of the market relationship from 1990 to now; the correlation of accelerating mortgage debt with changing house prices is 0.8. It is a very high correlation.

Now, that means that when there is a period where private debt is accelerating you are generally going to see rising asset markets, which of course is what we had up to 2000 for the stock market and of course 2006 for the housing market. Now that we have decelerating debt -- so debt is slowing down more rapidly at this time rather than accelerating -- that is going to mean falling asset markets.

Because we have such a huge overhang of debt, that process of debt decelerating downwards is more likely to rule most of the time. We will therefore find the asset markets traumatizing on the way down -- which of course encourages people to get out of debt. Therefore, it is a positive feedback process on the way up and it is a positive feedback process on the way down.
He sees all of the major countries of the world grappling with deflation now, and in many cases, focusing their efforts in exactly the wrong direction to address the root cause:
Europe is imploding under its own volition and I think the Euro is probably going to collapse at some stage or contract to being a Northern Euro rather than the whole of Euro. We will probably see every government of Europe be overthrown and quite possibly have a return to fascist governments. It came very close to that in Greece with fascists getting five percent of the vote up from zero. So political turmoil in Europe and that seems to be Europe’s fate.

I can see England going into a credit crunch year, because if you think America’s debt is scary, you have not seen England’s level of debt. America has a maximum ratio of private debt to GDP adjusted over 300%; England’s is 450%. America’s financial sector debt was 120% of GDP, England’s is 250%. It is the hot money capital of the western world.

And now that we are finally seeing decelerating debt over there plus the government running on an austerity program at the same time, which means there are two factors pulling on demand out of that economy at once. I think there will be a credit crunch in England, so that is going to take place as well.

America is still caught in the deleveraging process. It tried to get out, it seemed to be working for a short while, and the government stimulus seemed to certainly help. Now, that they are going back to reducing that stimulus, they are pulling up the one thing that was keeping the demand up in the American economy and it is heading back down again. We are now seeing the assets market crashing once more. That should cause a return to decelerating debt -- for a while you were accelerating very rapidly and that's what gave you a boost in employment --  so you are falling back down again.

Australia is running out of steam because it got through the financial crisis by literally kicking the can down the road by restarting the housing bubble with a policy I call the first-time vendors boost. Where they gave first time buyers a larger amount of money from the government and they handed over times five or ten to the people they bought the house off from the leverage they got from the banking sector. Therefore, that finally ran out for them.

China got through the crisis with an enormous stimulus package. I think in that case it is increasing the money supply by 28% in one year. That is setting off a huge property bubble, which from what I have heard from colleagues of mine is also ending.

Therefore, it is a particularly ugly year for the global economy and as you say, we are still trying to get business back to usual. We are trying to rescue the creditors and restart the world that is dominated by the creditors. We have to rescue the debtors instead before we are going to see the end of this process.
In order to successfully emerge on the other side of this this painful period with a more sustainable system, he believes the moral hazard of bailing out the banks is going to have end:
[The banks] have to suffer and suffer badly. They will have to suffer in such a way that in a decade they will be scared in order to never behave in this way again. You have to reduce the financial sector to about one third of its current sizeand we have to also ultimately set up financial institutions and financial instruments in such a way that it is no longer desirable from a public point of view to borrow and gamble in rising assets processes.
The real mistake we made was to let this gambling happen as it has so many times in the past, however, we let it go on for far longer than we have ever let it go on for before. Therefore, we have a far greater financial parasite and a far greater crisis.
And he offers an unconventional proposal for how this can be achieved:
I think the mistake [central banks] are going to make is to continue honoring debts that should never have been created in the first place. We really know that that the subprime lending was totally irresponsible lending. When it comes to saying "who is responsible for bad debt?" you have to really blame the lender rather than the borrower, because lenders have far greater resources to work out whether or not the borrower can actually afford the debt they are putting out there.

They were creating debt just because it was a way of getting fees, short-term profit, and they then sold the debt onto unsuspecting members of the public as well and securitized their way out of trouble. They ended up giving the hot potato to the public. So, you should not be honoring that debt, you should be abolishing it. But of course they have actually packaged a lot of that debt and sold it to the public as well, you cannot just abolish it, because you then would penalize people who actually thought they were being responsible in saving and buying assets.

Therefore, I am talking in favor of what I call a modern debt jubilee or quantitative easing for the public, where the central banks would create 'central bank money' (we cannot destroy or abolish the debt, which would also destroy the incomes of the people who own the bonds the banks have sold). We have to create the state money and give it to the public, but on condition that if you have any debt you have to pay your debt down -- no choice. Therefore, if you have debt, you can reduce the debt level, but if you do not have debt, you get a cash injection.

Of course, this would then feed into the financial sector would have to reduce the value of the debts that it currently owns, which means income from debt instruments would also fall. So, people who had bought bonds for their retirement and so on would find that their income would go down, but on the other hand, they would be compensated by a cash injection.

The one part of the system that would be reduced in size is the financial sector itself. That is the part we have to reduce and we have to make smaller.  That is the one that I am putting forward and I think there is a very little chance of implementing it in America for the next few years not all my home country [Australia] because we still think we are doing brilliantly and all that. But, I think at some stage in Europe, and possibly in a very short time frame, that idea might be considered. 
Click the play button below to listen to Chris' interview with Steve Keen (48m:50s):





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