Debts now too big to boom and crash again...
LAST WEEK I was lucky enough to see Professor Steve Keen give a talk at the House of Commons, writes John Stepek at MoneyWeek magazine.
Keen is among the minority of economists who foresaw the financial crisis that started in 2007, but hit the front pages in 2008.
The question before him: "Could there be a repeat of 2008?"
It's something I'm sure we'd all like to know. So what's the verdict?
Steve Keen has a bone to pick with traditional economists. He picks it very politely, but he doesn't hold back in his criticism.
They missed the 2008 crisis because they are using the wrong models, he says. They don't pay any attention to the role of credit. If they did, they'd have realised that our pre-crisis trajectory was unsustainable.
A common refrain of mainstream economists is the idea that debt doesn't matter, because – on a global basis – "we owe it to ourselves". Every liability is someone else's asset. I owe you £1,000. You own an IOU worth £1,000. That's how it works. So for the purposes of big picture thinking, you can just net the debt out and it doesn't matter.
I think that most "civilians" (ie, non-economists) can see that there's something wrong with this way of thinking. The key, says Keen, is that it ignores the role of banks in money creation.
Let's keep this as simple as possible. You have £1,000. You stick it in the bank. The bank lends the £1,000 to me. Even if I spend the lot in the local pub rather than on setting up a productive business, and you don't end up getting a penny of it back, the £1,000 is still floating around the economy (probably sitting back in the bank, only this time in the pub landlord's account). So in that case, you can indeed ignore credit for big picture purposes.
But that's not what happens in the real world. In the real world, you have £1,000 and you stick it in the bank. The bank lends £1,000 to me, and nine other people. That £1,000 has turned into £10,000. And pretty soon, if you don't maintain that rate of credit creation, economic activity will collapse.
At first it's fine, because the debt funds productive investment that generates more money than it costs to fund. Then you get projects that cover their funding costs, but no more. And finally you get Ponzi schemes that rely on borrowing ever more money to stay afloat.
This is why debt is a problem. The more and more of it you pile on, the more you need to create, just to stand still. Eventually, it can't continue (this is the Hyman Minsky view of the world, which Keen draws heavily on).
This might cause consternation among economists. But it won't be news to most investors. As all investors know (or find out to their cost), as soon as you add borrowed money to anything – even the "safest" investment – you multiply your risk, often in unexpected ways.
The good news is that Keen says we're unlikely to see another 2008-style crisis in the US and the UK. The bad news is that this is because we're now like Japan was just after 1990.
In short, to have a 2008-style crash, you need to have the mega-boom in credit before it. We now have too much debt already to get another proper credit boom going. So instead we'll have stagnation.
It is however, he says, very likely that we'll see something like the 2008 financial crisis in other countries whose credit booms never really ended.
Keen's native Australia – where he's been an infamous house-price bear for a long time – is one candidate. Norway and Sweden (where negative interest rates have created rampant house-price bubbles) are too. Belgium – oddly enough – is another.
The most worrying of all of these, however, is the risk of China having a 2008-style meltdown. China, acknowledged Keen, is different in that the heavy involvement of the state in the financial system makes it easier for them to shuffle things about on the balance sheet. But that's not a solution – it just means that the timing of a crash is harder to predict.
That's all pretty gloomy. But in practical terms, what's the end result? There's the rub. Keen might have a better model than most economists for explaining why 2008 happened in the first place, but that doesn't mean he has a magic wand that can fix the aftermath.
You have to get rid of the debt. And as we've pointed out many times in the past, there are only three ways to get rid of debt. You pay it back honestly (in other words, you generate the repayments through productive activity); you repay it dishonestly (you print the money to fund the repayments or otherwise inflate the debt away); or you outright default on the debt (you stiff your creditors).
This is why Keen likes the idea of a debt jubilee (writing debt off en masse), or "QE for the people" – where the central bank credits a few thousand Pounds direct to everyone's bank account, and those with debts have to use it to pay them off.
Those ideas sound extreme, but not as extreme as they might have sounded ten years ago. And if we really are turning Japanese, and this really isn't "lift-off" in the US, it seems quite possible that we might see one or more of these suggestions move from being politically impossible to politically inevitable in the next few years.
If that sounds far-fetched to you, bear in mind that Keen's audience for this talk was not primarily journalists – it was mainly Lords, MPs, think-tank staff and other policy "gurus".
My colleague Merryn interviewed Keen last year. You can (and should) watch the video here. You may not agree with everything he says, but it'll definitely make you think.