Steve Keen predicts a decade of volatility



Lelde Smits: Hello, I’m Lelde Smits for the the Finance News Network. Joining me today to cast some light on the global debt situation is Associate Professor of Economics and Finance, Steve Keen. Steve, welcome back to FNN. Now debt has been in the headlines and it certainly seems the US and Europe are drowning in it. How did we get into this situation and how is it different to the Global Financial Crisis of 2008?

Steve Keen: Well it isn’t different; it’s the continuation of exactly the same crisis, because we began accumulating too much private debt - not public - private debt. Gambling on rising asset prices all around the world, everything from the madness of the dotcom and the internet bubble of the nineties. Before that the eighties bubble which Australia was also caught up in. Real estate bubbles are all over the globe, of course the subprime but also in Australia and England and Spain, and God knows what. That private debt stopped growing in about 2007/2008 because the private sector had taken on far too much for this gamble. When it stopped growing that caused the crisis and now we are in the period where people are reducing their debt, and that’s what is causing the continued slump. And this particular experience now is just a case of people realising, ‘Hey, we’re not going to get growth back anymore’.

Lelde Smits: So it’s nothing different, it is the continuation of the GFC?

Steve Keen: It’s the continuation. This won’t be over for ten to fifteen years.

Lelde Smits: If global asset prices are overvalued is what we’re seeing here a massive, necessary and very inevitable correction, or in other words a bubble?

Steve Keen: Yes, it is necessary. You can’t get away from it because rising levels of debt have levered asset prices out of all synchronistion with consumer prices, and you can continue pushing the two apart so long as you keep on borrowing more money. But at a certain point you can’t borrow any more money, you can’t do that trick anymore and then you’ve got to service that debt out of what you sell your consumer goods for effectively. And so they’ve got to come down. Either asset prices have got to plunge, or consumer prices have to come up to bring them back into coordination. But we are so far from that period, we’ve got a long, long time of financial chaos ahead of us.

Lelde Smits: So in that case, how much further are global markets likely to fall?

Steve Keen: Given the level of private debt we’re in and that’s - the whole cause of this is really the private debt level.  So given America’s case, their debt level peaked at 300% of GDP, it’s now fallen to 260% of GDP, that’s taken about two years to do it. But if they keep on doing it at the rate they are currently reducing it, it might take a decade before they are down to a level where the debt is back to where it should be a sustainable level, and then the private sector can start properly spending again. We could face a decade of this before the chaos finally washes through.

Lelde Smits: If we can take a look at the regions, what are the big differences between European and US debt?

Steve Keen: Well the main differences are Americans have a central bank. Believe it or not Europe does not have a central bank. They call it ‘European Central Bank’ but in fact it’s only required to fund the European Union. This is a bit like; imagine the Federal Reserve only being required to fund the operations of Washington and leaving the States to themselves. That is madness, but that’s what the Europeans designed with the Maastricht Treaty when they brought in the common currency back in 2000. And that treaty not only said that the Nations of Europe have to cover their own finances, but it said if you have a deficit of more than 3% of GDP, we will not finance the additional level above that, you’ve got to issue bonds to do it. And that’s a bit like requiring California to finance itself right now. Well if these rules were applied in America right now, all the States of America would be bankrupt. So we’re seeing real chaos in Europe right now rather than America because at least Americans have a central bank.

Lelde Smits: Which situation concerns you the most?

Steve Keen: Europe, because what we are seeing in England right now is obviously related to the squeeze that’s going on in the welfare state over there. Because to try and get their books back in balance again, which they should not be doing in the current circumstances but by having that as their political objective, they’re squeezing welfare payments. And now what we’re getting is people who were on welfare and marginalized and excluded during the bubble, are now being told we’re going to cut your welfare during the slump. That’s why the riots are breaking out. So I was always afraid that when this crisis hit - I could see this coming from back in 2000 - that when it hit the reaction of governments to go into austerity in the middle of it, could lead to a rise of fascist behaviour and the most likely place of that was Europe. And with the Maastricht Treaty, they’ve set themselves up for that sort of behaviour. 

Lelde Smits: Looking closer at Europe now, several countries are actually technically bankrupt. What can be done, or needs to be done, to claw these countries out of the red?

Steve Keen: They have to turn the European Central Bank into a Central Bank and that means - this is a proposal put forward by a very good Greek economist who actually used to work in Australia, Yanis Varoufakis. He calls it the modest proposal and that is to simply say, make the ECB behave like a central bank. What that should mean is that the debts of say Italy, Spain, Portugal and Germany and France, all get aggregated at the national level. And then the European Central Bank issues the bonds to fund it, but each Nation State has to pay for its own income stream. If they did that it would be just like the way the Federal Reserve issues bonds right now and issues them at trivial rates. And then finances out of that, the economic activities of the American Government that fund what happens in California. If they did that, you wouldn’t see the rates blowing out but because they’re not doing that, because they’re saying Greece has to issue its own bonds and nobody believes that Greece can actually finance it. Therefore, Greece issues the bonds at say a face value that represents say a 3% yield and the market says sorry 15% or nothing. Well they couldn’t pay it at 3% so they certainly can’t pay it at 15% and you’re going to get, you know, a domino reaction of all these things falling over. You could even take France and Germany down if we keep on going this way, it’s so mad.

Lelde Smits: Do you think such a move would be an admission of the failure of the Eurozone and centralized currency?

Steve Keen: No, it’s an admission of the failure of neoclassical economists who designed the Maastricht Treaty in the first place, who had this fantasy that you could limit the deficit of the government no more than 3% of GDP, which assumes there’s never going to be a crisis, never going to be a serious downturn. That’s sheer madness and I wrote in Debunking Economics back in 2000 that it was bound to fail. So it was just the Treaty itself. If they designed it sensibly so that the European Central Bank issued the debt on behalf of the Nation States and then they finance that out of their own revenues, we wouldn’t be having this severe a crisis in Europe right now. We would still have one, but nowhere near as severe as this one.

Lelde Smits:  Moving to Wall Street, what are the facts here, just how much debt is the Nation grappling with? 

Steve Keen: Well the level of private debt peaked at 300% of GDP back in 2009. That’s now falling as mainly the finance sector de-levers, that’s the main one that’s reducing its debt right now. The public debt started about 60% of GDP and was only high because of the foolish military intervention of the Americans that kept their debt levels high, otherwise they might be 20% of GDP, quite trivial. It went through the roof because when the private sector stopped borrowing money, demand in the economy collapsed and therefore the Government boosted it both through deliberate policy, but also through a drop in tax receipts and an increase in welfare payments which they had to do. So this whole public debt crisis is really caused by the private sector’s failure and therefore, the total level of debt worked out to being about 360% of GDP when you add the two to get 380%. But the part that’s really causing the crisis is the private sector debt that the politicians are still ignoring.

Lelde Smits:  The US managed to raise its debt ceiling before the default deadline but what have they achieved and do you think it’s enough?

Steve Keen: Well no, the way they’ve achieved the deal is they’re trying to achieve the impossible. They’re trying to get back into surplus while the economy tanks beneath them. Now what that means is you’ve got the private sector spending less money because you’re using income to pay down debt rather than demand goods. If at the same time the government decides to go into austerity and try to reduce its deficit as well, you’ve got two forces both sucking money out of circulation. The economy will go down faster. So their attempt to set this to reduce the deficit by austerity will actually drive down tax receipts, not reduce welfare payments as much and they’ll still have a deficit further down the track. And they’ll need to go through this whole debt ceiling fiasco once again, probably sometime next year. So they’re not addressing the cause. The best analogy I can give is, it’s as though they think America has the common cold and they’re prescribing drugs for the common cold. Now they’re taking away when America’s got pneumonia.

Lelde Smits:  Well, if they do have pneumonia I’m sure Standard and Poors will be certain to let them know. The ratings agency recently downgraded the US long term credit rating. What do you think are the repercussions of this move?

Steve Keen: Well it doesn’t actually matter until all three ratings agencies do it, because the only way it can actually cause trouble is if people then are forced to sell American bonds because they can no longer hold – you know they’ve got to hold triple A and they’ve got stuff with is currently double A. So that could force companies to liquidate their holdings and that could then cause rates to rise in America. But as we saw in this most recent chaos even though they’ve been in a downgrade, the price of the bonds went up and the yields fell, because people rushed at “the safety” of American bonds. And the reason they’re safe is the American Government can never run out of American dollars okay. Even Greenspan – I normally disregard everything he says, here at least he is technically right. He said the American Government technically cannot go bankrupt, so in the flight for safety that will reverse the direction. The main thing is this is a sign of how badly America has mismanaged its own prosperity over the last fifty years. And what we’re seeing is the decline of an empire.

Lelde Smits:  Thanks Steve. Closer to home, we’ve seen the Reserve Bank of Australia cut its domestic  forecast for growth over the next year by 1% to 3.25%. What do you think are the repercussions for Australia?

Steve Keen: Well finally a bit of realism in the Reserve Bank, but the Reserve Bank being staffed mainly by neoclassical economists, ignores the role of credit and debt in the economy. And they just focus on what they saw booming exports from China, therefore, massive boosts of income coming into the country. And therefore, their role was to tighten interest rates to cut back domestic demand. I’ve been saying for over a year now well before Bill Evans came along and happily joined me, that the Reserve will probably raise rates to fight an inflation bogey man, and then be forced to reduce them when the economy simply doesn’t perform, as they thought it was going to do. Now that’s the first admission it’s not performing as they thought, but they’ve actually balanced it by bumping up their growth forecast for the year after. Well good luck! I mean fundamentally we have a similar problem to America here. We have also had a private debt bubble that financed the big bubble in house prices, that’s also starting to unwind now. We’re having people paying their debt down as well, we’re going into deleveraging. So people trying to adjust their credit books are going to reduce the demand, that’s why we’re having a two-speed economy. And overall a two-speed economy is going to be slower than the RBA thought their one-speed version was going to be.

Lelde Smits:  Will this derail the Federal Government’s pledge to return to surplus by 2012/13?

Steve Keen: They won’t make it back to surplus and they shouldn’t. The irony is of course, when we first hit the crisis you know back in 2007/2008; Kevin 07 could do whatever he liked because the opposition was decimated. Now the opposition has almost decimated the Government. So I think we’ll find our economy suffering out of this stupid politics that sees surplus as always a good thing.

Lelde Smits:  Finally Steve, how long can we expect this volatility to continue?

Steve Keen: Volatility will fluctuate at different times because occasionally when we actually slow down the rate at which we are deleveraging, ironically that gives you a boost to demand. So that’s what happened in America over the last one and a half years when it looked like things were improving, was actually a decline in the rate of deceleration of debt and that actually boosts demand. Now we’re going back down the other direction again, well this is where the volatility is coming from now and that will continue fluctuating as we go down. But we’ll have pulses of volatility until such time as we’ve wiped out this enormous ponzi debt we took on in the last twenty or thirty years, and it could take at least a decade to do that.

Lelde Smits: Steve Keen, thanks for your insights.  

Steve Keen: You’re welcome.


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